US Executive Pay Policies
5 September 2006 Marcus Peaker
In the UK, companies are required to disclose certain information to their shareholders regarding executive pay. Marcus Peaker, chief executive of Halliwell Consulting, looks at whether or not this is a trend that we could see taking off in the US.
Boards of UK companies have had to adapt over the last few years to executive pay taking a disproportionately high profile in corporate life and in the relationship between a company and its shareholders.
The reason for this prominence has been wholesale changes in both the information companies are required to disclose on executive pay and the impact of an annual shareholder vote on a company's remuneration committee report.
The motives behind these changes are generally commendable, intended as they are to encourage companies to explain and justify their executive pay policy to shareholders.
However, the resulting rules have had a significant impact on management time. In addition, remuneration issues tend to dominate the dialogue between shareholders and the relevant company. This can be an uncomfortable issue for both the board and shareholders due to the emotive nature of pay.
When the board of a UK company looks at its executive remuneration policy and sets out the actual levels of compensation paid, it has to be mindful of the following:
- Regulations setting out detailed disclosure of all aspects of executive compensation paid to its executives in the past year and the proposed policy for the next year
- The remuneration aspects of the combined code which applies to all UK listed companies
- The voting guidance issued by shareholder representative bodies such as the ABI and RREV on how their members should vote on remuneration matters - this voting guidance is based on how a company's remuneration 'stacks up' compared to their guidelines on acceptable pay which go significantly further than set out in the statutory regulations and combined code
- Their institutional shareholders, who will also have guidelines on acceptable pay, some of which will be consistent with the ABI and RREV guidelines, some will be consistent with each other and some will be unique to that particular investor
EXECUTIVE PAY ALTERATIONS
The final determinant of whether a company has successfully negotiated the maze of regulations and guidelines above is the advisory vote on the remuneration committee report.
'Advisory' in this context is a bit of a misnomer, as while legally the company is not obliged to make any changes to its executive pay as a result of a No vote, in practice the resulting vilification is enough to make boards comply.
Those companies that have experienced a No vote have generally spent a material amount of management time and incurred significant third-party costs in remedying the situation.
There has, perhaps, been a perception in the US that this is a quaint English problem resulting from our media's obsession with 'fat cats' and the national pastime of knocking anyone who has been successful.
Compared to their UK counterparts, US executives have until very recently had a very benign pay environment. Required US disclosure is cursory compared to the UK, with US investors being positively apathetic on both the issue of disclosure and the levels of compensation provided.
WINDS OF CHANGE?
Recently we have seen option expensing affecting the results of US companies, that is one thing guaranteed to make shareholders sit up and take notice. Remuneration excesses have also come to light in the corporate scandals that have hit the US in recent years.
Most recently we have seen a mass confession from companies who have been selective when setting the strike prices of the historic option grants to their executives.
In this context it is interesting to note that the reason the option pricing issue has hit the headlines is as a direct result of the increased disclosure required by new accounting standards.
Even with these issues and the resulting changes proposed by the SEC, the US is still a long way from shareholders voting on executive pay.
However, experience in the UK suggests that once the disclosure bandwagon is given a push it starts building up momentum quickly with more and more details being required by regulators and investors.
Furthermore, if the US takes the same route as the UK, once the information is disclosed the following may start to happen:
- Investors will start to compare and contrast companies
- Investors will look at the total cost of a company's executives compared to corporate performance
- Investors will start to give their opinion to companies on what levels and structures they feel are appropriate
- Some companies will ignore these views giving rise to shareholder concerns
In these circumstances it only takes one or two further high-profile issues surrounding company performance and executive pay to act as a catalyst for shareholders to press for a greater say. This may well result in a UK-style vote.
WHAT CAN THE US DO?
Hopefully not the remuneration equivalent of Sarbanes-Oxley! In the UK, executive remuneration is managed through a mixture of regulation, self-regulation and informal pressure. This is far from perfect, but the detailed legislative approach would be far worse.
The idea of binding votes on US executive pay would be a disaster for all concerned and would not work in practice as ultimately the board has to be responsible for running the company, not shareholders.
The role of shareholders is to appoint the board to run the company, not to start running it directly themselves. However, the difficulty of shareholders influencing US board appointments is another issue getting significant airtime in the US.
I do not believe that UK-style votes on executive remuneration will happen in the near future in the US. However, there is an awakening of US shareholder interest in this area.
Historically, the US has demonstrated the capability of a knee jerk response to corporate issues (Sarbanes-Oxley). Therefore it might only take a few high-profile cases involving inappropriate executive pay for US regulators and shareholders to look at the UK model and consider whether to adopt it.