Theresa May on Corporate Governance: A misguided approach?

When last I wrote, I rose some preliminary objections to the idea of employee representation on corporate boards in the UK. I am not against strengthening the position of employees because I do not believe the current 'normative consensus' espoused by Hansmann and Kraakman: that the best way to achieve aggregate social welfare is through running the company in the collective interests of shareholders.

However, I noted that giving employees a voice on the board would be nothing more than a palatable political response because of the legal structure in companies it probably would not change the way companies operate. An employee representative would be under the same duties as any other director and it may cause new conflicts of interest or raise questions as to their independent judgement.

Now, fortunately, her government appears to have rowed back from this position and it is being reported instead that the proposed reforms will include:

1. Introduce corporate governance codes to private companies
2. Require companies to publish pay ratio between CEO chief executive and average employee
3. Improve effectiveness of remuneration committees and the extent to which they should consult shareholders and the wider company
4. Introduce binding votes on executive pay packages

The reasons behind this reform are, supposedly, to 'increase public trust in business in the face of the rise in anti-globalisation and anti-business sentiment'.

In response to this, the common objection is dusted off that more controls on business and boards will lead to some sort of mass exodus of top management talent from the country, just as there was a mass exodus from Britain after Brexit and America after Trump... as if the only thing tying management to this country is whether or not shareholders have a binding say on their pay.

Yet, what I object to under these proposals is the government's inability to think outside the box. Everytime, there is a scandal we hear the same story: "More shareholder power", that is the answer, despite seemingly ignoring considerable evidence that shows increasing shareholder power does not improve business.

There is the work from Cheffins that shows increase in investor confidence often comes from essentially soft forms of control rather than granting shareholders more rights.

There is work from Armour, Siems et al that shows increasing shareholder power in some cases decreases prosperity as it significantly relates to reduced public listings.

We must also consider some of the seminal work on agency theory by the likes of Fama, who highlighted matters such as portfolio theory. Shareholders diversify their risk and have little incentive to monitor one company. There is also the problem of information asymmetries between company and shareholder, that even if they did have the incentive they may not be properly informed to make good or fully informed decisions.

There is also the fact the government point to other countries' practices, such as the US, France, and Australia, but ignore work by Tubner that highlights the impact of developing legal systems by analogy or legal transplant can result in legal irritants as laws operate out of context. Not to mention using Australia as an analogy for legal development of strengthening shareholder power ignores there own reforms of removing the 100-member rule that allows 100 shareholders to table resolutions at annual general meetings.

Then you have my own current work (forthcoming, so don't want to give too much away just yet) that shows even if shareholders tried to legally enforce anything against the company, the courts are parsimonious in allowing shareholders to enforce the company's rights due to restrictions on locus standi.

So, I am not sure the case is really made out, that the way to improve public confidence in business is to give shareholders more power. It is built on a faulty premise that: (1) we trust shareholders to make the right decision, or any decision at all; and (2) the faulty premise that the best way to achieve aggregate social welfare is to run companies for the shareholders' collective interest.

This begs the question, of course, what should we do? Now, I have many angles I could take on this, but I draw attention to Cheffins' work on whether law matters, and I also draw inspiration from Schynder's recent paper on why should law matter.

It would appear that the objective of reforming the law, i.e. why should law matter, is to improve public confidence. It does appear there are other objectives, such as deterrence, but confidence appears to be the main concern. The reasons for this are highlighted in the news article such as 'good governance helps companies take better decisions, for their own long-term benefit and the economy overall'; and 'businesses are a pillar of our society, creating employment opportunities and contributing significantly to funding our country's public services'. Seemingly if we are confident in what businesses are doing we can rely on them and we as the public and consumers become more confident in the market and continue to spend.

Cheffins points to the different ways investor confidence is improved, noting this is not achieved through increasing their rights. Factors such as financial intermediaries and the stock exchange are better at achieving this.  One must stress that this looked at increasing investor confidence, so one must be careful in drawing an analogy between investor and public confidence. But from this observation our working hypothesis could be increased shareholder rights will reduce public confidence in business.

