Archive for the ‘Executive pay’ Category

On Shareholder Democracy: what democracy?

The mid-nineteenth century vision of the joint stock, limited-liability company was exquisitely simple and superbly successful.  Ownership was the basis of power.  Shareholders appointed the directors, who reported regularly on their stewardship over the company. Shareholder democracy was based on one share – one vote. 

 Then something went wrong.  Directors took control.  As long ago as 1932, in research that is still among the most cited in the corporate governance lexicon, Berle and Means showed that power over public corporations in the United States had become concentrated in corporate boardrooms.  What happened to the original notion that power over a corporation should be exercised by the owners?  A similar erosion of shareholder power occurred in the United Kingdom, and indeed in most other countries whose company law reflected the old Commonwealth company law traditions.

 The UK Cadbury Report (1992) and corporate governance codes in other countries attempted to redress the balance by requiring board-level nomination committees, with independent non-executive director members, to put forward the names of potential directors.  But these non-executives, themselves, had been approved by the chairman and CEO, and owed some allegiance to them. The board then put their proposals to the members, who got to vote.  But incumbent directors effectively could re-appoint themselves and, when the time came, appoint their successors.  

 The shareholders of a UK public company can now call for a special meeting of the members, at which a simple majority can vote to remove any (or indeed all) of the directors.  Section 338 of the UK Companies Act 2006, broadly, enables members of a public company to require the company to give all shareholders notice of their resolution, provided they hold 5% of the total voting rights or total at least 100 members.  But the financial risk and uncertainty of such actions make them newsworthy.

 In the United States the situation is worse.  One share one vote still prevails, but the board decides which names get on the ballot paper.  The only way for outsider candidates to get nominated is through proxies circulated to all the other shareholders at the proposer’s expense.  This financial exposure results in most board appointments being uncontested, with incumbent directors keeping their seats around the board room table, with the attendant benefits, even though in practice only a small proportion of shareholders actually voted for them

 Attempts to persuade the Securities and Exchange Commission and state regulators to change the rules have been frustrated by aggressive lobbying from corporate director interest groups.  The latest attempt by the SEC to reform the system was put on hold earlier this year. 

Companies in the United States, of course, are incorporated by individual states. There are no provisions for incorporation at the federal level.  Many companies are incorporated in Delaware, because company law and the Delaware companies’ court tend to be sympathetic to their interests.  But Delaware company law was changed earlier this year to allow companies to reimburse the costs of circulating the names of outsider directors to other shareholders.

 A straw in the wind was reported in the Economist (31 October 2009).  The American company, HealthSouth, a company that runs private hospitals and clinics, which in the past has been criticized for poor corporate governance, changed its corporate governance rules to allow activist shareholders to propose candidates for election to its board.  The company even offered to cover the costs involved, if 40% of the votes were subsequently cast for the outside candidates. 

 In his clumsily titled, but brilliantly perceptive book Corpocracy (Wiley, New Jersey, 2008), Robert (Bob) Monks showed how modern corporations have maximized their wealth, balked at government regulation, and locked-out their shareholders, whilst the executives rewarded themselves with massive pay packages.  Shareholder control over large corporations, he argued, is weaker now than ever.  Not only are these corporations rarely held to account by regulators, they face even less control by those whose interests they are ostensibly there to serve. 

 Bob Monks feels that shareholders, particularly institutional shareholders, should attempt to influence corporate behaviour and governance for the benefit of all shareholders and society. He has called for the United States to adopt the British approach, with a federal statute that would give investors the right to call a special meeting to remove directors. 

 The Economist commented “in a healthy shareholder democracy, such a rule would not be controversial.”

 Bob Tricker



Say on Pay

Widespread concern at the high levels of executive director remuneration has led to calls for wider adoption of a ‘say on pay’ in the US.  Investors in the UK and Australia have, for many years, had the right to vote on the remuneration committee report of the companies in which they invest.  The vote on the remuneration committee report is an advisory one meaning that it is not binding on the company.    However in practice institutional investors have tended not to vote against the remuneration committee reports and on the -until recently – relatively rare occasions on which the remuneration committee report was voted against, it was seen as a strong signal of disapproval about some aspect of executive remuneration and one which the directors would be unwise to ignore.

