Little action on big pay-offs: Institutional investors' hands are tied over excessive 'compensation' to directors, writes Gail Counsell

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The Independent Online
MICHAEL HESELTINE has no doubts about the unacceptability of huge pay-offs handed out to departing directors. Cornered on radio on Saturday, he insisted there were too many of them and something should be done.

Not by him, though, but by the institutional investors who control more than two-thirds of UK equities. For the President of the Board of Trade argues institutional shareholders could and should play a more 'positive' role in this area.

Fund managers see things differently.

'You've got to ask yourself whether this is an important issue for institutional shareholders,' says John Rogers, secretary of the investment committee of the National Association of Pension Funds, which represents the bulk of institutional investors.

The sums involved are often 'flea bites' as far as the earnings of most big companies are concerned, he points out. What interests fund managers most is the share price and profits performance of a group, not how much directors pay themselves.

Even if they were willing to follow Mr Heseltine's advice and take up the cudgels against corporate excess, the ability of shareholders to do much about directors' 'compensation' for loss of office is extremely limited.

The basis for the compensation is almost always breach of contract by the company - that it has sacked or constructively dismissed the director involved. Otherwise it would, under the 1985 Companies Act, have to seek shareholder approval for what would be 'ex gratia' payments - so much for statements of departures by 'mutual agreement.'

Some institutional investors have - privately - been hinting they would be happy to see boards refusing to pay compensation where they feel they have been forced to oust a director for unsatisfactory performance.

But lawyers warn that - fraud aside - proving a director's performance has been unsatisfactory is extremely difficult, especially if the contract has failed to set out the basis on which performance is to be measured - as nearly all do.

As David Pollard, a partner with the City solicitors Freshfields, says, there is little case law on standards expected of top management.

Similarly, since few director contracts spell out the job a top manager will be expected to perform, companies find it difficult to make even small changes in an individual's role without becoming vulnerable to claims of constructive dismissal.

For institutional investors there is another problem. Persuading boards to sue departing chief executives is a marathon task. But UK corporate law stresses the responsibility of directors to make decisions on company management; it is difficult for any shareholder to challenge a board's view in court.

Since doing anything about the pay-offs is so difficult, most of the emphasis has been on prevention rather than cure. Limit the length of the director's contract and the pay-off will be lower.

The running in this area has been made by Alastair Ross Goobey, who runs the UK's largest pension fund, PosTel. He has led a campaign for the replacement of the three-year rolling contract by two- or one-year rolling contracts, a move that would reduce the cost of getting rid of unwanted directors.

He has, perhaps predictably, met fierce opposition from some companies. Murray Stuart, chairman of Scottish Power, in which PosTel has a stake, successfully defended three-year contracts for his board on the basis that it was the 'market reward' for the job.

But Mr Ross Goobey's peers have also been less supportive than they might have been. 'I would be happy to have a little more public support for the things institutions are saying in private,' he observes.

The problem is partly lack of interest and partly pragmatism - there are relatively few sanctions open to institutional shareholders.

Apart from voting against the three-yearly re-election of a director at the annual meeting their only real option is to disinvest. They may not wish to do that if the company is a high performer, nor may they find it easy if their holding is large.

Then again much controversy - such as that surrounding the recent pounds 1m retirement package of Bryan Weston, Manweb's chairman - has surrounded share option schemes rather than salary packages as such.

Nevertheless, there are some changes Mr Heseltine might make which would be of help. While details of directors' contracts have to be available to shareholders, few shareholders look at such issues unless they are put under their nose. The 1985 Companies Act says that contracts with directors that run for more than five years have to be approved by shareholders. Changing that figure to one year would set a better tone and mean directors would have to explicitly justify their contracts to shareholders first .

Such a gesture would come at the right time. Although many of its members probably did not notice, the NAPF'S recommendation to the 1992 committee on corporate governance chaired by Sir Adrian Cadbury was that one-year rolling contracts should be the maximum advocated by Cadbury's (voluntary) code of good practice.

That proposal was not adopted, much to the NAPF's irritation. But the code is to be reviewed in 1985 and the NAPF wants to have another go and has written to ask pension fund trustees what they think.

A loud chorus of approval - possibly orchestrated by Mr Heseltine - would be an encouraging start.

(Photographs omitted)

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