It is taken from this that increasing shareholder rights we would observe a decrease in public confidence in business. While I said it was a danger to draw analogies with investor confidence as to whether increased rights would reduce public confidence, the hypothesis can be supported by the idea that shareholders, with their lack of incentives, will fail to monitor the company properly to increase confidence; those that do monitor the company will only do so to increase their own personal wealth; and when things do turn sour shareholders will lack the appropriate legal mechanisms to enforce the desired standards through the courts or company resolution.

If we want to increase public confidence we need more imaginative ways of doing that. Now, I am openly in favour of good regulation of business. I am not necessarily going to say what regulation that should be, as I do not think it is a matter for company law, nor is there the space or time to do so here. But, for example, employment law could be strengthened to support the statement above. That we rely on business for employment opportunities. We are not going to be confident in business if we feel they can remove us from our role in favour of short-sighted profit. So getting the balance of employment law right can help increase confidence. Yet, this Conservative government has gone about restricting employment rights.

This then boils down to what I said previously, these reforms are nothing more than palatable political responses.

SSAHRI Research Conference

As part of my research grant I have been asked to produce a poster about my research. I will be presenting it next Wednesday at Hertfordshire College Lane for anyone in the vicinity. I focused on the variable of remuneration from the study given the limited room to try and explain every variable and point from the study in a single poster.

Directors' Remuneration Reporting Regulations

A draft of the directors' pay regulations that is due to be laid before Parliament in the next couple of weeks can be found here.

When reading the following should be noted:

- There cannot be any further changes to the regulations, however, they may be required, as a result of the scrutiny process, to make some further drafting changes
- The regulations are still subject to Parliamentary approval

Part 3 is perhaps most welcoming for anyone researching remuneration as it introduces a single total figure for annual director remuneration.

Directors' pay: Guide to government reforms: It is not transparency it is simplification

I am thinking these reforms are as watered down as I was on my way to work this morning. The government has published its report on directors' pay reform proposals.

These plans are to strengthen the hand of shareholders and increase transparency. Well I think transparency is the wrong word because that implies more disclosure. Well in fact most of what is being proposed is already disclosed in most if not all annual reports. What these proposals are, is at best simplification.

I do not think I have to discuss the proposal to give shareholders a binding vote to a great extent. This is simply a bad idea. The government has pandered to its audience that believe shareholders own the company and somehow employee the directors. Quite simply they don't. The company as a separate legal personality appoints directors to undertake responsibility for its assets. It is for the company to reward its directors, not the shareholders. But for this to remain viable and for there to be a reduction in agency costs there needs to be a body of independent directors who reward the executive directors who actively run the company. This is where the real problem has stemmed from. These independent directors only became prominent on boards when they became useful to the executives, i.e. through helping in strategy and advice. Supposed independent non-executives have become increasingly involved with the running and strategy of the company which reduces their independence.

Thus I remain unconvinced that shareholders deserve a stronger hand. They buy shares in a company, they do not own it. If they do not like what the bought then they can sell it.

If remuneration is going to be managed properly you need to ensure that the non-executives who are deciding on remuneration are truly independent. This does not mean all non-executives need to take a step back, just those deciding remuneration. The Corporate Governance Code or the Financial Reporting Council is suggesting to revise the Code with measures on restrictions in regard to executives sitting on remuneration committees at other companies. This is probably a positive step, but one from the FRC rather than the government proposals. See here for relevant links.

For some of the proposals...

It would be interesting to see how the government tries to disclose details of the directors' employment contracts. Their rights as an employee are separate for rights as a director. I am not quite sure if this is something that should be published in annual reports. More information needed though before further comment.

