MM&K news 2019

  • April 9, 2019

    Data Analyst Apprenticeship 

    MM&K are recruiting an apprentice data analyst who will work alongside the Head of Analysis to deliver solutions for the Consulting team.

    The successful candidate will be able to show their analytical capabilities to provide and produce comprehensive data analysis for the Consulting team and ultimately the Client. Good communication skills are essential.

    If you are interested in the position, please review the full role profile here.

  • March 28, 2019

    Pending changes to Directors’ Remuneration Report Regulations

    On 3 March the European Commission issued new guidelines on the standard presentation of the remuneration report under Directive 2007/36/EC. This was to comply with a mandate presented in Article 9(b)6 of the 2017 revisions to the second Shareholder Rights Directive (SRD II). The guidelines are non-binding and the UK Government has to decide how far it will translate the new guidelines into revised regulations by the deadline of 19 June.

    Context

    The original Shareholder Right Directive was issued in 2007 and was concerned with strengthening corporate governance and particularly the rights of shareholders in relation to voting at general meetings. It applied to companies which have their registered office in a member state trading on a regulated market situated in a Member State.  This definition includes Main Board listed companies on the London Stock Exchange but not AIM companies, which fall into the category of “exchange-regulated’ rather than EC regulated.

    In 2017, the EC issued revisions and extensions to the Directive, aimed at strengthening the first Directive and encouraging institutional investors and asset managers to take a longer-term view of the market. One new set of articles focused on directors’ remuneration:

    • Article 9a covered the requirement of companies to prepare a remuneration policy and to submit it for a (binding or non-binding) shareholder vote in general meeting on inception and whenever a material change is made and, in any case, at least every four years. The Article covered the information to be provided in the policy, which is very close in content to that required for UK companies under Schedule 8 (the 2013 Directors’ Remuneration Reporting Regulations, DRRR) as amended by the Companies (Miscellaneous Reporting) Regulations 2018, and the associated voting requirements of the Companies Act.

    • Article 9b covered the information to be provided in the remuneration report (ie the implementation report for the previous year) and the requirements to submit it to a shareholder vote. Again, the requirements are very similar to the UK regulations.  However, 9b(6) mandates the Commission to adopt guidelines to specify the standard presentation of the information laid down. These are contained in the communication from the Commission on 3 March labelled “Guidelines on the standard presentation the remuneration report under Directive 2007/36/EC”.  The aim of the Commission is to achieve a standard format across Europe.  Unfortunately, the requirement is more detailed than the DRRR, especially in relation to individual directors’ performance over time and their pay movements compared to average employee remuneration.

    Fortunately for UK companies, it looks as if the Government does not intend to adopt the detail of these guidelines.   We spoke to BEIS who told us that they are proposing to put a new statutory instrument (SI) in front of Parliament in the next few weeks. It will be accompanied by a table comparing what is already in place in the DRRR with what needs to be implemented under SRD II Article 9. The regulations will be mandatory, but they do not intend to require companies to adopt the full EC guidelines.

    If the new SI is approved by both houses, it will enter into force on 10 June, which is the transposition date for SRD II. However, it will contain various transitional provisions for companies and it will not need to be adopted by companies for reporting until 2020.

    BEIS will be publishing FAQs on the new regulations and the GC100 Investor Group will be updating their own Guidance. BEIS are thinking of appending the final EC guidelines for information, allowing companies, if they choose, to adopt some of the new guideline provisions, if they appear useful.  We got the impression that all this will go ahead whatever the Brexit outcome.

    For further information, contact Damien Knight

    Directive EU 2017/828 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement.

  • March 28, 2019

    FRC consults on Stewardship Code

    The Financial Reporting Council (FRC) has published a consultation paper on a new Stewardship Code that sets substantially higher expectations for investor stewardship policy and practice.  The proposed changes call for higher transparency regarding institutional investors’ stewardship activities and encourages more engagement with companies.  The proposed changes have significant potential consequences for investment organisations and the companies in which they invest.

    What is happening?

    Under the proposed changes, all signatories of the Code would be required to make public disclosures about their stewardship activities.  This could address current concerns about investors’ inadequate engagement with the companies they own.  Although we currently have several corporate governance codes which require companies to engage with shareholders, they place no such obligation on investors.

    Other key proposed changes include requiring signatories to establish an organisational purpose, strategy, values and culture.  This aligns the draft 2019 Code with the UK Corporate Governance Code, which it is designed to complement.   The draft Code also makes explicit reference to environmental, social and governance (ESG) factors.  Signatories are expected to take into account material ESG factors, including climate change, when fulfilling their stewardship responsibilities.

    All signatories would be required to make public disclosures about their stewardship activities and their assessment of how effectively they have achieved their stated objectives.  Reporting would be in two parts: a Policy and Practice Statement upon signing the Code and an annual Activities and Outcomes Report.

    Shareholder Rights Directive

    The FCA is also undergoing a consultation, proposing regulatory measures to implement the provisions of the amended Shareholder Rights Directive (“SRD II”).  The Directive comes into effect in June 2019 and, assuming a transition period for EU Withdrawal is agreed, will need to be transposed in the UK.

    SRD II also aims to improve the effectiveness of stewardship and long-term decision-making in listed companies.  It will do this chiefly by improving the transmission of information in the investment process; therefore, major business impacts on listed companies, institutional investors and intermediaries are expected.  Through increasing transparency and awareness, the SRD II hopes to shed light on the extent to which investors fulfil their responsibility as stewards, of both the companies they hold shares in and the assets they manage for their clients.

    Tasked by SRD II, the European commission has published draft guidelines which recommend a standardised presentation of remuneration reports, subject to consultation until 21 March 2019.  We have summarised the key points in the guidelines:

    • Introduction – a general overview (key events, changes in directors, changes in policy or its application) followed by more details on the performance and business environment and major decisions on remuneration and, where applicable, how the vote or views of shareholders on the previous report were taken into account.

    • Remuneration – reporting each component, divided into fixed, one-year variable and multi-year variable pay

    • Performance metrics and outcomes – for variable pay plans, including minimum and maximum targets, actual performance and how any discretion was applied.

    • Share-based remuneration – share-based remuneration tables.

    • Malus and clawback provisions

    • Comparison of annual change in each director’s remuneration with company performance and average employee remuneration over five years

    • Response to AGM voting – how the vote at the previous general meeting was taken into account.

    Joint discussion paper

    As you may have expected, the FRC and the FCA have teamed-up to tackle the issue of stewardship, publishing a discussion paper on ‘Building an effective regulatory framework for stewardship’.  The paper aims to advance the discussion about what effective stewardship should look like, expectations for financial services firms, and how this can be best supported by the UK’s regulatory framework.  The paper notes that some benefits of effective stewardship – eg higher long-term investment returns – accrue not only to the firm that incurs the cost of exercising stewardship, but also to all other investors.  As such, some investors may not exercise stewardship as fully as they otherwise might and instead ‘free-ride’ on the stewardship of others.

    The FRC’s proposed Stewardship Code aims to both increase the expectations set by SRD II and expand its scope.  The ‘new rules that are due to come into effect under SRD II intend to enhance transparency about how equity investors exercise stewardship and “raise the bar” for stewardship across the market.  However, we are considering whether the UK regulatory framework should aspire to go further than the provisions of SRD II’.

    Beyond the EU

    The EU is not alone in taking steps to improve stewardship.  In November, the US Securities and Exchange Commission (SEC) held a roundtable addressing whether the capital markets system can be improved – in context of the principal/agent problem and investor participation.  The three topics for discussion were the proxy voting process, shareholder proposals and proxy advisory firms.

    Why should remuneration committees be interested in the proposals?

    The consultations currently taking place have significant implications for remuneration committees.  Under the FRC’s proposed changes, signatory fund managers would be urged to look harder at whether companies fit their investment strategies.  Remuneration structures and performance targets play a large role in this.  Further, they would be required to take a more active approach in engaging with and influencing committees.

    Committees should also take note of the proposed Stewardship Code’s focus on ESG issues.  In December, Shell announced that they will be linking executive pay and carbon emissions, becoming the first energy company to do so.  If investors are required to take ESG factors into account, we will likely see more and more companies linking ESG criteria to executive pay in the future.

    The steps taken under SRD II to increase transparency and awareness will have a similar effect, but remember that the requirements under SRD II are compulsory for listed companies and asset managers in the EU (whereas the FRC’s Stewardship Code is voluntary).  Remuneration committee members should be paying particular attention to the European Commission’s remuneration report guidelines.

    What they should be doing in response?

    Remuneration committees have a responsibility to communicate with investors.  Some committees may find it difficult to engage with their investors; some of the more common complaints we have heard include failures to respond (either at all or in a timely fashion) and the use of proxy advisors, who are more remote from the company.  The proposed changes discussed in this article have the power to change this – hopefully, committees will have provided input to the consultations in order to get the best outcome.  They should also be prepared to take advantage of any changes, if and when they come into effect.

    MM&K are experts in advising remuneration committees on a range of issues surrounding corporate governance, regulatory and disclosure requirements.  We have a wealth of experience helping committees communicate with investors.  For queries and further information, please contact Paul Norris or Damien Knight.

  • March 23, 2019

    The AIM Market – heading for trouble in 2019?

    On the face of it, things do not currently look too rosy for the AIM market. There has just been one new IPO on AIM since the turn of the year. In the same period last year, there were nine.

    Indeed, last year as a whole saw a regular stream of IPO’s on AIM. In 2018 there were 9, 19, 6 and 8 listings respectively, per quarter.

    The health of any market is shown, to a greater or lesser extent, by the number of new companies that are willing to go through the time and (considerable) expense to raise finance.

    Moreover, given that Q4 of 2018 saw an almost record breaking number of trade and Private Equity M&A deals (748 in total), it would be easy to conclude that the AIM market is facing trouble with company owners increasingly considering alternative ways of obtaining the finance to either exit or grow their business.

    However, as always when confronted by headlines and statistics it is worth digging deeper to understand the broader picture.

