I was in my local Sainsbury’s doing some food shopping. Conscious of health advice I thought I would look at the label on my breakfast cereal. The label listed the contents as:
- Wholegrain Wheat
- Malted Barley Extract
- Folic Acid
Included in the informative label were the “typical average value per serving” and the “Guideline Daily Amount”. All excellent information – but what did it actually mean? Should I be comparing my chosen cereal with others to ensure good value with the right level of vitamins and minerals? Should I perhaps compare my breakfast cereal with porridge, similar, but not quite the same?
A similar issue occurs over disclosure in corporate pay. Compensation Committees and shareholders are bombarded with guidelines on what should be their “exposé” on executive pay. In the US there is a corporate filing called the Compensation Analysis and Discussion (CD&A) which is a mandatory pay disclosure requirement. If we look at the recent filing by Apple Inc. at http://files.shareholder.com/downloads/AAPL/1719223512x0x531628/b6ec469d-aff8-4eef-9077-1defc2258f6b/2012_Proxy.pdf we see the following disclosures for senior executives;
- Base salaries
- Annual performance based cash bonuses
- Performance criteria
- Performance Goals
- Pay out structure
- Long term equity awards
- Stock awards
- Option awards
- Changes in pension value
- Estimated future pay outs under non-equity awards
- Estimated future pay outs under Equity incentive awards
- Other stock and option awards
- Fair value of stock and option awards (and good luck with your Black-Scholes calculations).
And while Apple Inc. does not use the following for their executives they could also report on:
- Employment agreements;
- Severance arrangements;
- Cash payments in connection with a change in control of the Company;
- Tax reimbursements;
- Supplemental executive retirement benefits.
- Change of control benefits
I could go on….. (For a fuller discussion on disclosure regulations see http://crossborder.practicallaw.com/4-101-7960 )
Like my breakfast cereal contents, it is all exciting stuff – but what does it mean?
The disclosure requirements in the US and the UK were conceived to help stakeholders judge if pay is “fair” and not “excessive” (No definition of “fair” or “excessive”, like an elephant, you are supposed to know it when you see it). The Association of British Insures guidelines (http://www.ivis.co.uk/ExecutiveRemuneration.aspx) state that ABI members seek to ensure that: “remuneration practices and policies of companies they invest in are aligned with shareholder interests and promote sustainable value creation.” No one would argue with those good intentions.
How many institutional shareholders – who hold the majority of shares in the US and the UK, have the time or expertise to undertake the analysis that I would have to make with my breakfast cereal? Is the remuneration good value for shareholders? How does it compare with other similar (or dissimilar) organizations? Multiply that by 140, the average numbers of stocks held by US mutual funds, and you have a complete supermarket of breakfast cereal content to deconstruct.
Increasingly institutional shareholders are leaving it to shareholder advocacy groups such as Institutional Shareholder Services (ISS) in the USA and the ABI in the UK to flag up deviations from what they consider best practice.
The reliance on these groups leads to a number of unintended consequences:
- A “tick-box” mentality to disclosure
- Compensation Committees being frightened into designing their pay plans to fit the guidelines rather than be fit for purpose for their organisation for fear of a shareholder advocacy group recommending a “no” vote on their “say on pay” vote or similar.
- Executives not wanting to be promoted to senior executive positions because of the disclosure and the restrictions on the nature of their pay structure.
- Greater homogeneity between organisational compensation approaches and levels of remuneration.
- Senior executives seeing their pay becoming much more contingent on factors outside their control – such as share price movement (for absolute and relative TSR measures for example); what behaviours will this generate?
- Conflict of interests by advocacy groups who also offer corporate services
- Compensation advisors becoming more expensive, as risk adverse as Compensation Committees and giving similar advice as all their competitors to maintain compliance.
- Even greater labour market distortions at executive level.
- A mismatch between the time horizons of the remuneration structure and the different return horizon of investors.
- Shareholders being placed in the position of micromanaging reward policy.
- Investors (and particularly political pressure groups) using a no vote on remuneration to “punish” company directors on or draw attention to, issues unrelated to reward.
Actual consequences – to date
The US has one of the most stringent pay disclosure regimes, yet it has the highest executive pay in the world and, arguably, the greatest inequality between employees.
The excellent KPMG guide to Directors remuneration www.kpmg.com/uk/en/issuesandinsights/articlespublications/pages/kpmgs-guide-to-directors-remuneration-2011.aspx points out that there has been a fall of 18.6% between 2010 and 2011 in the number of remuneration report shareholder resolutions with a greater than 20% oppose vote in the UK FTSE All share. Thus, it is unclear if greater pay disclosure is a panacea against corporate excess or simply a kneejerk political response to public concerns – much fury signifying nothing.
I go on buying my breakfast cereal because I like it; I guess institutional shareholders are going to do much the same thing with the companies they choose to take as investments – regardless of the remuneration disclosures.