Hermes EOS, NAPF join forces to tackle executive pay

UK - Hermes Equity Ownership Services (Hermes EOS) has published a discussion paper aimed at changing current pay structures.

The paper - entitled 'Proposed Reforms to UK Executive Remuneration' - highlights a number of key areas including structure, quantum, disclosure and transparency, as well as the role of nomination and remuneration committees.

Colin Melvin, chief executive at Hermes EOS, said: "We are at a moment of crisis in the evolution of publicly listed companies and their relationship with their shareholders, with a poor economic backdrop and minimal growth intensifying the need for reform.

"The overall success of companies and our economic futures will be influenced by the extent to which corporate boards, their remuneration committees and their long-term shareholders work together to address a flawed system of compensation.

"Effective reforms will reconnect companies with their employees, clients and other stakeholders and provide the basis for the generation of long-term value for their long-term shareholders."

The paper highlighted a number of ideas such as:

• Boards, their nomination committees and remuneration committees must recognise that motivation does not solely arise from pay and ensure that succession, recruitment and retention discussions focus on matters other than pay.

• Longer-term alignment should be achieved by shares being owned for the long term and even after leaving the company.

• Claw-back by remuneration committees to be used where the outcome of the awards does not properly reflect actual performance, or breaches of behavioural standards or policies by the individual or more widely in the organisation.

• Other measures to be used in preference to earnings per share (EPS).

• Fixed pay for directors and senior management to increase by no more than the average that is awarded in the rest of the organisation.

• Remuneration schemes have become too complex, which makes them less able to motivate directors and management: the best alignment with long-term owners is long-term ownership of shares by board members, as agents of the owners. Rewards should be in the same currency, as the capital invested by the owners - i.e. shares.

• Consultation should be more timely, wider and deeper and should ensure that the owners' views are taken sufficiently into account.

• Remuneration committees should explain the rationale behind their chosen policy and practices and, in particular, how they are aligned to achieve the strategy, taking into account the interests of the company's owners.

The report is a result of a late February meeting between 42 global occupational pension funds and remuneration committee members from 44 of the FTSE 100 companies hosted by Hermes EOS and the National Association of Pension Funds (NAPF).

Melvin added: "The forum was the first step to resolving the widely debated issue of executive pay by creating a candid dialogue between remuneration committee members and pension fund trustees, which had never been done before." 

The paper said that, "often, companies tell shareholders that they have to pay well to hire and retain top talent, which would otherwise defect in a global marketplace. At the same time, investors are frequently informed that these executives are not interested in the money, but that it is the only way they can keep score with their peers and, in the interests of fairness, remuneration committees should pay the going rate.

"[But] such behaviour is facing a crisis of credibility. Many directors at larger companies sometimes appear immune to the effects of the economic crisis, such as falling living standards, faced by the rest of society. Those directors, both executive and non-executive, who realise that profound reform and a significant realignment is overdue and work to improve the way pay and performance are linked will be recognised as true leaders in difficult times."

The NAPF now plans to set up a working group of pension funds that will liaise with remuneration committees and company boards to ensure executive remuneration is aligned with the long-term interests of pension funds and their members.

Such collaboration will enable funds of all sizes to develop and refine their policies on executive pay, according to the NAPF.

The working group initially intends to identify and work with those remuneration committees at companies that it believes, or have themselves indicated, are most amenable to considering significant reform of their remuneration policy and practices.

In addition, it plans to test the mooted voting hurdle of 75% by seeking to engage with all companies in the FTSE 350 whose remuneration report fails to achieve this level of acceptance.

The NAPF also recognises the need for pension funds to hold their asset managers to account for their exercise of stewardship responsibilities and will be exploring what practical steps it can take to support its fund members in doing so.