    On a macro level, whilst the 43 admissions of 2018 is down from 50 l in 2017, it is still one more than the 42 that occurred in 2016.  This would seem to indicate that there is no overall downward trend –other factors are likely to be at play.

    The overwhelming weight of evidence indicates that the principal reason for the lack of AIM IPOs so far this year is nervous investor sentiment generally.  There is no shortage of companies seeking admission to AIM.

    We have recent first-hand knowledge of companies who are keen to IPO but have had to delay on advice from their brokers that the market would not buy at a price that would have made the transactions viable.

    It is undeniable that in the short term, the uncertainty of Brexit has caused a pause in making such “public” investments by Institutional investors.  However, monies have been raised and need to be placed in order to grow.  With the comparable difficulties of finding the “right” investment to place PE money, it is likely that, once the markets have settled (hopefully by this summer) a flurry of deals will come to AIM.

    Ironically, whilst there are risks associated with any investment, the requirements of AIM Rule 26 that each AIM company must adopt a corporate governance code, identify the chosen code on its web-site and explain how it complies (or why it has not complied) with that code makes the AIM market a better regulated place for making investments.

    We will continue to watch the AIM market with interest and will provide updates throughout the year.  For further information or to discuss any questions you may have, contact Stuart James.

     

  • March 22, 2019

    Executive pensions – do you know your limits?

    In the past, pension benefits used to form a substantial proportion of top executives’ total remuneration.  This was not just because their entitlements were based on higher salary levels than employees generally but also because these executives had more generous percentage employer contributions or accrual rates.  Moreover, the full value of directors’ pension rights was not always apparent because of incomplete disclosure in companies’ accounts.

    The combination of controversy about executive pay levels and the Government’s wish to reduce the costs of tax reliefs has now led to severe restrictions on the value of executive pension benefits.

    Corporate Governance Code and investor guidelines

    The July 2018 UK Corporate Governance Code, which applies to all companies with a premium listing, requires that “pension contribution rates for executive directors, or payments in lieu, should be aligned with those available to the workforce”.

    In its November 2018 Principles of Remuneration, the Investment Association (IA) supported this provision, interpreting it to mean “the rate which is given to the majority of the company’s workforce”.  The IA went on to announce on 21 February 2019 that the Institutional Voting Information Service (IVIS) will:

    • ‘red-top’ companies which pay new directors, appointed from 1 March 2019, pension contributions which are not in line with the majority of the workforce; and

    • ‘amber-top’ companies where any existing executive director receives a pension contribution of 25% of salary or more.

    Reporting requirements

    The Directors’ Remuneration Report Regulations now require listed companies to disclose in their annual reports the value of all pension-related benefits, including payments made in cash or otherwise in lieu of retirement benefits and benefits from participating in pension schemes.  The Remuneration Policy approved by shareholders must include the maximum pension benefit and, if this amount is exceeded, the directors who authorised the payment may be liable for any resulting loss.

    Annual contribution limits

    Changing tax rules may have had an even more dramatic impact.  From April 2015 the annual limit on tax-relieved pension contributions for a member of a registered pension scheme has been reduced to £40,000 (or 100% of taxable earnings, if less).  This ‘annual allowance’ includes contributions by the employee, employer or any third party to a money purchase/defined contribution (DC) arrangement and additional accruals to a defined benefit (DB) scheme.  If the limit is exceeded, a tax liability arises (the ‘annual allowance charge’).

    Individuals can, however, carry forward any part of the £40,000 allowance which was not used in the previous three tax years, provided they were members of the pension scheme in those years.

    High earners

    Since April 2016, the standard ‘annual allowance’ has been reduced for high earners with an ‘adjusted income’ (which includes total taxable income plus employer pension contributions) of more than £150,000.  The annual allowance is ‘tapered’ from £40,000, for those with ‘adjusted income’ of up to £150,000, down to £10,000, for individuals with an ‘adjusted income’ of £210,000 or more.

    Those who have already drawn from DC schemes

    Since April 2017, there has been a substantially lower ‘money purchase personal allowance’ of £4,000 for individuals who have already drawn money from their DC pension schemes under flexible access arrangements.  This is to discourage people from obtaining additional tax relief by reusing funds which have already received tax relief.  This £4,000 allowance cannot be topped up with unused allowances from earlier years.

    Lifetime allowance

    In addition to the annual contribution restrictions mentioned above, there is a ‘lifetime allowance’ which limits the total value of pension benefits which an individual can draw without an additional tax charge to £1,030,000 (2018/19).  This includes the value of all an individual’s pensions, through DC and DB schemes, but not the State Pension.

    For DC schemes, including personal pensions, the value is the pension pot used to fund retirement income and any lump sum.  For DB schemes, the expected annual pension is multiplied by 20 and any lump sum is added to the total.  So an individual on a 60ths accrual rate and 40 years of service would exceed the lifetime allowance if his final salary was £78,000 (40/60 x £78,000 x 20 = £1,040,000).

    Any pension pot worth more than the allowance is subject to a tax charge of 55%, if paid as a lump sum.  If paid as a pension, the tax charge is 25%, but the gross amount is also subject to the individual’s marginal tax rate.

    Some executives have preserved a higher earlier level of ‘lifetime allowance’, for example at £1.25 million by taking out Individual Protection 2016 or Fixed Protection 2016.  Those with Fixed Protection, in particular, need to ensure that they do not build up any further pension benefits after 5 April 2016.  They should have opted out of automatic enrolment and any life assurance cover may have to come from a different source than the pension scheme.

    What should companies be doing about this?

    It is clear that the days of generous executive pensions are now over.  It is becoming standard practice for companies’ contribution rates to executive pensions to be equalised with the majority of the workforce.  This can be achieved easily for new appointments and promotions.  For existing executives, the contribution rate is part of the employment contract and cannot be reduced except by mutual agreement.  However, companies will wish to note that the IA Principles of Remuneration state that shareholders expect contribution rates for incumbent executive directors to be reduced as soon as possible and that no compensation should be awarded for this change.  Recent press reports suggest that the major UK banks have adopted this approach.

    This reduction in pension entitlement will change the balance between the fixed and variable elements of remuneration.  Depending on their remuneration strategies, companies may choose to readjust this new balance by modifying other parts of the total package.

    In cases where the statutory annual and lifetime allowances prevent executives from receiving even the standard workforce pension contributions, the practice of paying cash in lieu of pension is likely to continue.  In determining the size of any cash alternative, companies should take into account the extra employer’s NICs costs of cash payments (in comparison with pension contributions) and whether the payments will increase entitlement to bonuses and other benefits.

    Important note:

    This article is intended to draw attention to possible implications arising from the variety of restrictions on building up pension benefits for executives.  Please note that MM&K’s consultants are not pension experts and you should obtain advice from an appropriate professional adviser before taking any action on any of the issues discussed.

    For further information contact Mike Landon

  • March 20, 2019

    International Share Incentive Plan – a case study

    This case study explains how a FTSE 250 company, with MM&K’s help, adapted a UK Share Incentive Plan (SIP) for its employees in Germany and Luxembourg.

    The Company regards employee ownership as essential to aligning employees and shareholders by creating a common interest in the growth in value of the Company.

    The UK SIP

    The Company established its UK SIP in 2017 to give all permanent UK-based employees an opportunity to invest in partnership shares annually up to the lower of £1,800 and 10% of their taxable earnings. Each employee can choose to make either monthly salary deductions or a single annual contribution, following payment of annual bonus.

    The Company matches each partnership with an award of one free matching share. Provided that the partnership shares and the matching shares are held in the SIP Trust for five years, no tax liability will arise on participants in respect of those shares.

    Replicating SIP in Germany and Luxembourg

    The Company’s business in Germany and Luxembourg was growing. Its workforce in those countries was expanding and the Company wished to provide equity incentives on similar terms to those provided to the UK workforce. Unfortunately, neither Germany nor Luxembourg has any tax advantaged legislation equivalent to the UK SIP.

    Challenge

    A challenge was to design a plan whereby German and Luxembourg employees could be awarded matching shares when they purchased partnership shares without:

    (a) a ‘dry’ tax charge arising on the award date, as employees would receive no benefit from their matching shares until after the end of a three-year forfeiture period; or

    (b) additional cost (such as hedging costs) to the Company for the provision of the matching shares.

    Additionally, the Company did not wish to establish an offshore employee benefit trust to ‘warehouse’ shares during the three-year forfeiture period.

    Solution

    The plan for Germany and Luxembourg is administered by a professional administrator, which also acts as nominee for the employees. The administrator collects monies from employees out of their post-tax income and purchases partnership shares for them participants as nominee. As such, it holds the legal title to both partnership and matching shares on behalf of the participants.

    No ‘dry’ tax charge arises in respect of an award of matching shares . Instead, the tax liability is delayed until after the end of the forfeiture period when the shares are transferred to them by the administrator in its capacity as nominee.

    No additional cost, such as hedging cost, is incurred by the Company, which pays for the matching shares at the time of award.

    Whilst participation terms are similar to the UK SIP, modifications had to be made to deal with issues under local laws. We worked closely with local lawyers to ensure the procedures for making salary deductions, acquiring partnership shares and awarding matching shares avoided the law of unintended consequences.

    Conclusion

    Whilst German and Luxembourg participants do not enjoy similar tax advantages to their UK colleagues, the outcome ensures that the charge to tax coincides with the receipt of benefits and the Company’s commercial objective to provide an opportunity for substantially the whole of its workforce in the UK, Germany and Luxembourg to participate in equity on similar terms has been achieved.

    For further information contact JD Ghosh

  • February 27, 2019

    The Holt – MM&K – Buyouts Insider North American PE Compensation Survey 2018

    Holt Private Equity Consultants, MM&K’s allied firm in the US for Private Equity compensation matters, recently published the results of its North American PE Compensation Survey.  This survey is the sister survey of our European PE and VC Compensation Survey.  The results from the North American survey make for interesting reading.

    The survey analyses compensation data from over 100 North American PE and VC firms. The headlines include:

    • In 2018, compensation in North American Private Equity and Venture Capital spiked for many employees.

    • For non-partner level employees, the median total cash (salary + bonus) increased by 20%.

