Say on Pay: Six Years On — Lessons from the UK experience

In the Winter 2010 Barroway Topaz Bulletin, Deborah Gilshan reports on her Railpen Investments research report. Findings include:

• Both investors and companies report that since the introduction of the vote there has been an increase in engagement over remuneration. Whilst this has led to some friction, it has also created an improved dialogue between companies and their owners over this important governance issue.
• There has been a sharp reduction in directors’ typical notice periods since the introduction of the shareholder vote. 75% of directors were on one year in 2001, compared to over 95% now. This has reduced the risk of payment for failure.
• Performance-related elements of remuneration now account for a much larger percentage of the total, with long-term incentive plans (LTIPs) becoming a more significant element.
• Between 2000 and 2008 there was a clear movement away from the use of option schemes towards LTIP share awards. And from 2003 onwards there was a small increase in the number of share matching (or bonus deferral schemes) being introduced, suggesting that following the introduction of the vote in 2003 companies were more innovative in considering their remuneration structure.
• But total remuneration has continued to grow even when markets have fallen, suggesting shareholders need to do more to achieve true performance linkage.
• Some shareholders do not appear to have used their voting rights effectively, with the average vote against a company’s remuneration report falling from a peak in the 2004 season. Therefore the report argues that shareholders must use their new ownership rights actively if it is to have a meaningful effect.

The report identified three areas that need further consideration:

1. What pay for what performance? The vote has not addressed the appropriate levels of pay for performance achieved, and the report evidences that the total remuneration for directors of the UK’s largest companies continues to rise rapidly, and not always reflective of the performance achieved. This leads to the next question: what is defined by “exceptional performance”? Finally, we come to the quantum question — should shareholders take a view on what is “too much”?
2. Pay differentials. The difference between pay at board level and pay for other employees has generally not been debated, except for the observation that such pay differentials continue to widen rapidly. Should pay at other levels of a company influence pay at board level? Should shareholders be voting on all pay across an organisation? The Companies Act 2006 includes a requirement for quoted companies to report on how they have taken pay and employment conditions elsewhere in the group into account when they are setting directors’ pay. Beyond this requirement, which is merely a reporting requirement, how should shareholders dialogue with companies over this?
3. Advisory or binding? Should the remuneration report vote stay in advisory form or become a binding vote on a company? What would be the consequences of a binding vote, especially if the vote was defeated?

Gilshan concludes, “The UK’s experience demonstrates there is nothing for companies to fear from the introduction of a vote on remuneration, and much for them, and their shareholders, to gain.”