Shareholders are beginning to flex their muscles by voting against inflated executive remuneration packages in listed companies, says Nina Röhrbein

Talk of a ‘shareholder spring’ may be premature but there is no denying that shareholders have been involved in a growing rebellion over executive pay. Whether it was at the AGM of Aviva, Barclays, Citigroup or UBS, more shareholders have voted against pay packages perceived to be too generous, complex or out-of-sync with the general economic climate and shareholder value.

Hermes Equity Ownership Services (Hermes EOS), which votes at around 10,000 AGMs a year on behalf of 25 investors, has frequently voted against excessive remuneration proposals.

Colin Melvin, chief executive at Hermes EOS, says: “There has been an increase in both dialogue and publicity around remuneration votes, and the instances of votes against, which reflects the public and political mood, particularly with regard to financial sector companies such as banks and fund managers.”

F&C Investments voted against 20% of all pay proposals last year. In the US, it opposed almost half of all say-on-pay proposals put forward by companies - some of which only reluctantly put the issue to the vote following the implementation of the Dodd-Frank Act. In 2011, it also called upon banks to bring in a credit-quality underpin for bonus payments - in other words, to put conditions on their remuneration packages.

The main issue investors are concerned about is that remuneration is often based on short-term earnings and share prices. Liz Murrall, director of corporate governance and reporting at the UK’s Investment Management Association (IMA), says: “Directors are incentivised to maximise the share price for earnings in a short time frame at a cost to the company’s long-term viability, meaning the link between pay and performance is no longer in alignment with investors’ interests. Even long-term incentives rarely extend beyond three years. All this is exacerbated by the short tenure of certain executives, which is not particularly conducive to fostering long-term perspectives from a company’s viewpoint.”

In late February, Hermes EOS and the UK’s National Association of Pension Funds (NAPF) met 44 remuneration committee members of FTSE 100 companies and 42 global occupational pension funds. As a result, Hermes EOS proposes a plain shareholding approach, perhaps an annual bonus mainly paid in shares. The shares are to be held beyond the period of employment, while basic pay for directors and senior management is to increase by no more than the average pay award for the rest of the company.

“We would also like wider and deeper consultation by companies, considering the position of the employees within the firm in their consultation,” says Melvin. “In addition, the poor level of disclosure and explanation needs to improve. A vote on the appointment of the consultant would be sensible too.”

Hermes EOS suggests that incentives should be based on more than three years’ performance to discourage short-term thinking, because FTSE 100 companies’ strategies, capital projects and investment decisions often take longer than three years to be specified, implemented and assessed. It also believes earnings per share should be reconsidered because it is often not a good measure of long-term performance.

With the assistance of Hermes EOS, the NAPF has set up a working group of pension funds to work with companies to produce a best practice framework in relation to pay.
Because the proposals were well received by companies and many recognise the need for change, Melvin does not expect many opponents.

But foreign shareholders could oppose the proposals. IMA members - who are the main institutional investors in the UK - only own 40% of the UK market; the rest is held elsewhere. “Most foreign owners tend not to engage in as much detail on issues such as remuneration,” says Murrall.

Another argument is that companies compete in a market for talent, making it difficult for one company to make pay reforms when others are not. George Dallas, corporate governance director at F&C, says: “A change in culture needs to occur, which is never easy, particularly when other institutions do not show the same kind of discipline. Ultimately, if the market itself is unable to address this satisfactorily it opens the door for regulators to intervene.”

The UK’s department for business, innovation and skills (BIS) has already issued a consultation document on executive remuneration. It proposes an annual binding vote on future remuneration policy of directors in UK listed companies, increasing the level of support required on votes on future remuneration, an annual advisory vote on how remuneration policy has been implemented in the previous year, and a binding vote on exit pay over one year’s basic salary.

Hermes EOS is a firm supporter of the UK’s comply-or-explain regime of corporate governance. “Approached in the wrong way, binding votes could be counterproductive, creating unforeseen and unhelpful consequences,” Melvin says. “Some shareholders may be less likely to use their power if it is mandatory. Moreover, most remuneration committees currently take account of substantial expressions of disquiet falling short of majority opposition to their remuneration reports. With a binding vote, this may switch to concern only for majority support.

“The proposals on binding votes are going to have resource and cost implications,” adds Murrall. “The proposals could divert resources from issues such as strategy and performance that more often directly impact value. There is also a risk that within this framework, companies could set broad pay policies to obscure contentious issues and undermine the objective of the binding vote.”

F&C suggests a variant on the proposal, which is triggered by an advisory vote failing to achieve 75% of support. If that were the case, the binding vote would apply on a risk-based basis to those companies that may have the most contentious pay structures.

Hermes EOS proposes that if a company receives a substantial vote against but does not lose the resolution - maybe up to 20% of the shares voted - it should be required to announce how it will respond. Such a vote could also trigger a binding vote the following year, which would encourage talks between companies and shareholders in the most urgent cases.