    • The biggest increases were seen at the Associate and Vice-President levels.

    • The standard model of two and twenty still pertains.

    • Partners tend to take 71% of the carry pot.

    • The vesting of carry plans now is spread over a longer period.  The typical length of time that it takes to get to full vesting is now eight years.

    • Only 31% of VC funds in North America require a hurdle rate of return before carry clicks in.

    MM&K is pleased to announce that copies of the North American survey report are available to be purchased from us at a price of £2,000 (plus VAT).

    A copy of the Preview of the North American PE Compensation report can be found here:

    For further information contact Nigel Mills or Margarita Skripina
  • February 27, 2019

    Are you getting the best out of your LTIPs?

    Whether you are a well-established organisation or still in early stages, it is important to make sure that the long term elements of your executive and key personnel remuneration are working properly for your business.

    Whilst establishing whether or not this is the case will take some time and discussion, it is important for anyone connected with executive remuneration in an organisation to have an initial sense or understanding of what a plan is delivering.

    To help with this, here are five quick-fire questions which will help you evaluate your long term incentive plans (“LTIPs”):

    1. Do your LTIPs meet the reality of what is happening in your business?

    Plans which were put in place during a more prosperous period may start to look out of kilter with the value now being delivered to owners/shareholders.  Alternatively, if you are growing, current levels of reward may not lock in the people you need.

    2. Is a change of direction appropriate?

    Doing the same as last year may be cost-effective and simple but it could also generate disquiet if it is not aligned with the business.  A good LTIP reflects and rewards the important things both in terms of performance and culture.

    3. Are you making awards with the right frequency?

    Where the value of the company has dipped, a single larger award (rather than annual awards) could generate more interest and be a better retention tool, so long as suitable balances and checks are also put in place.

    4. Have you spread the awards widely enough?

    Whilst award sizes should not be so small as to be meaningless, there is a correlation between increased retention and access to LTIPs.  Even if the current LTIP doesn’t lend itself to wider participation, there may be another complementary structure which could be introduced.

    5. Is now the time for succession planning?

    Part of any effective succession plan will include giving those coming through the business a clear view and a tangible understanding of what they are working towards.  Similarly, current owners need to be prepared for future changes.

    For further information or to discuss any questions you may have, contact Stuart James.

  • February 27, 2019

    Enterprise Management Incentives and Brexit

    Like any EU member state, the UK is subject to the ‘state aid regime’ regarding competition law, governed by the Treaty on the Functioning of the European Union and associated European legislation. These rules are in place to ensure open and fair competition and to prevent subsidies causing unfair distortions within the single market.

    State aid is relevant to Enterprise Management Incentives (“EMI”). This is because it is an employee share incentive arrangement with very generous tax reliefs that is available for the benefit of selected employees of small and medium sized companies which meet certain legislative requirements. In other words, EMI is an advantage or benefit that is being conferred to certain undertakings on a selective basis by the UK.

    For so long as the UK remains in the EU, it will need continued approval from the European Commission for EMI share schemes to be operated by ‘selected’ undertakings. The current state aid approval for EMI, which was granted on 15 May 2018, is valid until 6 April 2023, subject to the terms of any withdrawal agreement between the UK and EU.

    What happens after 29 March 2019? 

    The government has indicated that if there is a ‘no-deal’ Brexit, from 29 March 2019 the ‘EU state aid rules will be transposed into UK domestic law under the European Union (Withdrawal) Act’ (See https://www.gov.uk/government/publications/state-aid-if-theres-no-brexit-deal/state-aid-if-theres-no-brexit-deal). The guidance also indicates that existing state aid approvals will be carried over to UK domestic law.

    In a recent meeting between HMRC and UK tax advisers, HMRC stated that, in the event of a “no-deal” Brexit, the current state aid approval for EMI will continue to remain valid until 6 April 2023, without any break.

    If, on the other hand, the UK reaches an agreement with the EU to the effect that the UK remains subject to the EU’s state aid laws, it is also reasonably expected that the existing state aid approval for EMI will remain effective at least until 6 April 2023.

    In short, irrespective of whether there is a ‘no-deal’ Brexit or the UK reaches an agreement with the EU in which the UK remains subject to the EU’s state aid laws, qualifying UK companies should be able to grant tax-advantaged EMI options to selected eligible employees for the foreseeable future.

    For further information contact JD Ghosh or Mike Landon

  • February 26, 2019

    Labour Party policy input on executive remuneration

    In November 2018, John McDonnell, Shadow Chancellor, published a review he had commissioned from a group of 13 academics into the thorny subject of executive pay.  The review is described as “independent” but the intellectual allegiance of the contributors is evident in the title: “Controlling Executive Remuneration: Securing Fairer Distribution of Income” (my italics).  The unfairness of current pay differentials and the belief that it will only ever be addressed by legally enforceable controls is the starting premise of the paper.

    A number of the writers are active in the Labour party, including the editor, Professor Prem Sikk (University of Sheffield); one contributor, Professor Alastair Hudson (University of Strathclyde) ran for Parliament on a Labour ticket in 1997; Anne Pettifor, Director of Prime economics policy research, is on the Labour Party Economic Advisory Committee and is declaredly anti deficit reduction and pro-state.  Several of the academics, for example Jeroen Veldman and Martin Parker, believe that current capitalism is profoundly biased in its allocation of resources and privileges to managerial and shareholder “elites”.

    I point out these strong inclinations not to present an opposing political viewpoint, but to highlight the danger in believing this is in any way an “independent” review, which the Shadow Chancellor claims.  He says in his introduction that “the contents of this document form a submission to Labour’s policy making process; they do not constitute Labour Party policy nor should the inclusion of conclusions and recommendations be taken to signify Labour Party endorsement for them.” That is questionable. There are some very radical proposals in this report, including employee votes on individual directors’ pay and a stakeholder-set total pay cap. If Labour were to win a general election, we could expect similar measures to form part of an assault on the current status quo in UK corporate governance.

    I would add that the document lacks the intellectual rigour we might expect given the academic credentials of the various writers, four of whom (including Prem Sikk) are professors of Russell Group universities. Following academic protocol, the research quotes its sources at every point in its argument, but it merely quotes the conclusions that support its own arguments.  There is no attempt to appraise the quality of each source.  Notable cases are the citing of the 2014 IDS report for the High Pay Centre, stating that there is either no relationship or at best a weak link between directors’ pay and performance; and repetition of the research conclusion in The Spirit Level, written by meta researchers Richard Wilkinson and Kate Pickett that health and social problems are worse in countries with high wealth disparity.  The IDS methodology produced statistical nonsense (as I have previously demonstrated) and any top grade business professor should have spotted it.  The Spirit Level  is still the subject of debate after a thorough debunking by Christopher Snowdon (The Spirit Level Delusion).

    Following an executive summary of recommendations and an introduction, Chapter 2 of the review presents the context of executive remuneration – it describes current practices for executives and other employees. It shows how the differential of FTSE 100 executive to average pay increased from 20 times in the 1980s to 160 times in 2017. Subject to a missing definition of total remuneration and distinction between remuneration awarded and remuneration realised, we do not dispute their findings and anyone must find them disturbing.  What we do dispute are the accompanying statements that the link with company performance is virtually non-existent (this is not true) – it contrasts executive pay increases with low growth in the FTSE 100 index, ignoring dividends entirely,  a key element of shareholder returns. It makes the extraordinary sweeping accusation that “the financial sector has been a serial offender, and actively engaged in mis-selling financial products, rigging foreign exchange rates, interest rates, money laundering, tax avoidance and tax evasion to boost profits, shareholder returns and performance related executive pay.”

    It states: “There are no statutory mechanisms for clawing back bonuses though a number of companies claim to have mechanisms for clawing back some of the bonuses at the board’s discretion.” In fact clawback in banks in large financial institutions is mandated under the EU Capital Requirements Directive (CRD IV).

    The report claims that executive pay continues to soar – yet even the High Pay Centre has recognised that it has flattened out in recent years. It takes a few egregious cases of abuse (eg Carillion and Persimmon) and draws the conclusion that controlling action is required for the 7,000 UK companies with more than 250 employees.

    Chapter 3 looks at the consequences of inequitable income distribution, including its implications for access to housing, education, food, pension, healthcare, transport, justice, security, democratic institutions “and much more” and builds a case for stronger control of executive pay.

    Chapter 4 seeks to document the failure of Government, shareholders and institutions to exercise such control.  Here the political slant is evident.  The section starts with an attack on the failure of corporate governance codes from the time of the original Combined Code in the early 90s: “The corporate governance codes assume that corporations exist primarily for the benefit of shareholders and that the levels of remuneration are a matter for elites.  Professor Sikka is particularly fond of the word “elites” (he clearly does not number university professors in their ranks). The paper rolls out the old canard that directors sit on each other’s remuneration committee and have no interest in controlling executive pay, in democratising decisions or choosing lower benchmarks. We believe this is serious libel of non-executive directors who, in our experience, are fastidious in dealing objectively with executive pay.  The paper goes on to attack the concept of maximising shareholder returns and builds a case for attending to the interests of all stakeholders.

    The attack on the UK corporate governance record is particularly weak and full of errors.  For example, “the corporate governance codes have secured some disclosures of executive pay but the information is poor. Executive remuneration disclosures in annual accounts often understate the pay collected by directors.  Many receive perks such as subsidised housing, chauffeur driven cars, the use of private jets, private healthcare help with house buying and school fees, and these are often poorly accounted for.  The use of share options complicates calculation of the value of executive package and often understates it.  Company executives have also been known to fiddle share options by backdating them (sic) to maximise their own personal gain.”  Spot the hidden truth amongst the lies (answer – executives do get private healthcare!)  The writer of this section does not seem to realise that directors’ pay disclosure is not a matter of corporate governance codes but is mandated by regulations under the Companies Act.  The value of all remuneration has to be disclosed, the valuation methodology is prescribed and the reports are subject to audit.  The writer of this section presents no evidence to support these gross statements.

