Effectiveness of Shareholder Voting on Executive Pay: UK Perspective

7/28/2019 Effectiveness of Shareholder Voting on Executive Pay: UK Perspective

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LLM CORPORATE GOVERNANCE AND LAW/GRAD ICSA

Effectiveness of

shareholder voting onExecutive pay: UK

perspectiveLegal Dissertation U16187 -11B

Randhir Mehrotara UP639100

4/2/2013


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Contents

Abstract 2

Introduction 3

Chapter 1 5

Chapter 2 12

Chapter 3 39

Conclusion 50

Bibliography 54


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Abstract

This study attempts to demonstrate how the Advisory vote on Pay hasnt met the

challenges put forward before it - namely to match performance to pay for the seniormanagement teams. The new development of the Binding vote is a reactive attempt to

curb excessive remuneration. The main positives are the transparency in remuneration

with clarity in narrative reporting. Whether such legislative muzzles are required remains

to be seen. It is expected, the Binding vote will, over time, set best standards for

benchmarking pay practises among peers and increase the engagement with

shareholders.


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Introduction

The nature of the problem

FTSE100 chief executives were last year awarded average total remuneration of 4.8m,

a rise of 12 percent, which in the context of stagnating earnings for the vast majority of

the populace, might seem exorbitant, as it is over 200 times average total pay in the

private sector of just under 24,000 (figures from the Office for National Statistics).1

According to a study conducted by the consultancies Manifest and MM&K, main

problems with pay are in the largest companies, where directors' remuneration - while

large in itself - is a small proportion of total costs. 2 Basic pay for the bosses of the UK's

biggest companies rose 2.5 percent. It was the variable elements of pay - so-called long

term incentive awards and deferred bonuses - that soared.

Over the past two decades, Companies have struggled with addressing the principal-

agent problem and improving the link between pay and performance. This led to a

significant change in the structure of remuneration where most companies now pay a

much larger proportion of remuneration in the form of variable and deferred pay.

Most directors pay packages contain the following elements:3

Base Salary: usually determined through benchmarking, based on general industry

salary surveys supplemented by detailed analyses of selected industry or market peers.

Annual Bonus/Incentive Plans: Typically bonuses pay out an award based on the

performance of the company over no more than one year, usually the previous financial

year. The payments may be made in cash or shares or a combination.

Deferred Bonus Plans: annual bonus plans which incorporate an element of deferral.

1http://www.guardian.co.uk/business/interactive/2012/may/09/shareholder-rebellions

2http://www.bbc.co.uk/news/business-18407587

3http://www.bis.gov.uk/assets/biscore/business-law/docs/e/11-1287-executive-remuneration-discussion-

paper.pdf
http://www.guardian.co.uk/business/interactive/2012/may/09/shareholder-rebellionshttp://www.guardian.co.uk/business/interactive/2012/may/09/shareholder-rebellionshttp://www.guardian.co.uk/business/interactive/2012/may/09/shareholder-rebellionshttp://www.bbc.co.uk/news/business-18407587http://www.bbc.co.uk/news/business-18407587http://www.bbc.co.uk/news/business-18407587http://www.bis.gov.uk/assets/biscore/business-law/docs/e/11-1287-executive-remuneration-discussion-paper.pdfhttp://www.bis.gov.uk/assets/biscore/business-law/docs/e/11-1287-executive-remuneration-discussion-paper.pdfhttp://www.bis.gov.uk/assets/biscore/business-law/docs/e/11-1287-executive-remuneration-discussion-paper.pdfhttp://www.bis.gov.uk/assets/biscore/business-law/docs/e/11-1287-executive-remuneration-discussion-paper.pdfhttp://www.bis.gov.uk/assets/biscore/business-law/docs/e/11-1287-executive-remuneration-discussion-paper.pdfhttp://www.bis.gov.uk/assets/biscore/business-law/docs/e/11-1287-executive-remuneration-discussion-paper.pdfhttp://www.bbc.co.uk/news/business-18407587http://www.guardian.co.uk/business/interactive/2012/may/09/shareholder-rebellions


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Long-Term Incentive Plans (LTIPs): LTIPs typically involve the granting of shares to

directors after a three year period upon the achievement of performance criteria, and

must include some qualifying conditions with respect to service or performance that

cannot be fulfilled within a single financial year.

Share Option Plans: Share option plans are contracts giving directors the right to buy

shares at a pre-specified price for a pre-specified period of time, which usually starts

three years after the agreement of the plan and ends no later than ten years after it.

Share option plans are non-tradable and are often forfeited if the executive leaves the

firm before they become exercisable.

Retirement Plans: Top executives routinely participate in supplementary retirement

plans in addition to the company-wide pension plan.

Argument for High Compensation/ Retaining talent

This problem is predominantly the prevalent boardroom culture and the mindset of

directors. Those who sit in the boardroom tend to have spent their working lives in a

corporate environment dominated by the idea that the only way to attract and retain top

executive talent is to pay the going global rate for the job. Similarly, the Remuneration

consultants, advising the Remuneration committees in navigating the intricacies of

increasingly complex executive compensation packages, rely on benchmarking

compensation packages of senior executives with those of their global peers. Lastly, the

independence of these remuneration consultants has been called into question as

remuneration consultants have consistently been hired by the firms in different

capacities. This has created an upward-only ratcheting system for corporate

remuneration and made boards too insulated from what's going on in the rest of the UK

economy.

The rising executive compensation packages may also be seen as the manifestation of

globalisation, as most FTSE 100 companies generate most of their revenue outside the

UK. While the economies of UK, United States and Continental Europe are posting

weak results, Asia is still booming and is the revenue driver for most multinationals.

With the London Stock Exchange becoming the listing destination of choice for global


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commodities companies at a time when the world is experiencing perhaps the greatest

commodities and energy boom in history, it's perhaps not surprising that the pay of

those who run the likes of Xstrata, Rio Tinto.4

Recognizing the issue of shareholder voting on Executive Compensation is a complexone, this study considered the inputs of major stakeholders in the consultative process

such as Association of British Insurers (ABI), Investment Management Association

(IMA), Public Interest Research Centre (Pirc), Proxy voting firms Manifest and

ISS/GlassLewis along with consulting firms Deloitte, PWC. Viewpoints of additional

stakeholders such as FRC,CBI, TUC, IoD, IDS, ShareSoc and the main professional

accounting and governance bodies such as ICAS/ ICAEW / CIMA / ACCA and ICSA

were also considered.

With greater media attention bringing the issue of linking Executive Pay to Performance

into the forefront, it leads to the asking of two primary questions:

1. Is there a need for a Binding vote?

2. Are current proposals a step in the right direction?

This study will attempt todetermine how effective shareholder voting on Executive Pay

has been in matching Pay to Performance

Objectives:

What is the shareholder vote on Executive Compensation?

Trace the development of the Advisory Vote and Reporting Requirements

Examine the workings and effectiveness of the current system

Explain the new proposals and what effects they may have

Conclude whether the proposed changes are required

http://www.bbc.co.uk/news/business-13594215http://www.bbc.co.uk/news/business-13594215http://www.bbc.co.uk/news/business-13594215http://www.bbc.co.uk/news/business-13594215


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Chapter 1

Evolution

This chapter aims to provide a summary of the evolution of company law reporting

requirements on directors remuneration.

Oversight of corporate governance issues is a responsibility placed on investors in the

UK. A good example of how the UK government encourages increased stakeholder

involvement is by reviewing the Directors Remuneration Report Regulations 20025

(later incorporated into the Companies Act 2006)6 but it might be prudent to first

examine the development of shareholder voting on remuneration.

The earliest reference of directors compensation reporting requirements can be found

in Section 148 of the 1929 Companies (Consolidation Act) which required companies to

provide details of directors compensation to shareholders on demand.

Developments under Section 196 of the Companies Act 1948 required a companys

accounts to show:

sum of directors' payments(salaries, bonus payments) ;

sum of past and current directors' pensions; and

sum of any compensation to past and current directors for loss of office.

