Remuneration in the spotlight

The current market downturn has thrown the apparent mismatch between executive performance and pay into sharp focus. Nina Röhrbein reports

Remuneration packages are in the spotlight. In late September, Stephen Green, group chairman of HSBC Holdings, told a responsible investment event in London that a more responsible approach to compensation was called for. "Compensation should be of a nature which keeps those who transact incentivised to think about the long-term issues," he said.

And he is not alone in this opinion.

Ethos, the Swiss foundation for sustainable asset management, together with eight Swiss public pension funds has filed a shareholder resolution for the 2009 annual general meetings of ABB, Credit Suisse Group, Nestlé, Novartis and UBS, requesting that shareholders be able to cast an advisory vote on remuneration reports.

"Remuneration is an important issue for all shareholders," says Dominique Biedermann, the executive director at Ethos. "First, remuneration packages are a direct cost to shareholders - especially when bonuses are very high - and can affect annual results. Last year, for example, UBS still paid bonuses of CHF11-12bn [€7-7.7bn] but did not pay any dividends to shareholders, unlike the previous year when shareholders received CHF4bn in dividends. Second, incentives such as badly structured stock-option plans can distort the implementation of company strategies. And third, wrong or exaggerated remuneration packages carry a big reputation risk, which impacts particularly sustainable investors, while companies can lose the trust of shareholders through this."

"It is the board's job to ensure that remuneration policies and practices align its executive management with the long-term interests of shareholders," says Jane Goodland, an investment consultant at Watson Wyatt. "That is a fundamental part of corporate governance. Based on the assumption that everyone is primarily self-interested, the challenge is, how to motivate people based on this assumption appropriately? How can executives be incentivised to take long-term investment decisions when his or her pay is related to short-term performance?"

She adds: "Executive remuneration can be very complex and includes various elements such as salary, performance-related bonuses, share-based incentives, pensions and other benefits. The problem is that this complexity can make it difficult to work out whether it is appropriate and likely to foster appropriate behaviour."

"Transparency is important because shareholders expect a minimum amount of information on how the system works," says Biedermann. "The structure of remuneration is crucial in order for shareholders to be able to analyse it. And it is also important to consider who decides about remuneration, only the board or also the shareholders."

According to Biedermann, the fixed salary part, which tends to be less than half of the remuneration package, is not an issue. "However, the majority is variable and has two components: a bonus for a good past performance and an incentive part for the future," he explains. "As shareholders we want to know what the maximum bonus could be relative to the fixed part. But two-thirds of companies refuse to tell us, which makes it difficult for us to vote for it. This is a big problem in Switzerland and the rest of continental Europe, with only the UK and the US being slightly more transparent."

He continues: "A lack of performance criteria makes incentives problematic. Executives receive options today with the condition that the share price must be higher in three years' time in order for them to automatically exercise their option rights. In the UK, however, executives usually also have to be in the first quartile of a peer group in order to be able to do that. But continental European companies are reluctant to introduce such criteria."

"When we research investment managers we look at the extent to which staff own a share in the business, which in theory should make them interested in its overall long-term health," says Goodland. "We also look at how investment managers' remuneration is linked to fund performance. There are many different incentive mechanisms available, but where performance-related pay is used it must be well structured to achieve the desired alignment of interests.

"Another issue is how much remuneration is appropriate. But then the debate gets drawn into the global war for talent and how much a company should be expected to pay for talent."

But Biedermann is sceptical about this. "If companies were to lower executive pay I am convinced nothing would change and most executives would remain with their company," he says.

As Swiss legislation does not yet provide shareholders with any right to express their opinion on executive remuneration, Ethos felt compelled to file the shareholder resolutions now. "It was the only way to apply pressure," Biedermann says. "And with more than half of the capital of large Swiss companies being in the hands of foreign shareholders, in particular institutions, we also count on their support."

Goodland believes that corporate disclosures have already improved. "Companies already disclose how executives are paid, but this can be complicated and arguably there is room for more clarity," she explains. "When it comes to remuneration structures for investment managers we ask the questions as part of our manager research process, as remuneration structures vary a great deal."

But Biedermann is confident about the future. "The fact that pension funds have become more active to support us in the resolutions sends a big signal in Switzerland," he says.