    The section goes on to attack the “notion” of maximising shareholder returns and the use of shares and share options to align the interest of directors with shareholders at the same time allowing them to push up share prices through share buybacks, excessive dividends and by issuing optimistic earnings forecasts.  Next the section demonstrates how the interests of shareholders have become increasingly short term and claims shareholders have become increasing unfit to exercise any joint control on executive pay.

    Finally, the chapter attacks the failure of the Conservative Government to check executive pay.  It acknowledges the introduction of the new June 2018 disclosure regulation requiring listed companies to report and explain the pay ratio of CEO to employee pay quartiles and the encouragement given to the Investment Association in publishing the name and shame list of shareholder resolutions obtaining less than 80% of shareholder votes.  But it complains that the name and shame register has not led to a more equitable distribution of income.  In fact, the register was published for the first time in December 2017, so it is hard to see how the impact might be felt by now.  The report said the only sanction the shareholders have is to sell their shares – but of course they can also vote directors off the board.  It also complains that the new UK Corporate Governance Code, introduced by the FRC in July 2018, has failed to curb excessive executive pay.

    Chapter 5 presents the researchers’ recommended reforms. Having concluded that the pay gap is growing and damaging to society and that current corporate governance regulations and codes have failed to control executive pay, they have recommended a number of radical new control measures.  “The challenge is not only to devise mechanisms that constrain undeserved executive pay in large companies but also create mechanisms to enable workers to secure an equitable share of income/wealth  created with their own brain, brawn, sweat, commitment and energy.  The key to that is to empower employees of large companies to vote executive pay.”

    The precise recommendation is rather confused.  Employees would have the power to vote on individual “executives’”pay. It is not clear whether this means parent company executive directors or a wider population of executives and managers.  Certainly they are proposing reporting the names and total remuneration in bands of people earning more than £150,000.  In a major multinational this could include well in excess of 1,000 employees and it seems unnecessarily intrusive.  It implies there is something reprehensible about earning that much rather than recognising the important contribution these people make.

    How the vote would work is vague – if the vote goes against the package, what happens then? Incentive payments require a vote on each element with at least a 50% voting turnout and a 90% vote in favour but, again, it is not clear what happens if the vote is less than 90%. There is then a complicated system of yellow cards for the directors if any remuneration vote is less than 80%.  This is accompanied by the threat of being voted off the Board.

    Employees and customers will also have the power to impose a cap on individual total remuneration.  The practicalities of this are not discussed.  Who proposes the cap that employees vote on?

    For me, the big problem with employees voting for executive pay is they have no accountability for the impact of the pay package, ie the success of recruitment, retention or motivation of the executives.  So what reason would they have for being anything but parsimonious? The report also recommends a limit to corporation tax deductability for total executive remuneration.  This would presumably require the Government to specify a limit.

    The report recommends a downgrading of the remuneration committee responsibilities to advising the Board (if the board chooses to have a rem com at all).  But the IA Working Group and the FRC in the new UK code have both emphasised the importance of having a rem com which is expert in remuneration matters and particularly a rem com chair who is expert.  They hope this will avoid the sort of error that was seen with the Persimmon share plan.  Passing the responsibility to the whole board will be a backward step.

    The review says that if there is a rem com it must have representative of employees and other stakeholders. Do the writers really mean a customer representative?  How is such a person selected?   I suspected the “other stakeholder” piece is a way of justifying the increased influence of employees.

    The cult of bonuses is to be discouraged.  Bonuses, if any, should only be paid for carefully specified and extraordinary performance.  The word “cult” is heavily value laden and the recommendation shows a failure to understand the principal reason for bonuses, which is to ensure pay is justified.  The writers seem to subscribe to a belief that most high pay in large companies is not justified; yet they are seeking to destroy the very mechanism that ensures it is.

    The same applies to share incentives. They recommend proscribing them and allowing cash only, in order to avoid abuses and complexity.  Executives would have to buy their own shares.

    A number of other recommendations in the review appear to be redundant given Government existing and pending new regulations:

    • publishing executive remuneration contracts – all the information on executive directors is already disclosed in the annual remuneration report;

    • pay differentials between executives and employees to be analysed by gender and ethnicity and published – the former requirement is already in place; proposals for ethnicity analysis are currently under consultation;

    • executives should not be compensated for tax changes – most companies do not do so anyway;

    • clawback should be reinforced by the Companies Act – this is generally unnecessary as it is open to companies to sue dishonest or grossly failing executives. For Banks and major financial institutions, it is already inscribed in the regulations;

    A particularly radical proposal is that in the case of companies with deficits on their employee pension scheme, their directors must not be eligible to receive any bonus or increase in remuneration unless they have reached a binding deficit reduction agreement with the Pensions Regulator.  Given that a pensions deficit is a theoretical figure determined by the actuaries, such a proposal could put some serious pressure on the actuaries.

    Finally, they recommend a newly constituted Companies Commission to oversee and enforce all these new controls and other aspects of UK company law – in other words a good old-fashioned Quango.

    The sad thing about this report is that 13 highly intelligent and well informed academics can only come up with solutions which involve legislative control. There is a widening gap between top and bottom pay, although top pay is not growing at the speed they report.  More serious is the problem of upgrading low value work at the bottom end of society.  Pulling down top pay is not going to help this.  All the time these academics are blinded by a prejudice about executive greed and capitalism and false assumptions about variable pay and the lack of a link of pay and performance they are not going to come up with any real and lasting solutions.

    What is MM&K’s diagnosis and prescription?

    1. High pay is principally a matter for shareholders, and the main test should be that it is justified by performance. This makes the use of bonus plans and share plans essential.

    2. Capping executive pay is a potentially damaging interference in free markets and must be resisted.

    3. We think all the measures are available in terms of disclosure, shareholder voting and incentive plan design. It is now up to shareholders to exercise their stewardship to ensure companies justify their pay levels.

    4. We agree with the academics, however, that pay ratios have damaged trust over time. This issue has come to a head in recent years because of the publicising efforts of the High Pay Centre, not because the gap is still widening faster.

    Using a somewhat out-dated Human Resources term this is a matter of internal equity.  In the late 1970s and the early 1980s, the principal aim of pay structures was to achieve internal equity – which required equal pay for work of equal value and a means of assessing the value of jobs – ie job evaluation.

    Grading structures based on job evaluation controlled the salary differentials between roles.  They also determined the level of access to bonuses and benefits. But they fell out of favour in the late 1980s and the 1990s because:

    • grade changes had become the principal route to earning more money and employees and their managers devoted much time to getting jobs re-evaluated and upgraded.

    • managerial and professional pay, in particular, became more focussed on external benchmarking as the talent markets became more active. Salaries were pegged to external benchmarks often at an individual job level rather than a structural level. This has led to criticism of benchmarking as an inherently inflationary process.

    • the de-layering of organisations which was possible with modern technology meant that managers (at least in their own eyes) often added substantially more value than the individuals who reported to them, so there was no natural brake on increasing the pay differentials.

    5. There may now be a case for re-introducing a framework of internal differentials using job evaluation concepts. This could be communicated to employees as part of the Section 172 disclosure and would be more informative than the statutory pay ratio reporting.

    6. We see no reason to change the composition and responsibilities of the remuneration committee. Corporate governance guidelines are emphasising the importance of remuneration experience in committee members. We think putting employees on the remuneration committee will achieve very little and create expectations that cannot be met.

    For queries and further information, please contact Damien Knight


  • December 18, 2018

    Launch of the Wates Principles for large private companies

    As we have already mentioned in our “Executive Remuneration Landscape” article, which was published in our September e-newsletter, 2018 has been one of the most eventful years in terms of remuneration governance in the UK.

    Earlier this year we saw the publication of the 2018 UK Corporate Governance Code, which is applicable to all companies with a premium listing on the London Stock Exchange and states general corporate governance principles for them to comply with.

    Now, as we reach the end of the year, the Wates Principles for large private companies have been launched for companies to adopt for financial years starting on or after 1 January 2019. This new requirement applies to companies that have either or both of the following characteristics, and will cover about 1,700 private businesses:

    • more than 2,000 employees;

    • a turnover of more than £200m, and a balance sheet of more than £2bn.

    The companies that adopt the Wates Principles as a suitable framework are expected to apply them fully and provide a supporting statement explaining how the Principles have been applied to create good corporate governance.

    Ahead of the Launch of the Principles, the FRC organised a consultation, which closed on the 7 September 2018. As a result of this, we can see that a lot of respondents support the initiative; however, some expressed a concern about the ambiguity of the Principles.

    We, in MM&K, support the initiative of the Wates Principles; the proposed Principles are short, logical points that map out the way towards a transparent corporate governance practice. The companies that apply the Principles will be able to develop/improve all aspects of their corporate governance. We also think that application of the Principles will generate a positive change in the relationship with stakeholders.

    Without a doubt, the “BHS scandal” was a trigger to the formalisation of corporate governance practices in the UK for private companies. It is unlikely that the Principles would have prevented the scandal from happening; however, there is hope that it would have made the board aware of the damaging effect of their actions for other stakeholders. And this is one of the purposes behind the Principles – to bring awareness into the boardroom.

    An especially remarkable aspect of the Principles, in MM&K’s view, is their “apply and explain” nature. It highlights the point that one size doesn’t fit all. Private companies have an opportunity to apply the Wates Principles the way they see fit. The freedom of interpretation makes the Principles appealing for a larger number of companies.

    On 12 December, the FRC held a launch event for the Wates Principles, which yet again affirmed that the Principles are welcomed by the attendees, as many large businesses already have similar corporate governance policies in place; the Principles are viewed as a guideline to consistent reporting practice. The discussion panel saw additional value created for companies that adopt the Principles, and view it as a competitive advantage.

    One of the points raised, as a part of a discussion at the launch even, was an adoption of a “Name and Fame” practice for monitoring purposes by the FRC. As a result, the FRC hopes to provide an illustrative guide on the good examples of the Principles’ adoption or of good corporate governance in general.

    The Wates Principles were not designed for companies to “tick the boxes”, but to provide guidance towards a healthy corporate governance environment. The Principles are designed to help companies of all sizes and types to understand the good leadership and performance essential for a successful business.