The development which laid the groundwork for shareholder voting on directors

remuneration was under the Companies Act 1948, Table A, where it is stated that:

The remuneration of the directors shall from time to time be determined by the

company in general meeting.7

Section 6 of the Companies Act 1967 required the accounts to show the payments ofthe chairman, and in respect of the directors, in bands of 2.500, the numbers whose

payments fell within those bands.

5Directors Remuneration Report Regulations 2002

6Companies Act 2006

7Companies Act 1948, Table A


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Companies Act 19858 consolidated and further reformed company legislation. The

provisions on directors pay were set out in Schedule 5 paragraph 22 and 25 with

provisions for the chairman at paragraph 24. The bands for directors pay were up rated

to commence at 5,000, and bands of 5,000.

The 1985 Act was amended shortly afterwards by the Companies Act 19899, and the

provisions on directors pay were moved to Schedule 6 (as given effect by section 232

of that Act).

In 2002, the Directors Remuneration Report Regulations 2002 revised section 232 and

provided that provisions of Schedule 6 on disclosure would only apply to companies that

were not quoted companies.

For quoted companies, section 234B was inserted into the 1985 Act which gave effect

to a Schedule 7A which required quoted companies to produce a directors

remuneration report for each financial year. 10 The schedule set out the details of the

report. The regulations also provided for a new section 241A of the Companies Act

1985 which gave the members the right to an advisory vote on the remuneration report.

The latest consolidation and reform of company legislation was the Companies Act

2006. The provisions for all companies other than quoted companies now appear in

section 412. The provisions on quoted companies can be located in section

420,421,422 and 439. The details of the remuneration report, formerly in Schedule 7A,

are now set out in the Large and Medium-sized Companies and Groups (Accounts and

Reports) Regulations 2008 Schedule 8.

Excessive remuneration in the UK- historical perspective

In the early 1990s, issues such as large golden handshakes, the structure of share

option schemes and pay increases disproportionate to the inflation, company

8Companies Act 1985

9Companies Act 1989

10BIS Discussion Paper: Executive Remuneration


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performance and average worker salaries caused the then Prime Minister to appeal to

directors for pay restraint.

In 1999, the Department of Trade and Industry (DTI) - currently the Department for

Business, Innovation and Skills (BIS) appointed PricewaterhouseCoopers to preparea report on listed companies regarding adherence to best practice framework on

directors remuneration set out in the Greenbury Code of Best Practice and the

Combined Code. It was discovered only 2.6 percent of the 270 firms monitored by PwC

chose to put forward the remuneration report for shareholder approval at the annual

general meeting something which the Greenbury Report 1995 had greatly encouraged.

As a result of the PwC report, the Government announced a consultation in July 1999

on measures for creating an effective and more focused way in which shareholders

could influence directors pay.

However, as the Government perhaps assuming the issue of excessive pay would solve

itself, wasted all of 2000 without announcing the outcome of its July 1999 consultation.

With growing frustration among share holders over the slowness of the Government, in

the absence of any initiative from the DTI, various investor groups independently took

matters into their own hands. By building on the push provided by the consultative

process, various ideas for improving shareholder oversight of the remuneration setting

process in additions to proposals to improve reporting were put forward.

Taking the lead, in early 2001, PIRC wrote to all 800 companies within the All Share

Index asking them to put forward a voluntary resolution seeking endorsement for

remuneration reports and notified them that PIRC would be advising clients to vote

against senior members of remuneration committees where no such resolution was

forthcoming. In a similar fashion, a group of investment managers, co-ordinated by

Hermes, wrote to companies with a similar request, suggesting also that they mightpropose a shareholder resolution on the matter at recalcitrant companies.

Approximately 10 percent of FTSE100 companies complied.11

11www.rpmi.co.uk/uploads/pdf/Say_on_Pay_report.pdf


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Finally, the Directors Remuneration Report Regulations (DRRR) came into force on 1

August 2002 and applied to companies' financial years ending on or after 31 December

2002.

The DRRR set out the need for incorporating the remuneration report within thereporting documents of a company, and also introduced a mandatory annual vote for

shareholders on the remuneration report for listed companies, in advisory form.

Listed companies are required to put their remuneration report to shareholders in

general meeting as a separate resolution. Taking a hands off approach, the

Government has typically refrained from getting involved in setting regulation in the

matter relying instead on the Comply or Explain format unless a proven necessity

arose. In its response to the Trade and Industry Select Committees 16th Report of

Session 2002-03, on Rewards for Failure, the Government stated that it recognised

best practice was the preferred option and that legislation was considered an

inappropriate route which would create unnecessary complexity and uncertainty as well

as significant regulatory burden, there are consequences should the voluntary

approach fail: the Government will be monitoring the position closely and, if need be,

will not hesitate to take the appropriate action.12

Here, it is important to understand not only the political and social context but also the

concerns raised by the practises of prominent companies in the period in question that

led up to the implementation of the remuneration report vote requirements as a

response for the need for a vehicle to allow shareholders a stronger voice on

remuneration concerns.

Here are some key examples:

At the turn of the millennium, British Airways angered shareholders by paying theirdeparting chief executive Robert Ayling compensation approximately 400 percent of

base salary. The Board of Directors, reacting to the controversy, put the remuneration

policy to a shareholder vote at the companys next AGM.

12SAY ON PAY: SIX YEARS ON - LESSONS FROM THE UK EXPERIENCE


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In 2001, a 2.5m payout to directors at Royal Bank of Scotland, following the NatWest

takeover, provoked a 17percent vote against the chairman of the remuneration

committee, Sir Angus Grossart.

At Schroders, the board tabled a resolution seeking approval for a payment of 5 millionto the departing chairman and ex-chief executive, Sir Win Bischoff. This was deemed as

a reflection ofhis outstanding contribution during the groups development and success

over a 16-year period. The resolution met with significant opposition by the

shareholders (40 percent voting against) who questioned whether such a discretionary

payment was justified given previously paid out salary, bonus and incentives schemes

had already rewarded him for company growth under Sir Wins guidance.13

In 2001,Billitons merger with BHPwas overshadowed by concerns about the automatic

vesting of share options with no connection to whether performance targets had been

met, on the completion of the merger. This met with massive opposition by

shareholders.

During 2002, 30 percent of companies put their remuneration reports or policies for

shareholder approval, up from 8 percent in 2001 and 3 percent in 2000. Larger

companies took point with 44 percent of FTSE100 companies bringing forward a

resolution, compared to 17 percent of Small Cap companies.14 The year 2002 marked

the time in the UK where two companies were forced to withdraw or amend their

proposed share option schemes due to the level of opposition. The first was Prudential

which, despite a prior consultation process, attracted 41 percent opposition for an overly

complex scheme for chief executive, Jonathan Bloomer, awarding him between 3m

and 6m (estimates varied) and around 90 percent of his salary for median

performance. Given Prudentials role as a reputed institutional investor, the issue

became one of setting best practises and benchmark of acceptability for other

companies.15 In the face of opposition from various fund managers, Prudential withdrew

the share scheme.

13SAY ON PAY: SIX YEARS ON - LESSONS FROM THE UK EXPERIENCE

14ibid

15ibid


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Selfridges amended its share scheme proposals in response to forum campaign waged

against it by institutional investors against its weak performance targets. The

amendment clarified the maximum award limit and introduced a 5 percent dilution limit

without amending the target. The resolution was passed with substantial 25 percent

dissenting vote. The company subsequently committed itself to reviewing the scheme.

Whilst share schemes attracted dissenting votes, major controversies also emanated

from other remuneration issues such as substantial increases in basic pay at BP,

Barclays and Schroders.

GlaxoSmithKline plc (GSK)

Whilst not the only company to have its remuneration report resolution defeated, GSK

was the first company to have its remuneration report defeated by its shareholders and

this served to raise the profile of the remuneration report resolution and the debate

about executive pay in general.

It was consequence of the happenings at GSK in 2003 that the remuneration report

resolution became firmly established as a key aspect of the UK governance timeframe.

