Unions call for tougher controls over boardroom pay

In June 2003, the UK government issued a consultative document on company directors’ severance pay-offs and their links with company performance. The move follows increasing shareholder and trade union concern over executive pay issues. Trade unions are leading calls for a tougher regulatory framework.

The issue of company directors’ pay is highly topical in the UK following regulations in 2002 to introduce a clearer role for shareholders (UK0111101N). With greater transparency has come controversy over the links between boardroom pay and corporate performance. In June 2003, the government issued a consultative document looking at best practice and legislative options concerning directors’ severance payments, with trade unions calling for a tougher regulatory framework.

The controversy over boardroom pay

In May 2003, the chief executive of the GlaxoSmithKline (GSK) pharmaceutical company, Jean-Pierre Garnier, became the first business leader to have his pay package voted down by shareholders under the new system of remuneration reporting introduced in 2002. Investors particularly objected to a severance package that Roger Lyons, general secretary of the trade union Amicus, described as 'obscene'. The Directors’ Remuneration Report Regulations (DRRR), which came into force in mid-2002, introduced new disclosure requirements for the remuneration policy of public companies and required a shareholders’ advisory vote on the remuneration report. Other companies facing criticism include HSBC, Equitable Life, BAE Systems, Corus, Barclays, Reuters, Royal & Sun Alliance and Reed Elsevier.

Much of the controversy relates not just to the scale of the awards but the link to corporate performance. Gerald Corbett of Railtrack, for example, reportedly received GBP 1.4 million on the company’s collapse, and Lord Simpson and John Mayo of the troubled electronics firm Marconi apparently received GBP 1 million when they left. Such 'rewards for failure', as the latest government consultation document is called (see below), are often the product of long 'rolling' employment contracts. The Pensions Investment Research Consultancy estimates that one in five UK directors have contracts longer than one year. These are defended by large companies on the basis of an international market for senior executives. In March 2002, BP (petrochemicals) reported a 58% salary rise for its chief executive Lord Browne to GBP 3.07 million, despite a falling stock market valuation, on the basis that 'rewards for our group chief executive ... must be competitive with the rewards of similar global companies'.

The government’s position

In June 2003 the Department of Trade and Industry (DTI) issued a consultative document called Rewards for failure: directors’ remuneration - contracts, performance and severance. The document invited views on strengthening best practice guidance and the possibility of legislation. The former includes restricting notice periods to less than a year, capping the level of 'liquidated damages', and encouraging phased severance payments. Legislative options include amending the Companies Act 1985 to reduce statutory contract periods, to which 'rolling contracts' would be subject. However the proposal included in a December 2002 Bill by Archie Norman, a Conservative MP and former chief executive of the food retailer ASDA, requiring compensation payments to be 'fair and reasonable' was rejected on largely practical grounds. This would have given boards the right to challenge contractual obligations to directors who had allegedly failed.

In her foreword to the consultative document, Patricia Hewitt, the secretary of state for trade and industry, paid tribute to the recent best practice statement issued jointly by the Association of British Insurers (ABI) and the National Association of Pension Funds (NAPF). Whilst welcoming increased shareholder activism over directors’ remuneration, facilitated by the DRRR, she also stressed that 'the government fully supports high levels of reward for high levels of success and has also made it clear that setting directors’ pay in individual companies is a matter for those companies and their shareholders.'

Trade union response

Trade union hostility to 'excessive' pay for directors reflects growing pay inequality within organisations and comes as many firms are closing final salary pension schemes to new employees (UK0301109F). In March 2002, a Trade Union Congress (TUC) report,Executive excess - time to act, noted that between 1994 and 2001 basic pay rises for directors were treble those for average employees. Similarly, an annual survey of boardroom pay conducted by the Guardian newspaper and pay consultants Inbucon, published in October 2002, reported an average annual increase in directors’ pay of 17% in 2002, following a 28% increase the year before. This occurred in a period of low inflation and general earnings growth of around 3%-4%, and when the FTSE 100 stock market index had lost nearly a third of its value. The survey found few links between executive pay and companies’ financial performance. Outgoing TUC general secretary John Monks said: 'With such excessive pay packages for company directors it is becoming clear to staff that there’s one rule for us and one rule for them.' The survey also showed huge additions made to directors’ pensions, often including more favourable accrual rates than for employees. Brendan Barber, general secretary-elect of the TUC, commented that 'it will be difficult for employees to swallow the reasons given for their diminishing pensions prospects when the generous lifestyle of executives is well provided by their schemes. The pensions double standards must end.'

The TUC’s demands include employee participation on remuneration committees, full disclosure of pay and conditions for other groups of employees and for remuneration committees to take this into account when setting directors’ pay. In May 2003, the TUC also joined the German Federation of Trade Unions (Deutscher Gewerkschaftsbund, DGB) and the Dutch Trade Union Federation (Federatie Nederlandse Vakbeweging, FNV) in issuing an appeal on excessive executive pay aimed at their national governments and the European Commission. The letter calls for mandatory binding votes on executive remuneration and compulsory disclosure of voting records by institutional investors. Although the Commission has no direct powers on executive remuneration, the internal market commissioner, Frits Bolkestein, said that forthcoming corporate governance rules would deal with the issue, including through a recommendation on directors’ remuneration. In an interview with the Financial Times in March 2003, Mr Bolkestein said that he found top executive pay 'excessive' and 'out of proportion' and attacked the practice of awarding generous stock options, arguing that it encouraged management to increase share prices rather than profits.

Employers’ views

In response to the government’s latest consultation process, the Confederation of British Industry (CBI) has set up a panel to investigate ways of enhancing shareholder involvement in setting directors’ pay and in strengthening the link to performance. Digby Jones, director-general of the CBI, emphasised that it was for shareholders rather than the government to decide issues concerning directors’ employment contracts, and claimed that any legislation on the issue 'would create confusion and uncertainty'. The CBI also strongly opposes reductions in the length of a directors’ contract below the current recommended ceiling of a year, claiming that this would merely raise base salaries and bonuses and increase job insecurity. Instead, the CBI says there is 'considerable merit' in proposals for phased payments when a contract ends prematurely.

Commentary

Executive pay has been controversial in the UK for some time. Though pay for company directors is not high by US standards, rates are significantly higher than in the rest of the EU. This is usually justified by the (unproven) argument that there is an international market for executives and that the few people who can do the top jobs are indispensable to business success. Yet the large pay rises, bonuses and preferential pensions packages repeatedly given to senior executives have become increasingly unacceptable in the face of falling share prices, job cuts and restrictions on final salary pension schemes for other employees. As Archie Norman put it, 'the current system encourages all the wrong values. It sends a message of one rule for the boss and another for the workers.'

However the obligation to hold a public vote on remuneration is beginning to hold boardrooms to account. Shareholders, including institutional investors, are becoming more active on the issue, and trade unions, employees and customer and other pressure groups are using annual general meetings to embarrass publicly companies over 'corporate greed'. Given this, the current consultation by the DTI is unlikely to lead to significant change, particularly as it focuses only on 'rewards for failure' rather than the more fundamental and general question of what criteria should normally be used to decide the remuneration of business leaders. The experience of Vodafone (telecommunications) and Marks & Spencer (retail) shows that a share price recovery fairly rapidly dissipates the concern of institutional investors over 'fat cat pay', yet whether this is the right 'incentivisation' for executives, let alone ethically justifiable, is not an issue that the DTI wishes to address. (J Arrowsmith, IRRU)