    For further information contact Margarita Skripina.

  • December 18, 2018

    The Investment Association’s new principles of remuneration for 2019

    Introduction

    On 22 November 2018, the Investment Association (“IA”), wrote to the chairmen of the remuneration committees of FTSE 350 companies attaching its updated Principles of Remuneration.

    These changes to the IA guidelines have been made against the backdrop of the new remuneration provisions in the UK Corporate Governance Code and the changes to the reporting of directors’ remuneration which is due to come into force for accounting periods beginning on or after 1 January 2019.

    However, it appears that many of these principles are aimed at reducing the risk of “excessive” pay or increasing the justifiability of pay.

    Main areas in respect of the principles of remuneration

    The main policy areas for the new principles are as follows:

    Levels of Remuneration

    It was noted that levels of remuneration must reflect corporate performance and pay should be no more than necessary and linked to long term value creation.

    The remuneration committee should seek points of reference against which appropriateness and quantum of pay is judged. Useful reference points are:

    • prescribed policy that links remuneration to overall corporate performance

    • the remuneration policy of the company as a whole

    • fairly constructed peer universe

    • remuneration paid to groups of employees including the median, upper and lower quartile through the use of pay ratios

    Discretion

    The IA observed that the discretion of the remuneration committee can assist in ensuring that executive pay schemes properly reflect overall corporate performance and value creation. It also observed that payment of variable remuneration to executive directors should be discouraged even if specific targets are met where the business suffers a negative effect and in such circumstances shareholders should be consulted.

    The IA recommends that:

    • the remuneration committee should be accountable for the way in which discretion is used and should have sufficient legal power to exercise discretion

    • discretion should be used diligently, aligned with shareholders’ interest

    • discretion to be exercised within policy boundaries

    • use of discretion should be clearly disclosed

    Pay for Employees below Board Level

    The IA recommended that:

    • the remuneration committee should have a role in pay for senior management and review workforce remuneration especially where the levels of pay or the risks associated with the activities are material to the overall performance

    • the remuneration committee should fully explain why the pay figures are appropriate where they are reported and disclose any action necessary to rectify issues

    Shareholder Consultation

    IA expressed its concern that shareholder consultation is being used as a validation of decisions taken by the remuneration committee rather than taking and understanding shareholders’ views.

    IA recommends that:

    • consultation needs to focus on major strategic remuneration issues

    • details of whole remuneration structure should be put forward so that the investors are provided with a full picture and sufficient information so that they can make an informed voting decision

    • shareholders’ feedback and response should be listened to by companies

    • remuneration committee should understand the voting policies of the shareholders

    • after the end of the consultation process and before finalising details in the remuneration report, the remuneration committee should review policies taking into account subsequent events occurring in between so that the proposal remain appropriate

    Malus and clawback

    The IA observed that the current standard trigger events (gross conduct or misstatement of results) for malus and clawback are rarely used in practice. Moreover, even if a trigger occurs, it is difficult to relate the same to an individual director. It therefore recommends a significant strengthening of these provisions.

    The new principles recommend that:

    • a “more substantial” list of specific circumstances should be established when malus and clawback could apply and they should also be disclosed to the shareholders

    • the malus and clawback terms are set out clearly and accepted by the executive (executives should sign a form of acceptance at the time of the award)

    • LTIP rules, allied documentation and communications materials are consistent in relation to the scope and application of malus and clawback provisions

    • remuneration committees should develop clear processes for assessing whether malus or clawback is triggered and how and when they will exercise a discretion to apply the such provision; the process and decision must be clearly documented

    Shareholding requirement

    The new principles include a recommendation that:

    • executive directors and senior executives should build up a significant shareholding

    • executives are encouraged to purchase shares out of their own resources to align their interests with the other shareholders

    • remuneration committees should set out minimum shareholding levels and the time period in which to reach them for executives and also the consequences for non-compliance

    • shares only count towards an executive’s shareholding if vesting is not subject to any further performance conditions; unvested shares not subject to performance conditions can count on a net of tax basis; vested shares subject to a holding period or clawback count towards the shareholding requirement

    • shareholding used in hedging arrangements or as collateral for loans should be fully disclosed

    Post-employment shareholdings

    The new principles include a recommendation that:

    • companies should set up post-termination shareholding requirement for a period of at least two years and at a level equal to the lower of the company’s shareholding requirement in force immediately before leaving or the executive’s actual shareholding on leaving

    • remuneration committee should determine the structure and processes (which might involve using an employee benefit trust or nominee arrangements) to ensure compliance with the post-employment shareholding requirement

    • the post-termination shareholding requirement should be introduced for all new and existing executive directors as soon as possible and by the next remuneration policy vote at the latest.

    Pensions

    The new principles include a recommendation that:

    • pension contribution rates for executives should be aligned with those available to the majority of the workforce

    • new executive directors and directors whose roles are being changed should be appointed on the new pension contribution level

    • contribution rates for existing directors should be reduced over time to comply with this requirement. Clearly this reduction cannot be made without the agreement of the director concerned

    Restricted Share Awards

    Restricted shares (in the UK) are awards of shares (or nil cost options) which vest to the relevant director based on time only and not according to main performance conditions. The new principles include detailed recommendation on the awards of restricted shares, including:

    • restricted share awards may be appropriate depending on the sector and situations such as turnaround situations; they should be assessed on a case-by-case basis, considering the context and the strategic rationale

    • remuneration committees should have the ability to exercise discretion on vesting outcomes to ensure there is an appropriate connection between pay and performance and non-payment on failure; some investors have expressed a preference for a quantitative underpinning condition to be achieved prior to vesting

    • vesting periods for restricted share awards should be at least five years; in addition, the post-employment shareholding rules should also apply

    • if there is a proposal to switch to restricted share awards, investors will consider the company’s previous approach to remuneration, comparing the proposed award levels, performance and vesting criteria with previous award levels and performance conditions

    • if the company moves from an LTIP to a restricted share awards, the remuneration committee should consider the appropriate discount to award levels; the discount should be at least 50% and grant levels should be held without gradual increase.

    Leaver provisions

    A new ‘leaver provision’ has been added with a recommendation that:

    • individuals who are not ‘good leavers’ should be regarded as ‘bad leavers’; in other words there should not be any ‘intermediate leaver’ category

    • for ‘good leavers’, only a portion of the award may vest based on time in service and achievement of the original performance conditions; however, if the award needs to vest early, for example on death, awards should vest by reference to performance criteria achieved over the shorter period

    • deferred bonus and LTIP awards should continue to be satisfied in shares and subject to appropriate performance conditions

    • appropriate mitigation clauses should be included in awards to deal with individuals retiring as a good leaver to take up further executive roles

    For further information contact JD Ghosh or Michael Landon.

  • December 13, 2018

    MM&K Annual Survey shows positive trends for Venture Capital Firms but a slowdown for Private Equity Firms

    MM&K has published its 2018 PE/VC Compensation Report. The Report, published annually, provides participating houses with comprehensive and incisive up-to-date information and data on both the quantum and structure of remuneration paid to individuals working in and for PE & VC fund management entities in the UK and continental Europe.

    2018 Outlook

    The outlook for 2018 is now becoming clearer and in terms of deal activity, the statistics show a rather mixed picture.

    European Private Equity (“PE”) activity, as measured by deal count, declined throughout the first three quarters of 2018. At the end of Q3, annual deal flow throughout Europe is showing a 15% decrease in the number of deals compared to the same period in 2017. Deal Value is also down by some 15%, suggesting perhaps that the uncertainty over Brexit is having an effect.

    In contrast to PE, the Venture Capital (“VC”) industry appears to be booming with European VCs deploying capital at a record pace. However, the number of deals is slightly down on the same period as last year.

    Looking at exits, it appears that there has been a 24% decrease in the number of PE exits in the first three quarters compared to the same period last year. This is in contrast to Venture, which has seen European exit activity at a four year high. The value of VC exits in the first nine months has exceeded their value in the whole of 2017.

    But on another downbeat note for PE, LPs have so far committed €56bn to European funds that closed in the first nine months of the year, a noticeable decrease in committed capital compared to the same time period last year.

    What all this will mean for PE and VC compensation next year is difficult to predict, although it suggests that the VC community will for once be seeing better rewards (relatively) than the PE houses. We would expect though that the industry’s focus on ensuring that the middle ranking investment roles are well rewarded (and therefore able to be retained within their current firms), will continue.

    Whether these trends will affect the remuneration structures of both VC and PE portfolio companies, is another question…

    If you are interested in finding out what else our 2018 Survey has to say, or are already thinking ahead to remuneration in 2019, please contact Nigel Mills or Margarita Skripina for further details.

     

  • December 5, 2018

    New Investor Remuneration Guidelines

    As we move into 2019, the investor institutions and proxy agencies have been busy, producing their revised remuneration guidelines.  After a very active year in corporate governance there are, not surprisingly, a lot of changes.

    Starting with Glass Lewis: this major voting advisory agency has just issued its 2019 Proxy Guidelines specifically for the UK .  It is really worth reading, not least because the document provides the best summary we have seen of all the UK corporate governance regulations and other initiatives from 2018, put together in one place.

    Their new guidelines focus particularly on the capability and evaluation of the board and its committees and the guidelines on remuneration itself are generally modest. One curious rule is that target bonuses should not exceed 50% of the bonus maximum.  MM&K considers that that this is misguided. The right relationship between the maximum bonus and the on-target bonus is not a matter to be dictated by rules.  It depends on the dynamics of the business, the extent to which out-performance is possible or likely and the sensitivity of forecasting.  There are businesses where target and maximum should be the same and others where 50% is fully justifiable.

    On 22 November, The Investment Association (IA) issued its new Principles of Remuneration,  with a letter to Remuneration Committee Chairs from Andrew Ninian, its Director of Stewardship and Corporate Governance.

    The new principles generally tighten up remuneration governance along the lines that the IA has been advocating since its Working Group reported in July 2016.  The circumstances and requirements for describing Malus and Clawback have been clarified further; further guidelines around the use of restricted shares have been introduced; and tougher requirements for directors’ shareholding are stipulated, including the need for a post-retirement shareholding period of at least two years.