The concerns at GSK related to the golden parachute provision within the pay

arrangements for then chief executive, JP Garnier, with respect to the two-year contract

provisions that GSK had agreed with him, and the US pay characteristics of the pay

structure, such as a lack of performance linkage. There was 51 percent opposition to

GSKs remuneration report vote. The total dissent of 61 percent (10 percent abstained)

made the GSK vote the highest opposition to a remuneration report at a UK company

since the advisory pay vote was introduced.

In response to this vote result, and the concern expressed by a majority of the

shareholders who voted, the company announced a fundamental review of all aspectsof its remuneration policy and practices by Deloitte & Touche. Subsequently, GSK

overhauled its remuneration plan for 2004 after extensive consultation with

shareholders and their pay consultants.


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Chapter 2

Over the last decade, it has been observed that directors pay in the UKs largest listed

companies has quadrupled with no clear link to company performance.16 The MM&K

and Manifest Executive Director Total Remuneration Survey 201117

demonstrated poorcorrelation between remuneration, performance and shareholder value.

The survey found that while the median FTSE 100 CEO remuneration was up 32

percent in 2010 from 2009, the FTSE 100 index only rose by 9 percent over the same

period. What was identified was a shift from longer-term incentives (typically over three

years) to annual bonuses, mirroring the approach that caused so many problems in the

banking sector.

The current regulatory system

Since 2002, under the current system which was introduced under The Directors

Remuneration Report Regulations 200218, shareholders in the UK have been entitled to

an advisory vote on the directors remuneration report which was designed to empower

shareholders and give them an effective and more focused way in which to influence

directors pay. The objective was to encourage shareholders to become more engaged

in corporate governance and to develop relationships with the companies they invest

in.19

The pay of the top executives in UK listed company is decided by the company's

remuneration committee which is made up of non-executive directors. The NEDs in the

remuneration committee are guided in determining the compensation packages by

remuneration consultants in trying to find the right balance between executive pay and

performance.

16Average total remuneration of FTSE100 CEOs has risen from an average of 1m to 4.2m for the period

19982010. Data from Manifest/ MM&K, The Executive Director Total Remuneration Survey 2011, May 2011,

available at: http://blog.manifest.co.uk17

18

The Directors Remuneration Report Regulations 200219

PIRC and Railpen Investments, Say on Pay: Six Years on: Lessons from the UK Experience, September 2009.

Available at: http://www.pirc.co.uk/sites/default/files/documents/SayonPay.pdf


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Development of the Current system

Prior to the new Regulations coming into effect, disclosure of directors remuneration

was based on a mixture of provisions in the UKLA Listing Rules20 (paragraph 12.43A),

the Combined Code21

and Schedule 6 Companies Act 198522

.

The Directors Remuneration Report Regulations 2002 (which amended the Companies

Act 1985) put the disclosure of directors remuneration onto a statutory footing by

requiring all UK companies listed in the UK, stock exchanges of any other EU state as

well as major US stock exchanges to:

include a detailed report on directors remuneration in the annual report; and

put a resolution on the report to shareholders at each annual general meeting.

Directors Remuneration Report Regulations 200223

Prior to the Directors Remuneration Report Regulations 200224, The UKLA Listing

Rules25already required a lot of detail about directors remuneration to be included in an

annual remuneration report. What the Regulations did was put these matters on a new

statutory footing, add new procedures that needed to be followed, add to the level of

disclosure in relation to pay policy and requirement to put the report to the annual, non-

binding Advisory vote.

Under Section 234B of the Companies Act 198526, requirement for listed

companies to prepare a directors remuneration report became a statutory

requirement, rather than only a Listing Rules27 requirement. Failure to comply

became a criminal offence making all directors liable to a fine.

20 UKLA Listing Rules21

Combined Code22

Companies Act 198523

Directors Remuneration Report Regulations 200224

ibid24

ibid25

UKLA Listing Rules26

Companies Act 198527

UKLA Listing Rules


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Requirement to have the Directors Remuneration report approved by the board

and signed on its behalf by a director/company secretary with filing requirements

with the Registrar of Companies at Companies House making it an offence to

circulate, publish or file the report, if it has not been properly signed, with all

circulated copies stating the name of the person who signed it.

Requirement of a copy of the report must be sent to every shareholder of the

company, every holder of the companys debentures and every person who is

entitled to receive notice of general meetings.

Under Section 241A of the Companies Act 1985,28 Listed companies were now

required to put the directors remuneration report to a shareholder vote. This was

the first instance of the Government heeding the prolonged and vociferous

campaign launched by institutional investors and other corporate governance

activists. Previously, the Combined Code29 only required a company to consider

whether the remuneration report should be voted on.

A Schedule 7A to the Companies Act 198530 set out the detailed information to

be included in the remuneration report. This was building on the information that

had been required in remuneration reports under the requirements of the Listing

Rules31 from years past. The UK Listing Authority amended the Listing Rules32

so that they did duplicate the requirements found in Companies Act 198533

28Companies Act 1985

29


31Listing Rules?

32Listing Rules



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Contents of the remuneration report

The detail of what was needed into the remuneration report was set out in Parts 2 and 3

of the Schedule 7A34.

Part 2 of Schedule 7A35 set out disclosure requirements on policy and performance:

The names of members of the remuneration committee, the names of any persons who

materially assisted the remuneration committee on matters relating to directors

remuneration and, if any of those who assisted were not themselves directors of the

company, information on the nature of any other services they provided during the year.

A statement of the companys policy on directors remuneration for the forthcoming and

subsequent financial years requiring companies to additionally disclose their policy on

non-executive directors remuneration

The policy statement including, for each director, a detailed explanation of the

performance conditions applicable to his or her entitlements to share awards. In relation

to each directors remuneration, the policy statement explained "the relative importance

of those elements which are, and those which are not, related to performance .

The policy statement included information on the companys policy on length of

contracts with directors, and notice periods and termination payments under those

contracts.

Requirement for a performance graph illustrating actual shareholder return on a holding

of the companys listed shares over the last five years compared with the shareholder

return over the same period on a portfolio with identically matching investment details.

Details of directors service contracts and/or contracts for services, and, in the case of

non-executive directors, letters of appointment including date, unexpired term and

notice periods; any provision for compensation on early termination; and details of any

other provisions in the contract which shareholders need to know about in order to

34Companies Act 1985,

35ibid


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estimate the liability of the company on early termination. An explanation of any

"significant award" made to a former director including any compensation package for

loss of office and details of what, if any, discretion was exercised to enable said director

to exercise options or receive other share awards.

Audited information

Part 3 of the Schedule7A36 required detailed information to be set out regarding the

actual amounts received in the financial year by way of salary and fees, bonuses,

expenses and other non-cash benefits and any compensation for loss of office or other

termination payment; information on each directors share options and interests under

long term incentive schemes; and information on each directors entitlements under

pension schemes. Additional requirements on excess retirement benefits, compensation

for past directors and sums paid to third parties for directors services.

Requirements on the auditors to report to shareholders on part 3 of the remuneration

report and state whether in their opinion it has been properly prepared in accordance

with the Act37. The auditors required to provide a statement giving details of any non-

compliance with the Act.

Summary Financial Statements

For those listed companies that send out a summary financial statement, the

Companies (Summary Financial Statements) Amendment Regulations 200238 set out

the minimum level of disclosure required in the summary financial statement: the

aggregated amount of directors remuneration, the statement of the Companys policy

on directors remuneration and the performance graph.

The Directors Remuneration Report Regulations 200239 came into effect by

applying to financial years ending on or after 31 December 2002. This required

companies with financial year ending on or after December 31, 2002 to produce a


37ibid

38Companies(Summary Financial Statements) Amendment Regulations 2002

39Directors Remuneration Report Regulations 2002,


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remuneration report satisfying the new requirements as part of its next annual report

and put the necessary resolution to shareholders at the next Annual General Meeting.

These changes placed the onus on those Non Executive Directors who were members

of Remuneration committees and were tasked in setting executive compensation to

have to immediately acclimatise themselves with the details of the Regulations. These

additional requirements along with the rise in increased complexity of executive pay

packages saw an increase of additional stake holders (pay advisors and chartered

secretaries) to get into the business of thinking about how information on remuneration

was to be collected, tabulated and presented in order to satisfy the new disclosure

requirements.

