What Labour can do about executive pay

Written by: Tom Powdrill on 8 January, 2013
Filed under Economy

Last year saw an unusually high level of shareholder opposition to executive remuneration policies at UK companies. More company remuneration reports were rejected by shareholders than in any other year since the introduction of a mandatory shareholder vote on executive pay in 2002. Although a total of six defeats means that it’s still only a fraction of the total, there have been some very high-profile corporate casualties, including Aviva and WPP. These defeats are also indicative of wider opposition. Analysis by PIRC has found that the average vote against a remuneration report was around 8.5 per cent last season. That compares with an average vote against of just under 6% in 2011, and a little over 3% back in 2008.

We should not forget, and to his credit Vince Cable has acknowledged, that the governance framework within which this shareholder activism has taken place was introduced by Labour. The existing advisory vote on executive pay, now being utilised by shareholders, and the standardised reporting of remuneration, were both Labour reforms. These were significant interventions and shaped the direction of UK corporate governance.

But we should also acknowledge that much has changed since 2002. We now have extensive experience of attempting to control executive pay through disclosure and shareholder oversight alone. The results are mixed, to say the least. Labour needs once again to break new ground in corporate governance.

A review into the growth of boardroom incentive pay and its effectiveness, early in a future Labour administration, could mark an important shift in direction in corporate governance policy. Such a review should properly consider the academic evidence, drawing on the work of experts in the field. It should also seek the views of directors themselves about the value of incentive schemes. I believe that many business people share the view that the current system is not working, but feel bound by existing corporate governance dogma. We could find we are pushing at an open door. If the evidence is clear, Labour should not shy away from calling for a shift away from relying so heavily on incentive schemes.

We also need greater transparency in relation to the existing oversight of executive remuneration. Despite the general upsurge in opposition this year, it is clear that many large shareholders nod through a significant majority of company remuneration policies. It is important to know which institutions are trying to make a difference and which are not. Labour should therefore enact the reserve power in the Companies Act that would make it compulsory for institutional shareholders to make their voting records public. Asset managers and other large shareholders only have economic power through the aggregation of the public’s savings. They must be accountable for how they utilise that delegated power.

A final, essential reform is therefore the introduction of employee representation on remuneration committees. This idea was on the fringes of the executive pay debate until relatively recently, and typically only advocated by trade unions. However, employee representation on remuneration committees is one of the core recommendations of the High Pay Commission, and has also been supported by Sir Michael Darrington, the former head of Greggs Plc.

No doubt many Labour supporters would favour representation of this kind in its own right, because it would recognise employees as one of the key players in the governance of successful businesses. However, there are also some grounds for thinking that it could actually change the operation of remuneration committees in a positive way.

For example, research by Cass Sunstein has shown that when people who share the same kinds of views are put together in groups they reinforce each others’ beliefs. This can lead those groups to reach more extreme decisions than the individual members would do alone. As Sunstein has argued, this research has implications for corporate governance. Thinking about remuneration committees, the research might suggest that if they comprise solely of senior business people there may well be a reinforcement effect. Current or former directors are likely to have views about high pay that cluster towards one end of the spectrum. Including employee representation on remuneration committees could help break up this reinforcement effect.

Seeking to address executive pay through reform of remuneration committees also has the advantage of trying to tackle problematic proposals before they are finalised, rather than relying on shareholders to challenge decisions already made.

Taken together, these reforms could start to get executive pay back under control. They would also represent a significant break with the past, but that is what is now required. Human motivation is more complicated than mainstream corporate governance, and its emphasis on behavioural control through incentive schemes, assumes. In addition, relying on the market solution of more disclosure and shareholder oversight alone will see only a handful of companies face significant pressure. If we try to persevere with the existing model we are very likely to be disappointed by the results. It is time for a new start.

This is an edited extract of an article that appears in the current edition of Renewal: A Journal of Social Democracy