The proposals want details of what directors will get paid for performance that is above, below or on target. Well anyone who owns a calculator could figure that out from the annual report already. They are required to disclose the shares awarded in a particular year and share price they were awarded at. They also publish the criteria that performance is measured against at the percentage that will vest depending on what targets they meet. Some firms do in fact already publish an estimated value at maximum vesting of the awards.

Thus this point does highlight that it is simplification and not increased transparency.

They also want information on the change of profit, dividends and the overall spend on pay. Well yet again this information is available through the annual reports. It is just more simplification.

They also want material facts taken in to consideration when setting pay to be published. Well let us face it, that is not worth the paper it is written on. Not to mention in most cases companies do already publish this. BP for example after the oil spill detailed their consideration of that matter in awarding remuneration. It did not stop their chief executive resigning that year on a package worth well over £5million if I remember correctly. What is the Government expecting from this proposal. A declaration that they considered these wider interests and then ignored them anyway. Increased evidence of watered-down simplification.

Table B of the proposals in the report do not seem to have any differences from what is already required of companies in annual reports. The requirement of a total single figure of remuneration does require companies to publish a single figure that includes variable pay and pensions. Again, the trusty calculator could have already done this without the need for reform. Apparently this figure will be calculated using a methodology complied by the FRC to include actual pay earned rather than potential pay awarded. However, the report does not clarify how this will then encompass pensions since this is never pay earned and is merely a debt on the company's balance sheet.

These are early days though. The next steps are for the government to bring forward reforms to the Enterprise and Regulatory Reform Bill as well as publishing revised Regulations setting out what companies must publish on directors' pay.

Executive Remuneration and banks

I have blogged elsewhere briefly about executive remuneration see here.

According to a recent survey from Manifest, see here, executive pay was up by 10% in FTSE 100 companies in 2011 but in more than 25 companies the rise was greater than 41%.

So, who is dragging this figure up? Such averages would suggest outliers. So from my data of 30 FTSE 100 companies over 5 years 2006-2010 below are two tables of accumulative executive remuneration. The first is the mean and median of executive remuneration which includes: Salary and benefits, annual bonuses, share options exercised, and estimated value of long term incentive schemes.

The second table is the mean and median of executive remuneration from the banking sector.

Executive Remuneration FTSE 100	2006	2007	2008	2009	2010
Mean	£13252224	£14015869	£12873733	£12842835	£15786086
Median	£10688919	£12181900	£11690076	£8715581	£13254605

Executive Remuneration FTSE 100 (banking sector)	2006	2007	2008	2009	2010
Mean	£26537106	£27249329	£25528610	£18476199	£25184382
Median	£23432917	£22214810	£22349487	£17130259	£22695000

Thus it is no great surprise to find the banking sector is the one that is dragging up remuneration. The mean between 2009 to 2010 itself saw an increase of 26.6%. However, this data is only descriptive and accumulative. Further evidence from the data also shows a significantly larger ratio of long term incentives to base salary in the banking sector. Thus, whilst the figures are high not all of the figure represents money earned. The long term incentive schemes is merely an award that is subject to performance and service conditions, see here for a little more detail.

If you haven't got anything nice to say... don't say anything: The Company Remuneration Bill

Ok so the title of this post is a bit of a misnomer. I do have one good thing to say. Good thing to say about what? Well I am referring to the Company Remuneration Bill that received its first reading in the House of Lords today. The triumphant Bill consists all of four sections. This Bill is, however, unlikely to become law, see here, but below I shall highlight some problems that may be informative for any regulation the government does eventually introduce.

So let's deal with each section in turn (excluding section 4 which is merely stating its application):

Section 1(1): Decisions of remuneration committees as to the remuneration of the directors and five highest paid employees, before implementation, must be ratified by an ordinary resolution.

Comment:
I have repeatedly pointed out apathy amongst shareholders. Ok yes there has been a bit of a rebellion as of late. But if we are truly honest most of that hype has come from the media. How long will this "shareholder activism" actually last? Not long.