The Directors Remuneration Report Regulations 200240 were rolled over into the

Companies Act 200641 under which the current regime has been:

to require boards to disclose how directors pay is decided, the details of

remuneration, and the criteria determining the size of payments in a Directors

Remuneration Report (DRR);

to give shareholders an annual advisory vote on the DRR (which covers both

details of remuneration in the previous financial year and the boards

remuneration policy); to require prior shareholder approval of remuneration which might either have a

direct major impact on the position of shareholders or which gives rise to the

most significant conflicts of interest; and

to create remuneration committees made up of independent directors.

40The Directors Remuneration Report Regulations 2002



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How effective has the Advisory vote been in maintaining the link between pay and

performance?

An effective way to demonstrate the disconnect between pay and performance is to

evaluate average executive compensation versus performance of FTSE 100 and FTSE250 indices. Using PIRC research42 over the period 200-2008, the graphical

representation allows the opportunity to study indirectly how effective the advisory vote

on directors pay under the Directors Remuneration Report Regulations 2002 has been

in matching pay to performance.

Figure 1: source PIRC

Figure 1 provides a graphical breakdown in average executive director total

remuneration and FTSE 100 Index performance with steady, marginal growth in salaries

42Say on Pay: Six Years OnLessons from the UK


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over the 2000 -2008 timeframe with maximum growth being in LTIP. It can be also seen

how the growth in Cash Bonuses was independent of the performance of FTSE 100

index. The only period of slowdown in LTIP correlates to the stock market slump of

2002.Subsequent to the market recovery in the period during the 2003- 2007, The

FTSE 100 index grew at steady 40 percent as compared to 300 percent growth in LTIP

and bonuses.

In Figure 2, on examining a similar relationship between average executive director total

remuneration and FTSE 250 (Mid Cap) Index performance, the sharp drop in LTIP in

2003 coincides with the market slowdown in the same timeframe. The 2005 crest in

LTIP and bonuses (slightly ahead of a rise in the FTSE 250 index) represents a clear

disconnect between pay and performance as the large gains in LTIP would relate to a

depressed market timeframe of 2002-2003. Perhaps, the most bizarre instance would

be 2008 when LTIP increased 150 percent year-on-year as compared to a decline in the

FTSE 250 Midcap Index returning it to same levels as the 2000 Base year.


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Figure 2: source PIRC

It might be inferred from both graphs is the rise in average total remuneration for

executive directors was due to an increase in the use of LTIP in executive

compensation replacing previous methods of compensation such as share options

which became unpopular in usage (among the senior executives) as options tied

compensation to share prices effectively making directors remuneration subject to the

same vagaries as the share holders. As can be seen, the shift to LTIPs was the biggest

driver of executive remuneration and helped in playing a huge role in the disconnect

between pay and performance.


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Shareholder Spring

Shareholder activism always has been an issue which grabbed headlines but its the

recent rise in instances of shareholder activism in these times of falling corporate

performance which has been dubbed the Shareholder Spring and is one of this years

biggest business stories, as the recent public disputes over executive pay attest. In

corporate boardrooms all across the UK, the term activism remains a word with

negative connotations with many commentators sceptical about the value of

shareholder activism, believing it to be disruptive and short-termist. Despite this, it is a

term which has become an established part of the corporate landscape. As a result of

some high profileshareholder activist situations, there has been an abundance of press

commentary on the drive for greater shareholder involvement in setting executive pay in

relation to performance. Using the United States as a comparative model, while there is

no conclusive evidence about how effective/ineffectiveness of activism by institutional

investors particularly pension funds and hedge funds evidence about ineffectiveness

has been inconclusive. However, in the case of the UK, it has been anecdotally

observed that shareholder activism is forcing senior management to ensure better and

more open lines of communication particularly with their major stakeholders i.e.

institutional investors which is a positive development.43

This activism can be in the form of soft power where it would be no more than the

gentle suggestion of strategic direction. These suggestions do carry the implicit threat of

the exercise of statutory powers, and often this is made explicit. 44An aggressive

demonstration is in the case of some Hedge fund investors who have acquired

reputations for activism and are less likely to be welcomed on a company's register by

its board. TCI (The Childrens Investment Fund Management) is a good example of a

UK domiciled hedge fund which is extremely aggressive in matters of investor activism.

With stated aims of ensuring sound corporate governance and increased shareholder

value in the companies it takes a significant stake in, TCI has overseen the overthrow of

43http://hb.betterregulation.com/external/shareholder_activism_in_the_uk.pdf

44http://www.capitalinsights.info/news-articles-edition-4/driving-change.aspx
http://hb.betterregulation.com/external/shareholder_activism_in_the_uk.pdfhttp://hb.betterregulation.com/external/shareholder_activism_in_the_uk.pdfhttp://hb.betterregulation.com/external/shareholder_activism_in_the_uk.pdfhttp://www.capitalinsights.info/news-articles-edition-4/driving-change.aspxhttp://www.capitalinsights.info/news-articles-edition-4/driving-change.aspxhttp://www.capitalinsights.info/news-articles-edition-4/driving-change.aspxhttp://www.capitalinsights.info/news-articles-edition-4/driving-change.aspxhttp://hb.betterregulation.com/external/shareholder_activism_in_the_uk.pdf


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the CEO of the German stock exchange Deutsche Borse in which it had a majority

stake when he refused to give up plans to acquire the London Stock Exchange a

move which was in line with the Quasi-Marris45 growth objectives of the German stock

exchange but one which would have destroyed shareholder value in the short/medium

term. Not one to step away from a fight, TCI has currently sued the Government of India

in order to safeguard its stake in Coal India Limited. The differing ways in which

institutional investors approach the issue of engaging the executive board demonstrate

the level of their risk aversion and susceptibility to media glare.

Shareholder engagement with companies is nothing new. However, the current difficult

economic environment has brought concerns into sharper focus for investors faced with

the prospect of lower returns. Many of the current issues causing shareholder

dissatisfaction have been under discussion between shareholders and companies for

some time, its just that they have come into prominence recently. It could be argued

public relationships between the board of directors and institutional investors have not

been critical enough. Large institutions have been pressuring directors to curb

excessive pay, in private, for a long time, but it has only had an impact once that

pressure has been made public.

The last few months have seen many high-level executives forced out of public

companies. In most cases, the assertive shareholders exercised their options regarding

concerns they had such as executive remuneration and company performance. Sly

Baileys departure from media group Trinity Mirrorand Andrew Mosss resignation from

Aviva46 are just some examples which exemplify the phenomenon that has been

dubbed the shareholder spring. Only a handful of FTSE 100 companies Aviva, WPP,

Royal Bank of Scotland, Royal Dutch Shell and GlaxoSmithKline have had

remuneration reports rejected since pay was subjected to a shareholder vote a decade

ago.47

46http://online.wsj.com/article/SB10001424052702304765304577478172485959522.html

47http://www.guardian.co.uk/business/2012/sep/21/revolts-top-pay-bosses
http://online.wsj.com/article/SB10001424052702304765304577478172485959522.htmlhttp://online.wsj.com/article/SB10001424052702304765304577478172485959522.htmlhttp://online.wsj.com/article/SB10001424052702304765304577478172485959522.htmlhttp://www.guardian.co.uk/business/2012/sep/21/revolts-top-pay-bosseshttp://www.guardian.co.uk/business/2012/sep/21/revolts-top-pay-bosseshttp://www.guardian.co.uk/business/2012/sep/21/revolts-top-pay-bosseshttp://www.guardian.co.uk/business/2012/sep/21/revolts-top-pay-bosseshttp://online.wsj.com/article/SB10001424052702304765304577478172485959522.html


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Sir Martin Sorrell, chief executive of advertising giant WPP, suffered the biggest revolt in

recent years with 60 percent of investors voting against a 30 percent increase in his

salary to 1.3m and total remuneration of 13m.