    It is clear that the IA sees reduction in the levels of executive remuneration as a legitimate goal.  For example, it mandates that, as soon as it is achievable within the limits of existing contracts, directors’ pension contributions should be aligned with those available to the workforce.  This rule, of course, is there to meet the requirement of Provision 38 in the 2018 UK Corporate Governance Code which comes into force from 1 January.  But it is also evident that IA members are coming under pressure from their clients to keep a ceiling on pay in “issuing companies” and curbing pensions is a gesture in this direction as well as appearing to be a move to reduce the gap between executive and general employee remuneration.  The IA press release says that “investors  will expect companies to pay pension contributions to Directors in line with the rate given to the majority of the rest of the workforce, rather than giving higher payments as a mechanism for increasing total remuneration.” In fact, the level of directors’ contribution has never been used as such a mechanism.   It has its roots in history, when all directors were on final salary schemes and the level of contribution was dictated by much higher final salary directors earned.  The DC contributions have been coming down over time as they could never be sustained at a level to match the old DB benefits. In any case, it is all rather academic as the HMRC Annual Allowance reduction of contributions to £10,000 a year means that most executives will receive cash in lieu and over time we expect that to become part of salary.

    The IA is turning up the gas on corporate governance compliance. On 5 December it wrote to 32 companies in the FTSE All-Share which have appeared on the Public Register for both years. The letter expresses concern that these companies are on the Public Register for the exact same resolution in 2017 and 2018, suggesting that they did not respond sufficiently to investor views and in doing so are risking more shareholder dissent in the future. 15 of these are for Remuneration Report resolutions.

    JD Ghosh will be writing a fuller article on the new IA guidelines for our December Newsletter. Click here to subscribe to our monthly e-newsletter.

    The new IA guidelines are reflected in new house guidelines from Legal and General Investment Managers (LGIM), who updated their Principles on Executive Remuneration on 28 November.

    The largest proxy agency, ISS, updated its 2019 Proxy Voting Guidelines for Europe, the Middle East and Africa on 19 November.  Changes include the criteria for voting down a director and a requirement for remuneration committees to develop a formal policy for post employment shareholding.  Like Glass Lewis, they say that the target bonus should typically be set at no more than 50% of the maximum bonus potential, with a demand for a robust explanation for any payments above target.  The intention behind this is to stop excessive payments for mediocre performance.  But we consider it is a blunt instrument.

    ISS have sharpened up the guidelines on LTIP performance measurement and shareholding periods. They encourage performance periods longer than three years and a total holding period of five years. They suggest that on-target vesting for LTIPs should be less than 25% if the total grant is a large multiple of salary.

    If a company’s share price has materially declined, the guidelines say, committees should consider reducing the size of LTIP grants.  ISS are trying to avoid the situation where the number of shares covered by the grant is increased in order to preserve the face value of the grant.  This can lead to excessive reward if the share price bounces back.

    Finally they advise dilution limits in line with the IA guidelines.

    The various guidelines can be downloaded by clicking on the links.  For further information contact Damien Knight.

  • November 27, 2018

    Valuation of share-based remuneration:  importance of underlying assumptions

    There are particular circumstances when a company needs to calculate a fair value of share options or performance share awards.  As the majority of performance shares in the UK are structured as nil-cost options this article refers throughout to options only. The most common circumstances are:

    1. To recognise an accounting expense under IFRS2 or FRS102 (the Finance Director’s nightmare)

    2. To agree the taxable value of the grant with HMRC – this can be needed, for example, to determine the taxable value (if any) on the acquisition of restricted securities, including growth shares or JSOP interests.

    3. To ‘benchmark’ share-based rewards against competitive practice more precisely than would be possible using the ‘face value’ of the shares involved, for example where there are different performance conditions for the company’s own share-based rewards and for those of a comparator company.

    4. To compare the value of share-based incentives with other parts of the remuneration package, where a trade-off between elements is being considered: such as a choice between share-based incentives and cash payments, or between different forms of long-term incentive.

    In each case, another party has to be satisfied that the resulting fair value is indeed fair – the auditor on behalf of the shareholders, HMRC, the remuneration committee and the executives receiving the grants.  Executives frequently prove to be the hardest to convince.

    Nevertheless, it is probable that very few of these parties really understand the mathematics involved, and most take the calculation on trust or apply some standard formula.  In fact, the final value is surprisingly sensitive to the valuation assumptions, such as share price volatility and the expected period before an option-holder chooses to exercise (“option life”).

    Volatility is the key to calculating the value of share options and performance share awards with market-based vesting hurdles.  The future pay-off from an option is a positive value or zero, depending on whether the share price at the time of exercise is higher than the exercise price (which is usually, but not necessarily, the share price at grant).  There are two components to the price increase: the underlying drift of the share price (a function of market expectations) and the extent to which the seemingly random daily changes add up to produce a resultant increase or decrease. If a share price experiences large daily fluctuations, we say that it has high volatility.  With a more volatile share price there is more chance of a high gain at exercise.  There is also more chance of a low downside in the share price, but because the pay-off cannot be less than zero (the option holder just would not exercise), this does not cancel out the extra value from the possibility of a high upside.

    Before we consider how different volatility assumptions affect the value of a share option, we need to find a workable definition of volatility.  To calculate the daily volatility, we look at the standard deviation of the logarithm of the ratio of each day’s share price to that of the previous day. We then multiple this daily volatility by the square root of the number of trading days in the year to get the annualised volatility, which is the measure used in valuing options. We take the natural logarithm because it results in a normal “bell curve” for compounding returns – which makes it possible, later in the valuation process, to model future outcomes randomly in our valuation model. A key assumption in share price forecasting is that returns are normally distributed.

    Not surprisingly, the value of a share option is highly sensitive to the assumption about share price volatility.  The graph below shows how the fair value of an option varies with volatility in a typical company. For clarity, we have expressed the fair value as a percentage of the face value of the shares under option.

    At 10% volatility, the fair value is 15% of the face value of the share. At 40% volatility, the fair value is 43% of the face value, with close to a straight line relationship in between.   The fair value per share is almost three times as much at 40% volatility as it is at 10% volatility.

    We can see that this variation matters when we make assumptions about likely future volatilities.    The reality is we do not know what the future volatility will be or how it will vary.  Most companies rely on the past as a predictor of the future.  If the company issues traded options, we can work out the implied volatility (ie the volatility assumed by market makers) but this will not apply for most smaller companies.

    The situation is even more difficult if we are dealing with a private company. The company is probably valued once a year for tax purposes or for internal share transfers.  The valuation methodology typically uses a profit multiple, or maybe a projection of future profits.  In this circumstance, there is no measurable “wiggle” in the share price.  The company has to estimate its volatility, for example by using an average of the observed volatilities of listed peer companies in its sector to provide a proxy.

    The table below shows how the volatility of one listed company’s shares has fluctuated, depending on the quarter over which it is measured.  The volatility varied by a factor of three, depending on the period chosen, ie Q1 2017 vs Q2 2015.  Neither historical period has a superior claim to representing the future.  There may be industry characteristics for 2017 which suggest that figure is a better predictor because it is more recent, but it depends largely on judgement.  As shown in the graph above, the volatility assumption has a crucial impact on the value of an option or performance share award.

    Conclusion

    Depending on the purpose of valuation, the company has a lot of opportunity to choose volatility assumptions which suit its own purpose, provided it can persuade the interested parties, HMRC, shareholders or executives, that the final result is reasonable – one might say “fair”. This persuasion/ negotiation is more important than the mathematical result.  It could well be easier to take a rule of thumb of, say, 30% of face value (MM&K uses 30% of face value for share options in surveys and this is often talked about as a market norm) and agree with the relevant parties that that is a fair figure for the particular purpose in hand.  Unfortunately HMRC is currently insisting that a Black-Scholes or similar option-pricing model is used for valuation of growth shares and JSOP interests, which therefore requires the use of a volatility assumption, even though we have shown this is effectively arbitrary.

    Volatility is not the only assumption that introduces a large degree of imprecision.  We also have to decide the likely behaviour of participants in exercising their options – in order to determine the option life (grant to exercise period).  The graph below shows the impact of different option lives for the value of the option in a typical company.  This is yet another reason for agreeing a rule of thumb.

    For further information contact Harry McCreddie

  • November 26, 2018

    Changes announced in the Budget to the rules for entrepreneurs’ relief

    Introduction

    While there had been concerns whether entrepreneurs’ relief (which reduces the rate of capital gains tax for higher and additional rate taxpayers from 20% to 10% on the first £10 million of an individual’s qualifying lifetime gains) would be significantly reduced, or even abolished, in the Autumn budget, the Chancellor has confirmed that the relief will be retained, albeit with a couple of changes.

    Until 28 October 2018, entrepreneurs’ relief was available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of one year ending with the date of disposal (the ‘qualifying holding period’):

    (a) the company is the individual’s ‘personal company’, and

    (b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

    For a company to be a ‘personal company’, the individual is required to hold at least:

    • 5% of the issued ordinary share capital of the company and

    • 5% of the voting rights of the company.

    Changes effective from 29 October 2018

    The first change to entrepreneurs’ relief is that, with effect from 29 October 2018, a company only qualifies as a ‘personal company’ if, in addition to the requirements relating to share capital and voting rights, the individual is also beneficially entitled to at least:

    • 5% of the company’s distributable profits, and

    • 5% of its assets available for distribution to equity holders on a winding up.

    How does this change affect employee incentives?

    There is no immediate effect on EMI Option holders, including holders of EMI Options over ‘growth shares’ (i.e. a special class of shares which gives the holder the right to share in the growth in value of the company in excess of a pre-determined hurdle). EMI Option holders continue to enjoy the benefits of entrepreneurs’ relief on the disposal of their qualifying shares.

    However, other employee shareholders who typically only hold 5% or more of a class of ‘growth shares’ with voting rights will be adversely affected. With effect from 29 October 2018, their rate of capital gains tax on disposal of their shares will increase from 10% to 20%, because they will not meet the two additional requirements of having a beneficial entitlement to 5% of the company’s assets and distributable profits.