Royal Bank of Scotland

It was no surprise to anyone that the Royal Bank of Scotland shareholders overwhelmingly rejected the banks remuneration committee report at the companies Annual General Meeting on 3rd April.  Jane Croft and Andrew Bolger (FT, Page 12, 4/5th April 09) in their article ‘Thumbs down for RBS pay report’ stated that some 90.42% of votes cast rejected the report.  UK Financial Investments Ltd (UKFI) the Government owned company which manages the taxpayers’ shareholding in RBS, and controls 58% of the RBS shares, voted against the report.   Manifest, the proxy voting agency, stated that ‘the resolution on the remuneration report at Royal Bank of Scotland Group plc represents the highest ever “Total Dissent” vote on the remuneration report since the introduction of the requirement for the report to be put forward to a non-binding vote’.

Remuneration (compensation) committees

Remuneration committees have previously been criticised for having a ratcheting effect on executive directors’ remuneration.  The composition of such committees is usually independent non-executive (outside) directors but nonetheless this has not stopped the increasing levels of executive remuneration.  This is probably in part attributable to the fact that remuneration committees would tend to recommend remuneration for executive directors in the upper quartile of their peer group hence the ratcheting effect over time.  The Corporate Library  points out that, in the US, chief executives pay rose 24 percent in 2007 giving a median remuneration of $8.8 million. 

Trade Unions Involvement 

An interesting development is for trade unions calling for more worker involvement in setting top executive pay.  Brian Groom (FT, Page 3, 6th April 09) in his article ‘TUC leader urges staff input over chiefs’ pay’ highlights that Brendan Barber, General Secretary of the Trade Union Congress (TUC), stated ‘there was “massive anger” among workers at paying the price for a recession made in the boardroom, not on the shop floor’.  The directors of FTSE 100 companies came in for criticism as well as the directors of banks, with Mr Barber arguing for ‘workforce representation involved in remuneration committees of major companies’.  The idea of representation of the workforce on the board or board committees has traditionally not been given much consideration by UK boards but maybe that might change in the future.

Shareholder proposals/resolutions

Another are where we may see change is in relation to shareholder proposals or resolutions. Although it is possible in the UK for shareholders to put forward shareholder proposals or resolutions, it is not that easy to do and hence dialogue has been the most frequently used tool of corporate governance with shareholder proposals maybe numbering just five or six a year. 

In the US it is much easier to put forward a shareholder proposal and so we can see 800 or 900 of these each year in US companies.  It is likely that in the future more of these shareholder proposals will be relating to executive remuneration and that they will achieve strong support from institutional investors who are increasingly being criticised for not having taken more action to help limit executive remuneration.   Francesco  Guerrera and Deborah Brewster in their article (FT, Page 21, 6th April 09) ‘Mutual funds helped to drive up executive pay’ highlight that mutual funds have tended to vote in favour of companies compensation plans and this has effectively sanctioned these spiralling executive remuneration packages.  Kristin Gribben (FTfm, Page 5, 6th April 09) in ‘Pay proposals to dominate proxy season’ puts forward the view that, in future, mutual funds in the US will be more likely to support remuneration (compensation) related resolutions filed by shareholders. 

Back-door pay

There is concern that some companies may seek to remuneration executive directors via the ‘back-door’ if, for example, bonus schemes do not pay out.  Pauline Skypala (FTfm, Page 2, 6th April 09) in ‘Warning over “back-door” pay’ highlights that this is a concern to some investors including Co-operative Asset Management whose corporate governance manager, Paul Wade, states ‘If a company fails to create value for its shareholders, it is totally inappropriate to grant rewards to management that are disproportionate to shareholder returns’.

Future developments

With the continuing focus on executive directors’ remuneration packages, the forthcoming AGMs promise to give rise to many interesting debates, much emotive discussion, more shareholder proposals, and many more instances where ‘say on pay’ will result in an emphatic ‘no’ to excessive remuneration or remuneration which does not have appropriately stretching performance links.

Chris Mallin 6th April 2009.