At Smith & Nephew, 30 percent of investors failed to back the FTSE 100 medicaldevices companys remuneration report. The advisory body Pirc had recommended

voting against the pay plans which included 1.4m "golden hello" for chief executive

Olivier Bohuon noting a serious disconnect between the financial performance of the

company which had fallen short of targets and cash bonuses nearly 100 percent of

salary . In its recommendation to clients before the AGM, Pirc advised "It is unclear how

a golden hello benefits shareholders"48

At Citigroup, shareholders rejected the banks plans to pay its CEO (now ex-CEO)

Vikram Pandit $15m (9.4m) for a year when shares fell by 44 percent. Having lost its

Say-on-Pay(SOP) vote with just 45 percent voting for, Citigroups Chairman,

understanding the importance of the issue, agreed to look at a more formula-based

approach for setting up senior executives pay despite the vote being non-binding.

Cairn Energy became a further casualty of investor ire as remuneration was voted down

by 67 percent.

At UBM, shareholders dissenting vote on executive remuneration topped 46 percent.

Also notable were the revolts at Cookson Group (32 percent) and Prudential (33

percent) which maintained pay pressure on companies.

The shareholder spring has claimed the heads of reputed chief executives at

AstraZeneca, Aviva and Trinity Mirror.

48http://www.guardian.co.uk/business/2012/apr/12/pirc-smith-nephew-pay-plans
http://www.guardian.co.uk/business/2012/apr/12/pirc-smith-nephew-pay-planshttp://www.guardian.co.uk/business/2012/apr/12/pirc-smith-nephew-pay-planshttp://www.guardian.co.uk/business/2012/apr/12/pirc-smith-nephew-pay-planshttp://www.guardian.co.uk/business/2012/apr/12/pirc-smith-nephew-pay-plans


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Company

ABI

Colour

Top

RREV

Rec.

Vote

on

DRR

Shareholder concern

Salary

increase

Overall

quantum

Performance

targets

One off

Award

Use of

awards

FTSE100

WPP Against 40% X X

Aviva Against 46% X

Xstrata Against 63% X X X

Prudential Against 70% X X X

Barclays For 73% X

FTSE250

Cairn Against 33% X

Centamin

EgyptAgainst 37% X

William

HillAgainst 50% X X X

easyJet For 56% X

Inmarsat Against 60% X

UBM Against 64% X X

Exillon

EnergyAgainst 65% X X

Premier

FarnellAgainst 68% X X

Spirax-

SarcoAgainst 69% X


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Hansteen Against 70% X

Afren For 71%

Figure 3 Source Keppler Associates

Does the Advisory vote on Remuneration work?

By looking at the 2012 Remuneration season to date and the data on the Shareholder

Spring, research shows ABI issued red top (grave concerns) and amber tops (some

concerns) guidance on the remuneration policies of 35 percent of FTSE 350

companies49 where the most common areas of concern were the amount and structure

of recruitment, retention and golden handshake payments; directors compensation

perceived as unwarranted by major stakeholders; deficient exposure on the connection

between pay and performance.

From Figure 3 above, some of the companies with the lowest approval votes on their

remuneration policies were:

WPP, where ABI red topped and issued a guidance against its remuneration policy ,

faced a situation where 60 percent of the shareholders voted against the Directors

Remuneration Report due to perceived disproportionate salary increase of its CEO.

In May, 54 percent of insurerAvivas shareholders voted against its DRR due to a

perceived mismatch between CEO pay and performance causing CEO Andrew Moss to

step down. ABI, in itsguidance, had red toped (citing grave concerns) and issued a

guidance against Avivas remuneration report.

Xstrata, amber topped by ABI, received 36 percent of its shareholders voting against

its Directors Remuneration Report due to LTIP awards of exceptional size.

Barclays, where ABI amber topped and issued a guidance against its Remuneration

report, faced a situation with 27 percent of its shareholders voting against its executive

pay package. What makes it particularly noteworthy is almost 21 percent of

49Keppler Associates Report


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shareholders voted against the re-election of remuneration committee chairman, Alison

Carnwath.

Ferri and Maber discovered increased sensitivity to CEO pay in times of poor

performances with particular focus on golden handshakes.50

It was surmised thatmanagement teams proactively acted to avoid confrontations with majority stakeholders

in the AGM in the face of high amount of dissent on executive pay thereby attempting to

reach a mutually acceptable solution.51

Figure 4: Source IDS52

Figure 4 evaluates the annual percent change in total earnings in Year 2011 for FTSE

100 CEOs and discovered an average increase of 14 percent which was significantly

lower than the 43 percent increase for the year before. The large increases can be seen

in the case of mainly commodity firms which posted impressive results due to a global

rise in commodity prices. The presence of ARM can be explained due to its significant

growth in the mobile phone chipset manufacturing market. By referencing the

companies in Figure 4 with the shareholder voting patterns on their Remuneration

Reports, it was discovered that rather dissenting Advisory Voting , it was the past three

to five year performance of the companies which affected CEO pay negatively.

50Say on Pay Vote and CEO Compensation: Evidence from the UK

51http://hbswk.hbs.edu/item/6253.htmlJulia Hanna

52http://www.ft.com/intl/cms/s/0/8e30409e-e86e-11e1-b724-00144feab49a.html#axzz2BgBSM78F
http://hbswk.hbs.edu/item/6253.htmlhttp://hbswk.hbs.edu/item/6253.htmlhttp://hbswk.hbs.edu/item/6253.htmlhttp://www.ft.com/intl/cms/s/0/8e30409e-e86e-11e1-b724-00144feab49a.html#axzz2BgBSM78Fhttp://www.ft.com/intl/cms/s/0/8e30409e-e86e-11e1-b724-00144feab49a.html#axzz2BgBSM78Fhttp://www.ft.com/intl/cms/s/0/8e30409e-e86e-11e1-b724-00144feab49a.html#axzz2BgBSM78Fhttp://www.ft.com/intl/cms/s/0/8e30409e-e86e-11e1-b724-00144feab49a.html#axzz2BgBSM78Fhttp://hbswk.hbs.edu/item/6253.html


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Was the dissenting Advisory vote ever ignored?

While the Shareholder Spring movement was successful to a very large extent in

bringing the issue of excessive and disproportionate executive pay to the forefront

causing a majority of the firms facing a large dissenting vote to voluntarily amend theDirectors Remuneration Report to appease their major stakeholders particularly the

institutional investors, there is always the instance of someone who wants to buck the

trend.

Using an example from 2012, William Hill was amber topped by ABI citing concerns on

its Remuneration Report. Despite having narrowly avoided defeat with 49.9 percent of

its shareholders voting against its executive pay report where the retention award for

the CEO did not demonstrate any additional performance linkages. Here, shareholders

questioned why the CEO was receiving a retention bonus of 2.1 million for just doing

his job. Despite these misgivings of the shareholders and the narrow margin by which

the Advisory vote on Remuneration squeaked through, the CEO was awarded his pay

package.

In 2012, SAB Miller faced a shareholders revolt with 22.7 percent of its shareholders

rejecting the companys Directors Remuneration Report. Despite investor advisory

body Pirc urging shareholders to vote against electing chief executive Graham Mackay

to executive chairman, all motions at SAB Millers annual meeting were carried, with

77.3 per cent of votes cast in favour of the pay package. The primary reason for this

could be that shareholders may be willing to look the other way when it comes to an

instance of bad corporate governance (outgoing CEO becoming Chairman) if the

rewards are there (SAB Miller had reported an 8 percent growth in revenues for the past

quarter, with a strong presence and growth prospects in the emerging markets of Asia).

This demonstrates that the vote on Directors Remuneration can be considered by some

boards and shareholders as just as what it states it is: ADVISORY. Under the current

regime, other than the reputational loss caused to the company for avoiding to take into

account a large dissenting vote on Executive Pay, if the Remuneration Report passes,


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even if it squeaks through as in William Hills case, theres nothing stopping directors

from ignoring the dissention-bad corporate governance be damned.

Similarly, it as the SAB Miller case demonstrates, if the shareholders are happy with

performance, they may be willing to look the other way when it comes to good corporategovernance.