    These changes have been brought in to counter incentive structures that the Government considers to be tax avoidance, where the incentive arrangement has been designed to comply with the letter but not the spirit of the conditions for entrepreneurs’ relief.

    Changes effective from 6 April 2019

    The second change to the entrepreneurs’ relief is that, for disposals on or after 6 April 2019, the ‘qualifying holding period’ (see above) has been increased from one year to two years.

    In other words,  entrepreneurs’ relief will only be available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of two years ending with the date of disposal (the ‘qualifying holding period’):

    (a) the company is the individual’s ‘personal company’ and

    (b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

    How does this change affect employee incentives?

    Practically speaking, this extension to two years is unlikely to have much impact on the majority of employee shareholders (who are otherwise eligible for entrepreneurs’ relief including EMI Option holders). The press release suggests that 95% of disposals already meet the two year qualifying holding period.  To qualify for the relief, an EMI Option holder must not dispose of the shares acquired through the option until at least two years after the option grant date.

    Dilution protection

    Legislation will also be introduced from 6 April 2019 to protect an individual’s entrepreneurs’ relief entitlement up to the point that the individual’s shareholding is diluted below the 5% qualifying requirement as a result of funds raised for commercial purposes by the issue of new shares.

    A new provision will apply where a company has issued shares for cash consideration for genuine commercial purposes, which has caused an individual’s shareholding to fall below the 5% personal company threshold. If gains on share disposals prior to the issue would have qualified for entrepreneurs’ relief, individuals may elect to be treated as having sold and reacquired their shares at market value immediately prior to the dilution, giving rise to a chargeable gain on which they can claim entrepreneurs’ relief.

    There will also be a provision for a second election to defer the gain until an actual disposal of (or of interests in) the shares or securities.

    For further information contact JD Ghosh or Michael Landon

  • November 26, 2018

    Largest AIM companies stick with UK Corporate Governance Code

    AIM companies are required to adopt a recognised corporate governance code – which one do they choose? One of the main attractions of listing on the AIM market is the reduced regulatory requirements compared to a main market listing, but do the biggest AIM companies take advantage of this, or do they stick with the UK Corporate Governance Code?

    This summer we saw a number of significant changes in light of the UK Government’s wider corporate governance agenda. Alongside the introduction of a new UK Corporate Governance Code and an updated QCA Corporate Governance Code, the amendment to AIM Rule 26 requires all AIM companies to select a corporate governance code.

    Under this rule, as of 28 September 2018, every AIM quoted company must state on its website which recognised corporate governance code it has decided to apply and to explain how it complies with that code. They also need to provide an explanation of any departures from that code.

    Many AIM quoted companies previously stated that they complied with the UK Corporate Governance Code or QCA Code “so far as appropriate for a company of this size” or something similar, i.e. that they do not comply in full (a qualified compliance statement). Such terminology is no longer acceptable and substantive disclosure is expected.

    MM&K has investigated the corporate governance statements of the 20 largest AIM quoted companies (by market capitalisation).

    11 of these companies have adopted the UK Corporate Governance Code, eight have chosen to comply with the QCA Code and one, Burford Capital, reports against the Guernsey Finance Sector Code of Corporate Governance. Research by the QCA itself into the practice of all AIM listed companies (over 900 companies) shows that 89% have adopted the QCA Code rather than the UK Corporate Governance Code. It is clear that the dominance of the UK Corporate Governance Code among the top AIM quoted companies is a feature of company size.

    In terms of level of detail, the corporate governance statements are generally similar. Companies following the UK Corporate Governance Code give a broad explanation of how they comply with its five main principles under the following headings:

    1. Leadership

    2. Effectiveness

    3. Accountability

    4. Remuneration

    5. Relations with shareholders

    Those following the QCA Code provide a broad explanation of how they comply with its 10 principles, which are:

    1. Establish a strategy and business model which promote long-term value for shareholders;

    2. Seek to understand and meet shareholders’ needs and expectations

    3. Take into account wider stakeholder and social responsibilities and their implications for long-term success

    4. Embed effective risk management, considering both opportunities and threats, throughout the organisation

    5. Maintain the board as a well-functioning, balanced team led by the chairman

    6. Ensure that, between them, the directors have the necessary up-to-date experience, skills and capabilities

    7. Evaluate board performance based on clear and relevant objectives, seeking continuous improvement

    8. Promote a corporate culture that is based on ethical values and behaviours

    9. Maintain governance structures and processes that are fit for purpose and support good decision-making by the board

    10. Communicate how the company is governed and is performing by maintaining a dialogue with shareholders and other relevant stakeholders

    The majority of companies make references in their website statement to their Annual Report, for example by providing a link to the Remuneration Report for further details on the committee’s activities. Several also point the reader towards the corporate governance statement in their Annual Report.

    At the beginning of their statement, some companies clarify whether they believe they have complied fully with the code. For example, Fevertree Drinks plc’s statement includes “Given our stage of development there are certain provisions of the Code which we do not feel are appropriate for the Group at this point in time and therefore do not fully comply, further details on which are set out below”. However, only five companies include a statement similar to Fevertree’s, with a further four proclaiming they have not departed from the code in any way. For example, Secure Income REIT plc state “As of 6 September 2018 the Board does not consider there to be any areas relevant to the Company where it does not comply with The Code”. The remaining 11 companies are less explicit on departures from their chosen code.

    The five companies referred to above are clear in explaining how and why they have not complied; a common departure was from provision B.1.2 of the UK Corporate Governance Code, which states that, except for smaller companies, at least half the board, excluding the chairman, should comprise non-executive directors determined by the board to be independent. The reason typically given is that despite non-compliance, the board has an appropriate balance of skills, knowledge and experience to enable it to discharge its duties and responsibilities effectively.

    Another trend is the inclusion of an introduction outlining the company’s beliefs and philosophy surrounding corporate governance. ASOS plc, for example, included the following one by the Chairman:

    “For ASOS Plc, ‘Doing the Right Thing’ is pivotal to every part of the business model and good corporate governance is a key part of this. As an AIM listed company with a significant market capitalisation, we recognise the need for ensuring that an effective governance framework is in place to give our external investor community and our employees and suppliers, the confidence that the business is effectively run”.

    Seven companies divulge their corporate governance philosophy (in six cases it is in the form of a chairman’s introduction).

    Hurricane Energy plc provides an interesting example of switching from the QCA to the UK Corporate Governance Code. In 2017, the Board decided to change due to the company’s size (Hurricane’s market capitalisation rose from under £65m at the start of 2016 to a peak of over £800m in 2017). Still, company size is not the only factor in deciding which code to follow, both Boohoo Group plc and RWS Holdings plc follow the QCA Code and have larger market capitalisations than Hurricane (£1.3bn and £2.4bn respectively).

    The requirement of AIM Rule 26 is very recent. The test of any code and disclosure under it is whether it provides shareholders with the information they need to exercise their stewardship or make decisions on their own behalf in the case of beneficial shareholders. We would expect shareholders to assess over the coming year whether companies are providing this information and to influence companies to change code if necessary. It will be interesting to see if the higher “outcome focus” rather than procedural focus in the QCA Code will lead some shareholders to prefer the AIM companies they invest in to use the QCA Code.

    For further information contact Harry McCreddie or Margarita Skripina

  • November 25, 2018

    Remuneration Consultants Group (“RCG”) Recruitment of New Chairman

    The Remuneration Consultants Group comprises the 11 UK consultancies that advise the remuneration committees of larger companies. The RCG manages the voluntary Code of Conduct (‘the Code’) that sets out the role of executive remuneration consultants and the professional standards by which they advise their clients. It was formed following the Walker Report in November 2009.

    The Board is looking to appoint an independent Chair to replace the current chairman who is stepping down after 8 years in the role. The Chair provides strategic direction to the Board – gained by prior experience as a senior NED able to demonstrate a clear understanding of the operation of remuneration committees (ideally as Chair of such a committee at a FTSE350 company). The time commitment is in the region of 10 days each year.

    In addition to attending Board meetings, the Chairman will be required to lead the Board in the review of the Code and of its effectiveness which may include interviews with representatives of institutional shareholders and chairs of remuneration committees on an annual basis. The Chair is responsible for leading on the appropriate communication strategy for of the Code. To date this has included occasional press interviews.

    The appointment will normally be for an initial term of three years commencing on or shortly following 1 January 2019.  Fees are currently £40,000 for this role.

    To obtain full details of the role and how to apply, please contact Damien Knight

  • October 30, 2018

    Changes announced in the Budget to the rules for entrepreneurs’ relief and their impact on employee incentives

    Entrepreneurs’ relief reduces the rate of capital gains tax from 20% to 10% on the first £10 million of an individual’s qualifying lifetime gains. It is available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of one year* (see below) ending with the date of disposal:

    (a) the company is the individual’s ‘personal company’ and

    (b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

    Until 28 October 2018, for a company to be a ‘personal company’, the individual was required to hold at least:

    • 5% of the issued ordinary share capital of the company and

    • 5% of the voting rights of the company.

    Changes effective from 29 October 2018

    With effect from 29 October 2018, a company will qualify as a ‘personal company’ if, in addition to the requirements relating to share capital and voting rights, the individual is also beneficially entitled to at least:

    • 5% of the company’s distributable profits and

    • 5% of its assets available for distribution to equity holders on a winding up.

    How does this change affect employee incentives?

    There is no immediate effect on EMI Option holders, including holders of EMI Options over ‘growth shares’ (i.e. a special class of shares which gives the holder the right to share in the growth in value of the company in excess of a pre-determined hurdle). EMI Option holders continue to enjoy the benefits of entrepreneurs’ relief on the disposal of their qualifying shares.

    However, other employee shareholders who typically only hold 5% or more of a class of ‘growth shares’ with voting rights will be affected as, with effect from 29 October 2018, their rate of capital gains tax on disposal of their shares will increase from 10% to 20%, because they will not meet the other two requirements re having a beneficial entitlement to 5% of the company’s assets or distributable profits.