I have also banged on about better non-executives on remuneration committees yet there is no mention of non-executives anywhere in the Bill. Surely the pay packages that were awarded to the directors at Aviva show a complete disregard for common sense amongst non-executives. If non-executives did their job properly there would have been no need for this tighter regulation.

With that in mind there does need to be some mechanism to prevent excess beyond non-executives. As the crisis highlighted, remuneration continually rose as it was a way of attracting the best talent with no consideration of the actual amount. Thus the formation of an independent regulator whom shareholders could complain to would be more desirable surely than trying to coordinate large groups of shareholders in public companies?

Section 1(2): Such decisions MUST be voted on in a secret ballot by all the company's employees, although this is not legally binding

Comment:
Yes this is a section. You have a remuneration committee, shareholders, and now employees second guessing what you are going to get paid. So much uncertainty and so many voices. Why do the creditors not get a vote if you give one to employees? The non-executives are there to be independent and award remuneration. If they do not do their job correctly they should be fired. The term overkill is certainly coming to mind with executive remuneration.

The wording is very interesting. The words "must" and "all" seem a bit optimistic. Are all the employees really going to vote? Did all public sector workers vote whether to strike?

Section 2(1): Where a ballot is held under section 1(2) this must be reported in the following year's annual report

Comment:
Well this section slightly ignores the wording of the one prior. If the decisions must be voted on by all the company's employees then ipso facto it will need to be published under section 2(1). Surely all that needs to be said under section 2(1) is the results of the ballot must be published if one is always required to be made.

Section 2(2): The remuneration report must prominently feature the remuneration ratio between the highest paid director or employee and average remuneration of the lowest remunerated 10% of employees.

Comment:
So this is something I actually agree on. In fact I do not think it goes far enough. I feel that long term incentive plans should probably have employee remuneration criteria attached to it. As such executive remuneration should not go up when employees are made redundant. At least some publication of the ratio will put things in to perspective for directors by physically having to consider the differences.

In fact this may be great for executives if they decide to fire everyone in the lowest 10% since the ratio will decrease... certainly food for thought as to the wording and ratio to be disclosed...

Section 3: Interpretation

Comment:
OK so I wish to focus on the interpretation of one particular word. That is "remuneration". This section defines remuneration as "all rewards and benefits, including, inparticular, share options, bonuses, beneficial rights and salaries.

Well for anyone who knows even the slightest bit about remuneration this section is as confusing as it can possibly get. In the UK remuneration already has two meanings where there are already discrepancies. So this is in fact a third definition that clearly has no consideration as to the differences between the different types of compensation paid to directors. I have discussed these different definitions and award schemes elsewhere, see here.

The definition says all rewards and benefits. Well surely that includes long term incentive plans? But how do you accurately quantify long term incentive plans? A director is not given the shares in long term incentive plans upon award. He has to satisfy criteria over a three year period. If that criteria is not satisfied then the shares do not vest and the director gets nothing. So do we assess the remuneration for Long Term Plans at all when working out the ratio between highest and lowest paid in accordance with section 2(2)? Do you calculate long term plans on the value at the time of the award by multiplying share price by shares awarded; or simply go on the value of the shares that actually vest?

Long Term Plans are also not the only problem. Are pensions to be included? Pensions again are not monies paid by the company. They are merely a debt on the company's books.

Share options also suffer from the same problem as Long Term Incentive Plans. A director only gets rewarded if he exercises those options. So at what point do you assess their value?

Finally as I mentioned, how does this definition of remuneration interplay with the other two found in the Listing Rules and the 2008 Regulations? Surely three definitions of remuneration is more complicated than one. If the idea was to simplify remuneration, I would not call this a good start. The problem with trying to simplify is that it will probably make it more confusing if you attempt to generalise remuneration. Although the rules may seem complex to an outsider, to someone with knowledge of the area the purposes behind the rigid definitions and different mechanisms become clear and quite simple to understand.

My final thought is this goes to show something so true in company law. If you do not regulate yourselves properly, the government will impose something worse.