Lessons Learned

A consequence of the shareholder spring could be if it leads to a better acceptance of

the investors who takes stakes in companies to agitate for change. In the past, these

activists (typically hedge funds) have often been referred to as being short-termist,

serving their own interests or in extreme cases, of being asset strippers yet a more

proactive role such as undertaken by this type of investor maybe exactly what the

doctor ordered for many of these firms.

Under the current regime, the resolution to approve or reject the remuneration report

has no legal effect the Regulations say that simply putting the remuneration report to

a vote does not make any directors remuneration conditional on the outcome of that

vote. Therefore, regardless if a companys shareholders do not approve the

remuneration report, it has no legal effect on past or future payments to directors.

Similarly, the company would not be in breach of the Act if it ignored the outcome of the

vote and implemented its defeated remuneration policy anyway. In practice, few listed

companies would take the risk of incurring the wrath of their institutional shareholders

flouting shareholder opinion as it is likely to be treated as a vote of no confidence in the

remuneration committee, if not the board.

With level of dissent votes on Remuneration issues typically being 10 percent, a 20

percent dissent vote at a shareholders' meeting would be easily enough to tell thedirectors that there was serious dissatisfaction. The high percentages of dissenting

votes in the above examples demonstrates the fact that executive pay should be

aligned with long term share holder value.


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Statistically, the average level of dissent against remuneration reports in FTSE350

companies was around 5-6 percent in the four years after the introduction of the vote.53

It has been the emergence of a number of high profile cases which brought the issue of

shareholder voting on the remuneration policy to the forefront.

The proportion of dissenting votes reduced to around 3 percent in 2008 but the financial

crisis predictably led to an increase in shareholder activism and in 2009, around one

fifth of FTSE100 companies had more than 20 percent of their shareholders withhold

support for their remuneration reports.54 The frequency of such significant votes against

has since declined, However, this has increased dramatically in the individual cases

which continue to attract a great deal of attention. A large disconnect between pay and

performance may be an indicator of failure of corporate governance in the organisation

in differing areas.

Using Barclays as an example, it can be demonstrated how a behind-the-scenes

meeting of institutional investors of the banks with Barclays chairman Marcus Agius

enforced a compromise solution by the bank whereby making concessions on the

bonuses of the chief executive Bob Diamond and finance director Chris Lucas satisfied

some institutional investors like Standard Life Investments. Here, Diamond and Lucas

agreed they would receive only half of their bonuses awarded for 2011 until negotiated

targets for the bank had been met.

In other cases, it might be surmised that the companies large percentage of their

shareholders voting against their Directors Remuneration Reports thought it would be

prudent to comply with the demands of the shareholders and negate the object of

contention. The primary reason could be Reputational Risk Management as the

principal negative fallout of ignoring a large dissenting vote could only alienate the

crucial institutional investors, who can play an important part in a companys long termstrategy.

53PIRC and Railpen Investments, Say on Pay: Six Years on: Lessons from the UK Experience, September 2009.

Available at: http://www.pirc.co.uk/sites/default/files/documents/SayonPay.pdf54

PwC, Executive Compensation: Review of the Year, 2009. Available at:

http://www.pwc.co.uk/eng/publications/executive_compensation_review_of_the_year_2009.html


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Shareholder Spring and the political class

In his statement in January 2012, PM David Cameron stated says it is wrong for

executive pay "to keep going up and up and up" when the companies have not been

very successful. He told Andrew Marr that such awards were "frankly ripping off theshareholders". He outlined proposals promising shareholders a "clear transparency, in

terms of the publication of proper pay reports and binding shareholder votes on

executive pay, in an effort to deal with excessive salaries citing a "market failure", with

some bosses getting huge rises despite firms not improving their performances. 55

Cameron gave his speech following the publication of Pay and performance:

creating a fairer share of rewards, where the Institute for Public Policy

Research(IPPR) suggested CEOs in 87 of the FTSE 100 companies took home an

average of 5.1m in basic pay, bonuses, share incentives and pension contributions in

2010-11 which represented a year-on-year increase of 33 percent, while the average

increase in market capitalization of the firm was 24 percent.

Cronyism

In his January 2012 with the Sunday Telegraph, PM David Cameron tried to create the

case for coming to grips with the merry-go-round cases of remuneration committee

members, sitting on each other's boards and handing out each other's pay rises."

Similarly, Nick Clegg,(leader of Liberal Democrats and current deputy PM) tried to win

the war for sound bytes by denouncing the current structure of remuneration

committees calling it crony capitalism and closed shops of vested interests in which

senior business figures appeared on various company boards, often setting each

others pay. Policies under consideration include barring executive directors at FTSE

100 companies from chairing remuneration committees at other companies. Not to beleft behind, Labour's Leader (Ed Miliband) and Shadow business secretary (Chuka

Umunna) both took the opportunity to push for what they termed responsible

capitalism pushing forth their measures to tackle high executive pay which include

55http://www.bbc.co.uk/news/uk-16458570
http://www.bbc.co.uk/news/uk-16458570http://www.bbc.co.uk/news/uk-16458570http://www.bbc.co.uk/news/uk-16458570http://www.bbc.co.uk/news/uk-16458570


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greater transparency by simplifying remuneration packages as well as forcing

companies to publish a pay ratio between the highest paid executive and the company

median average at the same time, placing an onus on the government to publish a

league table highlighting the biggest pay gaps. In the name of accountability, Labour

promoted putting an obligation on investors and pension fund managers to disclose how

they vote on remuneration packages. 56

While Investigating claims of cronyism, investor advisory firm Manifest carried out a

study of the annual reports of FTSE 100 for the year 2010 and did not discover any

such kind of blatant cronyism in the boardroom existing. Contrary to popular

misconception, the study readily demonstrates the existing provisions of the UK

Corporate Governance Code have proven effective in that there are very few cross

memberships of remuneration committees and the overwhelming majority of FTSE 100

remuneration committee members do not sit on any other FTSE 100 remuneration

committee. Summarising:

Only 52 FTSE 100 directors sit on another FTSE100 board as NED, or only 5

percent of FTSE 100 directors;

Of these, just 20 sit on the remuneration committees of these other companies;

Where an executive from one company sits as a non-executive on anothercompany's board, there are zero instances of an executive from that latter

company also sitting on the first company's board.

http://blog.manifest.co.uk/2012/01/5431.html

In other ways, there is no practical mechanism for executives of different companies to

pay lavish amounts to each other by sitting on each other's boards, in the way that Mr

Cameron or Mr. Clegg seem to believe is rife.

In November 2011, newspaper headlines were screaming 50 percent rise in average

pay for directors which led to further outbursts by the political parties who had vested

interests. The source of this data was a study published by pay research company

Incomes Data Services (IDS) stating the average pay for the directors of UK's FTSE

56http://www.bbc.co.uk/news/uk-16454102
http://www.bbc.co.uk/news/uk-16454102http://www.bbc.co.uk/news/uk-16454102http://www.bbc.co.uk/news/uk-16454102http://www.bbc.co.uk/news/uk-16454102


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100 rose 50 percent over the past year while average pay for the chief executives grew

by 43 percent.57

Looking closer to the IDS data, while base salary for FTSE 100 directors averaged a

modest 3.2 percent over the last year, it was the average increase in LTIPs and bonuspayments by 23 percent, from 737,624 in 2010 to 906,044 in 2011 which was the

reason for the increase in directors compensations. What most people failed to realise

is the valuation method used by IDS, where future bonuses that were to be vested (say

2 years hence- on achievement of certain, pre-established corporate goals by the

directors), was done at current market price, at the time of granting of the incentives. In

an environment of economic uncertainty, share holders are increasingly apt to align

executive compensation packages with a bonus structure to incite performance. For the

directors, mere acquisition of the options does not mean they will necessarily have

intrinsic value and will be exercised in the future (they could be worth nothing if the

firm fails to reach its profitability targets- an assumption totally ignored by IDS. This was

definitely the case of the banks where the current market price made it unfeasible for

senior management to exercise the options which they were awarded. However, in

IDSs method, they would be account for the salaries of the directors regardless of

exercise option).This raised questions about IDSs methodology and motivations of the

vested parties which kept highlighting the issue.58

A study to investigate boardroom pay, conducted by the High Pay Commission (set

up by left-leaning pressure group Compass with backing from the Joseph Rowntree

Charitable Trust) concluded the average pay of top executives at a number of FTSE

350 companies had risen by more than 4,000 percent in the last 30 years, with average

bonuses for directors have risen by 187 percent since 2002, without a corresponding

rise in share prices representing how the disparity between what top executives and

average workers earn has been building for many years. This report by the High Pay

57Total earnings were composed of fixed pay, salary and benefits, the value of bonuses earned during the year,

both cash and deferred, plus the crystallised money value of any long term incentive plan (LTIP) awards and the

nominal gains made on the exercise of any share options cashed-in during the year.