    These changes have been brought in to counter incentive structures that the Government considers to be tax avoidance, where the incentive arrangement has been designed to comply with the letter but not the spirit of the conditions for entrepreneurs’ relief.

    Note also that the Government has announced proposals to introduce new legislation, applicable to disposals after 5 April 2019, increasing from one to two years the holding period that must be met. This change will affect holders of EMI options, who after 5 April 2019 will need to have held their EMI options (or shares) for at least two years before their disposal for Entrepreneur’s Relief to be available.

    * Also for disposals after 5 April 2019 the requirements that need to be met throughout the period of one year* ending with the date of disposal (referred to in the Introduction above) will need to be met for a period of two years ending with the date of disposal.

    For further information contact JD Ghosh or Stuart James

  • October 24, 2018

    Are chief executives overpaid?

    In October 2018, Deborah Hargreaves published a new book, under the title “Are Chief Executives Overpaid?”. The question, of course, is rhetorical.

    Hargreaves is an ex Guardian business editor and FT journalist who has made it her life’s work to attack fat cat pay, which she believes is having a corrosive effect on the cohesion of our society and is putting liberal capitalism at risk.

    Hargreaves has been most effective at creating visibility in this area, although I suspect she fans the flames of discord rather than dampening them down. She was the original Director of the High Pay Commission in 2009 which was founded and funded by Compass, the centre-left pressure group, aligned with the Labour Party.  Compass’ mission was to get the Labour Party re-elected, and they figured that dissent over executive pay was a good lever for winning votes.  Mirroring the name of an existing official body, the Low Pay Commission, was a clever ploy.  It gave the High Pay Commission immediate credibility and a quasi-official status.

    In 2012, Hargreaves set up The High Pay Centre (the HPC), its successor organisation.  She describes it as an independent think tank, not aligned with any political party, although its spiritual affiliation to the Labour party is evident.

    Hargreaves has very firm beliefs on executive remuneration.  She believes it is a manifestation of human greed and is escalating far beyond the pay of the average worker and in a way that bears no relation to company performance.  Current pay differentials are essentially unfair. Chief executives are not worth anything like the amounts they are paid.  She is more sympathetic to entrepreneurs who are people creating wealth through their energy and ideas.  But “captains of industry” are essentially bureaucrats – they administer a system someone else has created. This refusal to believe they add so much more value than the average worker leads Hargreaves to use such ploys as “a captain of industry in the UK take 129 times the annual income of someone on average wages” and the more dramatic statement that before the end of the first week in January they will have “notched up” more income than the average annual wage.

    In keeping with those beliefs, Hargreaves’ language is heavily value-laden.  Executives “pocket” their pay. She talks about “late-stage capitalism”. Remuneration governance is a “religious cult”.  Thatcherism was intended to free the “supposed” entrepreneurial spirits in people.

    In her criticism of the conspiracy of excessive executive pay Hargreaves takes a swipe at pretty much everyone. US business schools take a lot of stick – principal-agent theory “doing the rounds of US business schools”.  Head-hunters are a “coterie” drawing from the same pool of usual suspects.  Institutional shareholders are too self-interested to act as effective policemen for executive excess. They provide “weak oversight”.  Government crumbles in the face of corporate UK and US. Remuneration committees are afraid of the executives. Former civil servants (in nationalised industries) were “pitched into the premier pay league”.  Remuneration consultants, the “high priests of the religion”, work to create high pay through benchmarking, chasing the upper quartile and opaque and complex incentive design.  Tony Blair and New Labour sought a cosy relationship with big business. Even Joe Public comes in for criticism: “The modern economy has succeeded in turning peoples’ needs (the basic material goods required to achieve a secure standard of living) into wants which are never-ending.”  The puritanical nature of these views indicate an aversion to people earning “loads-a-money” and a desire to produce any argument as to why they do not deserve it.

    You can feel sympathy for Hargreaves’ view point.  But what disturbs me is her careless use of statistics to support her case and the willingness of business editors and politicians of all parties to accept these statistics without question.  One notorious piece of earlier HPC “research” served up again by Hargreaves is the report of October 2014, Performance-related pay is nothing of the sort, produced for HPC by the now defunct Incomes Data Services. This was an appalling piece of sophistry: a fishing expedition which showed no real understanding of statistics or maths.  It was full of errors, but one notorious example will suffice here.  IDS plotted executive bonuses against company profit for 350 companies on one chart.  They showed there was virtually no correlation between profits and bonuses on their graph, and their conclusion was there was no relationship between pay and performance. But this was just nonsense maths. I will demonstrate why. Let us say you paid a CEO a share of profits in his or her company and nothing else, there will be a 100% correlation between his or her bonus and his or her performance.  If you accept profit as the measure of performance, his or her pay is perfectly related to performance.  Now If you do the same thing for CEOs in five companies – all paid on a profit share, but with a different profit percentage, the correlation for each company is still 100%, but the overall picture become blurred and the overall correlation falls dramatically.  Graphically, the points are all over the place because the percentage share varies by company.

    In fact IDS did this exercise not for five, but for 350 companies, the FTSE 100 and FTSE 250 combined, again making the assumption that profit was a good performance measure. Not surprisingly they found the correlation to be vanishingly small for the sample as a whole.  Does this mean that bonuses bore no relation to profit for these companies?  Of course not: you have to look at the correlation company by company, not the market as a whole– but that is what the IDS study concluded.  They then went on to do the same thing with long-term incentives and relative TSR.  Same conclusion: no relationship to performance.  At the report launch meeting, John Plender, the FT financial journalist sighed with relief “I always suspected this was the case” and heads all around the room nodded.  Since then the canard has been repeated time and again.  David Davis, the right wing Tory MP wrote an essay for the High Pay Centre in which he said “CEO pay has massively outpaced anything with which it can even remotely be correlated”.

    Rachel Reeves, chair of the Commons BEIS select committee told the Mail on Sunday the committee is going after the fat cats again later this Autumn.  Their April 2017 report said “executive pay is increasing at a rate that vastly exceeds increases for ordinary employees and which seemingly is at odds with the value created in the company”.  This statement is wrong on both counts – Minerva (formerly Manifest) data shows that, since 2010, CEO salary increases have fallen to a level much in line with the 2%-3% increases in the general workforce and this is has been the case for the past eight or so years.  What have gone up are the earnings from long-term incentives but this is precisely due to share price increases and consequent shareholder returns ie “the value created in the company”.

    Does this inaccurate propaganda matter?  Well yes it does.  It becomes accepted as fact and it affects Government policy and inflames public disenchantment with business.

    Hargreaves takes another swipe at non-executive boards, who she thinks are not doing their jobs effectively. Then she adds “ remuneration committee members are well-paid too.  Average pay for a remuneration committee member was £441,383 in 2015 (remember they are part-time jobs), 16 times the average for a UK employee”. This suspiciously precise figure is in fact dangerous rubbish.  The proxy agency Minerva produced an analysis for the MM&K Chairman and Non-Executive Director survey covering 2015.  The average total fees for a FTSE 100 NED was £115,386 (median £94,000).

    These figures are accepted by journalists and politicians simply because they want to believe them.

    This is from Margaret Hefferman in the FT on 1 October 2018:

    “Hargreaves amasses devastating data to prove that performance-related pay massively outpaces all rational measures, and that rewarding failure is routine”.

    Powerful stuff, except it is not true.  People want to believe it because they resent the pay for top executives in a way they do not, for example, resent pay for international football stars (Ronaldo and Messi each earn about £40m gross per annum at Real Madrid).

    Hargreaves devotes quite a lot of the book to arguing that companies introducing performance related pay fail to understand human motivation.  Executives do not need all this money.  But this misses the point. By blaming executive greed, Hargreaves’s book does not follow through on the real economic issue, which is low pay for the average worker. She blames low wage growth on low investment which in turn she blames on executive incentives with a short-term focus.  She would rather pay the money directly to the workers than increase investment.  She claims to believe in free markets, but doesn’t like it when the market decides some people are worth a lot of money and pays them accordingly.  This jars with her puritanical viewpoint.  Hargreaves ends her book with a menu of actions that could be taken to pull down the share of wealth taken out by top executives:

    • Put up top taxes for executives and corporations.  Block loopholes.

    • Publish tax returns on-line like Sweden does (the “shaming” approach).

    • Move corporate focus away from achieving returns for shareholders towards achieving benefits for stakeholders, especially workers so as to create a new corporate ethos. She (wrongly) claims that the legislation for requiring the delivery of benefits to wider stakeholders already exists in Section 172 of the Companies Act.  (In fact Section 172 requires boards to have due regard for the interests of these other groups, but shareholder interests clearly have primacy.)

    • Give the workers a say in bosses’ pay – by a worker representative on the remuneration committee or board (“to inject some common sense”) or even by having a worker’s vote on the remuneration policy.

    • Improve companies’ consultation with workers.  Introduce a structure of councils.

    • Give the FRC the power to investigate and prosecute company directors for poor corporate governance. Create new statutory bodies in the UK and US focused purely on corporate governance, with new enforceable guidelines.

    • Phase out LTIPs.

    • Make any bonuses a pure profit share only.

    • Pay cash only – no shares.  Executives should buy their own shares.

    • Have a binding vote once the non-binding vote falls below 75%.

    • Reduce salaries to a reasonable level – all stakeholders to decide what is “reasonable”.

    She summarises by saying “a critique of the self-serving justification is often attacked for relying on the wrong data, a misunderstanding of the way companies work and plain old envy.  But if capitalism is not seen to be fair by much of the public there will be moves for something more drastic to replace it.  It is time for the business sector to listen to the moderate voices for reform or reap the consequences of growing inequality, anti-business sentiment and possibly more dramatic clashes. If it does not rise to the challenge, the fundamental trust that makes a liberal market democracy function could be damaged beyond repair.

    In fact there are only a few companies with the excessive pay arrangements this book is railing against.  Hargreaves’ proposals would result in a regime which would restrict legitimate reward and damage companies generally, without helping in any way to address the key problem, which is low wages.

    For further information contact damien.knight@mm-k.com