Executive Pay in the UK


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Executive pay in the UK

As a house we believe the levels of executive pay present a problem for the following reasons:

  • The level of reward is often unrelated to the long-term performance of businesses
  • Mediocre performance is well-rewarded
  • Volatility in performance or share prices is a lever to increase pay
  • It is a deeply imperfect market. Its structure – high demand (shareholders demand a new CEO, and quickly), perceived low supply (how many people in the world are really able to be a good CEO?) limited information (is the process for selecting a new CEO optimal?) – suggest pay will continue to rise
  •  It is difficult to identify at what point pay will stop increasing. Where is the cut-off?
  • The gap between the earnings of the top earners of listed companies and those of the rest of the population might undermine the support for companies by the wider public

Establishment of a working group by the Investment Association: time for a re-think

The Investment Association announced a working group in September 2015 to try and simplify UK executive pay.  After giving it some thought, we believe that there is a case for radical simplifications from our point of view anything short of this is worthless.

There should be a move away from the UK standard practice of salary plus annual bonus plus (perhaps) shares for deferring part of the bonus plus a long term incentive plan plus pension plus benefits. 

Taking into account our extensive experience, we propose the following for senior executives at listed companies:

  • An annual salary, paid monthly.  This would comprise a suitable living wage and reflect, modestly, the status of a Chief Executive Officer (CEO). 
  • Disclose the salary as a multiple of the average salary and earnings for both male and female employees across the company
  •  An award shares over a fixed number of shares per month, vesting (i.e. the executive becomes entitled to the shares) in tranches at 3, 5 and 7 years, with the greatest proportion of shares being released at 7 years. The proportion released at each tranche will vary according to the type of industry
  • Service contracts should be no longer than 3 months

There may be variations to that vesting schedule. Releasing shares will be subject to differing circumstances:

In the event of departure or retirement

The share awards would be released according to the schedule, irrespective of continued employment (ie they’ve left or been sacked) or retirement (contrary to current practice whereby share awards are often released at retirement – we’re trying to encourage long-term planning, so commit to the long term). 

In the event of a takeover or merger

In the event of a takeover or merger – and conscious that executives might be tempted to arrange a merger or sale of the company in order to force early release of the shares – awards are rolled forward into the shares of the acquiring company or, if no such investment opportunity is available, into a trust tied to a sector index with vesting at the previously arranged dates. 

In the event of a new hire

For the first two or three years of a new hire’s tenure, more flexible (that is, higher) arrangements can be used initially to reflect the risks of leaving a previously secure and/or successful employment. 

In the event of failure

We also recognise the share awards might be a reward for failure.  Our stance on long service contracts as a reward for failure was well-publicised in early 2015. A need to improve the whole pay system, however, means there will be some trade-offs.  We think our proposals will, on balance, improve the performance of the companies in which our clients’ monies are invested

Who is eligible for a share package?

This package would be limited to the most senior executives in an organisation.  The senior executives fulfil a different role to other employees and thus have a different pay package.

Pay targets

We no longer advocate the attachment of performance conditions to the exercise of these share awards.  We find after years of discussions about performance conditions, that they generally do not work. They are subject to distortion. The wrong measures can manipulate behaviour, contrary to the long term financial sustainability to a company. We see many targets currently set simply to secure approval of the pay arrangements at the Annual General Meeting, rather than for the purposes of the business - and shareholders have a wide disparity of views on what targets are acceptable.

Targets tied to strategy are often woolly, only measuring a component of the strategy for an amount unrelated to the overall value allegedly created by the strategy and if the strategy is wrong, we’ve all lost anyway. We’re also aware of arguments by analysts and academics regarding the efficacy of performance conditions and their potential negative impacts more generally on the wider economy. 

Effect of our proposals on executive pay

The package we have suggested rewards long-term growth in a company’s share price and therefore it follows the success of the business. Does it incentivise executives?  Ideally, yes, towards long-term sustainable performance that takes account of all factors: business performance, customer satisfaction, social and environmental impact. If these factors are ignored, the long-term success of the company is undermined. These proposals provide flexibility for boards to work with executives on managing performance for the long-term – the executives are not concentrating on particular targets to the detriment of overall performance but instead are more closely aligned with long term financial and societal sustainability. 

A good board should be aiming to achieve long-term success and, in the UK at least, engaged shareholders acting in accordance with the UK Stewardship Code should be contributing to and reviewing the performance of the business.  One of the benefits of these ideas is that boards and shareholders would spend far less time discussing pay.