58http://www.incomesdata.co.uk/news/press-releases/directors-pay-report-2011.pdf
http://www.incomesdata.co.uk/news/press-releases/directors-pay-report-2011.pdfhttp://www.incomesdata.co.uk/news/press-releases/directors-pay-report-2011.pdfhttp://www.incomesdata.co.uk/news/press-releases/directors-pay-report-2011.pdfhttp://www.incomesdata.co.uk/news/press-releases/directors-pay-report-2011.pdf


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Commission was used by TUC and most of the political parties to make sure the battle

for sound bytes regarding excessive Executive pay was kept well alive. 59

The Shareholder Spring highlighted the case against bankers by bring the focus of good

corporate governance with a call to curb bonuses and other perks to fit in with agency

conflict between managers and shareholders.60

But, as demonstrated in the prominent case of Royal Bank of Scotland, another issue

crops up: the agency conflict between majority and minority shareholders. Here, the well

entrenched majority shareholders (the UK government) tended to act in their own

interests by cashing in on the popular outrage instead of concentrating on the long term

viability of RBS as a business entity or looking after the minority 17 percent non-

government stakeholders. Mr Stephen Hester (current CEO RBS) faced a thankless

task of cleaning up the giant mess he inherited at RBS, replacing Sir Fred Goodwin

after Labour PM Gordon Brown announced taking up an 83 percent stake in the bank.

Here, the real and credible option, ofrunning RBS as an outpost of HM Treasury, using

it to finance small and medium-sized enterprises (SME) and large capital projects, was

ignored. In the present climate, this would have been highly desirable- invigorating

growth and job creation in the credit crunch affected economy. Instead, the political

class decided to grant commercial autonomy to the bank, 61 and accept the status quo.

Now, four years later, the very same Labours Ed Miliband threatened a Commons vote

denouncing Hesters 963,000 payment for failure bonus when share price halved.

In the case involving Mr Hester, if payment was withheld with the focus on making

remuneration transparent, predictable and deserved,62 it would have been valid despite

Hesters successes in shrinking the banks balance sheet and winding down its

investment banking. This was standard in case of a state-controlled entity such as RBS,

where the government has a locus to intervene as an investor and there is a public right

to know how bonuses for top executives are assessed. However, it seems it was more a


60http://highpaycommission.co.uk/facts-and-figures/

61http://www.ft.com/intl/cms/s/0/c5c22adc-4a89-11e1-a11e-00144feabdc0.html#axzz1l5JSRzHK

62http://www.guardian.co.uk/business/blog/2012/oct/08/rbs-stephen-hester-share-price
http://www.bbc.co.uk/news/business-14781254http://www.bbc.co.uk/news/business-14781254http://www.bbc.co.uk/news/business-14781254http://highpaycommission.co.uk/facts-and-figures/http://highpaycommission.co.uk/facts-and-figures/http://highpaycommission.co.uk/facts-and-figures/http://www.ft.com/intl/cms/s/0/c5c22adc-4a89-11e1-a11e-00144feabdc0.html#axzz1l5JSRzHKhttp://www.ft.com/intl/cms/s/0/c5c22adc-4a89-11e1-a11e-00144feabdc0.html#axzz1l5JSRzHKhttp://www.ft.com/intl/cms/s/0/c5c22adc-4a89-11e1-a11e-00144feabdc0.html#axzz1l5JSRzHKhttp://www.guardian.co.uk/business/blog/2012/oct/08/rbs-stephen-hester-share-pricehttp://www.guardian.co.uk/business/blog/2012/oct/08/rbs-stephen-hester-share-pricehttp://www.guardian.co.uk/business/blog/2012/oct/08/rbs-stephen-hester-share-pricehttp://www.guardian.co.uk/business/blog/2012/oct/08/rbs-stephen-hester-share-pricehttp://www.ft.com/intl/cms/s/0/c5c22adc-4a89-11e1-a11e-00144feabdc0.html#axzz1l5JSRzHKhttp://highpaycommission.co.uk/facts-and-figures/http://www.bbc.co.uk/news/business-14781254


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case of the political class acting in its own interest to cash in on popular outrage with

MPs from all parties joining in the cacophony of protests, amplified by the media.

Recent developments by Stakeholders

In conjunction with the Investor Stewardship Working Party, The Institute of Chartered

Secretaries and Administrators published a consultation paper63 on improving

engagement practices between companies and institutional investors. As part of the

consultation, ICSA have spoken to company chairmen about the shortcomings they

have experienced in investor engagement

The Financial Reporting Council has published changes to the UK Stewardship Code64

to provide greater clarity on the meaning of stewardship and the respective

responsibilities of asset owners and asset managers. Since very few signatories to the

Stewardship Code have updated their policy statements since its introduction in 2010,

signatories will be required to review their policy statements annually, update them as

necessary and indicate the date of their last review.

Finally, the Financial Reporting Council is carrying out a consultation on updating the

Corporate Governance Code requiring companies to make a statement when a

significant minority of shareholders vote against a pay resolution. These recent

developments are a direct result of the increased focus brought about by the

Shareholder Spring movement.

Comparison with US

The traditional US attitude towards Corporate Governance has been if an investor

doesnt like something, they can sell their shares. This hands off approach led to

Corporate Governance failures that plagued the American Corporate landscape by

destroying shareholder value and in some cases, entire firms such as Enron, Worldcom.

In other prominent examples, inability of shareholders to stop executives such as Home

63http://www.linklaters.co.uk/Publications/Publication1005Newsletter/UK-Corporate-Update-18October-

2012/Pages/ICSA-looks-improve-shareholder-engagement-practices.aspx64

http://www.linklaters.co.uk/Publications/Publication1005Newsletter/UK-Corporate-Update-4-October-

2012/Pages/FRC-announces-amendments-UK-Stewardship-Code.aspx
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Depots Nardelli and Pfizers McKinnell, ousted for performance failures from exercising

their contractual rights to undeserved golden parachutes only added to pressure for

change. In April 2007, HPs activist shareholders in a trendsetting move, aimed at

loosening companies near-absolute control over the composition of their boards, put

forward a proposal to nominate their own candidates to the board. Despite losing the

vote, this move by HPs shareholders was hailed as a leap forward in the US Corporate

Governance environment, traditionally hampered by a decentralised legal system which

prevented federal intervention with state law on key corporate matters such as

shareholder voting. The long bull run enjoyed by US equity markets contributed to

making institutional shareholders, especially the large mutual funds and retail investors,

less keen to disturb a system that has rewarded them handsomely.

It was the financial sector crisis of 2008 that highlighted the need for governance

reforms in the eyes of investors as well as regulators. Faced with deterioration in

shareholder wealth and inability in stopping the exercise of golden parachutes by

ousted CEOs, US shareholders began demanding a non-binding annual vote on

executive compensation, similar to the UK. Within months, more than 60 companies

found themselves on the receiving end of the campaign for a say on pay. During this

period of intense scrutiny, health insurer Aflac agreed to allow shareholders to vote on

executive pay from 2009 a first in the US. At least 10 of the original 60-plus targets

caved in to the activists demands and granted investors the right to vote on whether to

introduce the measure in the future.

Barney Frank, the Democratic chair of the House of Representatives Financial Services

Committee, proposed legislation on the advisory vote. The Dodd-Frank financial

reformsof 2010 contained measures designed to push a regulatory-led approach to

Corporate Governance, with all US listed companies now required to hold an Advisory

say-on-pay vote to approve executive remuneration. Despite being a mere Advisory

vote, it served to mobilise the large-scale dissatisfaction among shareholders who found

a powerful tool to oppose management without having to incur major expenses. This

prompted boards to wake up and pay attention or risk serious reputational damage.

The best example was the public rebuke to Citigroup by its shareholders who voted to
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reject its executive compensation package at the 2012 AGM. The proxy advisory firm

ISS had recommended against (then) Citigroup CEO Mr. Vikram Pandits awarded pay

package, which wasnt based on the firms financial performance as its stock price had

declined by 90 percent over the last five years. Rather than attempting to modify it,

Citigroup pressed ahead and faced a stunning snub by shareholders. The aftermath of

this widespread dissatisfaction saw Vikram Pandit step down as CEO claiming

accountability for loss of market capitalisation and shareholder wealth.

Impediments to Shareholder activism

It is quite unusual to have more than 50 percent of shareholders voting at all. The

problem of why there isnt a great deal of activism among shareholders could be

explained by the fact share ownership of UK companies has changed dramatically over

the last fifty years. In the 1960s, the majority of shares in UK companies were owned by

individuals, many of whom took a reasonable level of interest in the companies whose

shares they owned. By the 1980s, the majority of shares were owned by UK institutional

investors such as pension funds and insurance companies. For shareholder activism to

be effective, institutional shareholders like pension funds and insurance companies

would have to get involved but they only own around a quarter of UK shares. According

to the IMAs most recent figures, pension funds and insurance companies now hold

around 13 percent of UK equities each, with an additional 14 percent held by other UK

institutional investors.65 ONS figures show that at the end of 2008, 41.5 per cent of UK-

listed shares were owned by investors from outside the UK, and individuals held just

over ten per cent, the lowest percentage since the survey started in 1963.66

Governments seeking to tackle excessive boardroom pay have repeatedly returned to

the well-worn tools of UK-style corporate governance: greater transparency and

disclosure, improving the accountability of managers to shareholders, strengthening therole of non-executive directors, and a largely voluntary system of policing corporate

governance. While each has an important role, these tools have proved themselves to

be ineffective in reining in top pay over the last 20 years.

65IMA, Asset Management in the UK 2009 2010, July 2010

66Available at http://www.statistics.gov.uk/cci/nugget.asp?id=107


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This suggests that shareholder activism alone encouraging shareholders to vote

against remuneration reports or engage with pay and performance issues in other ways

will not work now either. Shareholder activism relies on institutional shareholders, like

pension funds and insurance companies, but they only own around a quarter of UK

shares. Over 40 per cent of UK shares are held by foreign owners. Even UK institutional

investors are increasingly holding shares over shorter periods of time, making it hard for

them to have oversight of the long-term interests of companies. Most institutional

shareholdings are managed by fund managers, who tend to have large remuneration

packages themselves, suggesting they are not best placed to tackle excessive pay. The

diminished ability of shareholders to tackle excessive boardroom pay is demonstrated

by the fact that only 5.6 per cent of remuneration reports in FTSE companies were

voted against by shareholders in 2010.

Summation

At the company's annual meeting, the shareholders get to vote on what that committee

has decided, which includes all of the pay, bonuses and pension provision of the

directors of the company. Since this is currently only an advisory vote, which means that

the company can completely ignore it if it wants to. The current regulatory environment

has not been successful in demonstrating linkage between pay and performance.

Where does shareholder activism go from here? The debate on executive pay currently

focuses on new legislation proposed in the Queens Speech, which introduced greater

powers for shareholders under the current magic mantra say on pay. The current

Advisory vote meets its goal of shareholder engagement quite effectively where it lacks

is in the requirement to ensure better understanding of complex pay packages and a

binding vote on executive remuneration.

The popular perception is majority of the positive results obtained under the

Shareholder Spring have been obtained by bringing the issue of the dissenting vote in

the limelight but closer analysis shows what really worked was the traditional approach

taken by institutional investors in holding closed door sessions with the senior

management teams of the firms they had stakes in and ensuring good corporate


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governance guidelines were followed vis-a-vis executive pay. Rather than utilising all

these conversations in secrecy, an offshoot of the recent development of increased

media exposure might be setting up of informal sessions where major stake holders get

together with the boards of companies and hash out their issues regarding issues of

dissention. Such collaborative discussions among the major stake holders would

facilitate greater transparency and restore faith in the reputations of companies

adversely affected by the recent Shareholder Spring events.

The foundations laid in the shareholder spring create a unique opportunity for activists

to force engagement and achieve their goal. UK company legislation provides the

mechanics for relatively small groups of shareholders to requisition shareholder

resolutions and require companies to present such resolutions to a meeting of

shareholders. Activists can now also use the media and social media to promote

their agenda.


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Chapter 3 The Binding vote

Background

Under the CA 2006,67 quoted companies68 are required to produce a directors

remuneration report69 as part of the annual reports and accounts, and to put this

directors remuneration report to the companys members at the annual general

meeting. At the AGM, shareholders are asked to approve the report by means of an

ordinary resolution70 . This resolution is advisory in nature and the company is not

required by law to take any action in response to the vote. As such, no individual

directors pay is contingent on the outcome of the vote.

Why the Binding vote on pay policy?

The current advisory shareholder vote on the directors remuneration report was initially

designed to give shareholders a way in which to influence directors pay. However, as

can be seen from Figure 3 feedback from shareholders in the form of dissenting

shareholder voting on executive remuneration did not stop ALL the companies from

responding adequately to their concerns. There was no legally binding requirement on

companies to follow the dissenting vote, even if the remuneration report had been voted

down. In order to address these shortcomings, the Government has introduced a new

binding vote on a companys pay policy with a two fold outlook :

to empower shareholders and

to encourage improved dialogue with the companies they own.

This vote will require the support of a majority of shareholders voting to pass. What

exactly will be this majority figure is the focus of a recently closed consultation by the

BIS.

The Enterprise and Regulatory Reform Bill repeals section 439(5) of the Companies Act

2006, removing the statutory provision which currently prevents the statutory


68Quoted company, as defined in section 385 of the Companies Act 2006.

69Section 420 Companies Act 2006

70Companies Act 2006, Section 439


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requirement for a vote on the directors remuneration report having the effect of making

a persons entitlement to remuneration contingent on the outcome of the shareholder

resolution.71 This entailed changes regarding Payments to directors of quoted

companies in:

Members approval of directors remuneration policy

Restrictions on payments to directors

Payments to directors: minor and consequential amendments

Payments to directors: transitional provision72

In his June 20th 2012 statement, Dr Vince Cable, citing lessons learned from

shareholder spring, announced a comprehensive package of measures altering the

framework for directors remuneration under amendments to the Enterprise andRegulatory Reform Bill 73(Bill 61 2012-13) which is currently before Parliament. The

intent behind the Governments reforms was to provide shareholders with new powers

to hold companies to account, while making it easier to understand what directors are

earning and how it links to company performance. The Government intends all these

reforms to be enacted by October 2013. These are a far reaching package of reforms

aimed at strengthening the hand of shareholders to challenge excessive pay.

Under the new proposals of creating a Binding vote for Executive compensation, theaim is to create a more robust framework within which directors pay is set, agreed and

implemented by:

Restoring a stronger, clearer link between pay and performance;

Reducing rewards for failure;

Promoting better engagement between companies and shareholders;

Empowering shareholders to hold companies to account through binding votes.74

71 Parliament.co.uk, Explanatory notes on Enterprise and Regulatory Reform Bill

72

http://www.publications.parliament.uk/pa/bills/cbill/2012-2013/0061/13061.pdf73

Enterprise and Regulatory Reform Bill74

BIS Department for Business Innovation and Skills, Directors pay: guide to Government reforms

accessed 28 June 2012
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Effectiveness of Shareholder Voting on Executive Pay: UK Perspective

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