Andreas Whittam Smith: It will take more than legislation to rein in executive pay

'The Lord Simpsons will still get substantial payoffs, unless most pay is linked to performance'
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The Independent Online

The scandals which have arisen over the pay of company directors concern not so much excessive rewards for success but huge payoffs for failure. At Marconi, Lord Simpson had a watertight contract and collected a substantial sum when he was forced out earlier this year – even though he had presided over the near collapse of the company and the loss of thousands of jobs. The share price dropped from £12 to just 13p as a result of his stewardship.

Lord Simpson's good fortune was nothing unusual. But his high-profile example of executive greed has finally persuaded the government to give shareholders more power to curb the "heads I win, tails you lose" treatment of directors' pay.

I should say moral suasion rather than power. Shareholders still won't be able to veto the pay packets of individual directors, nor to dismiss them without a penny when their fault is one of poor management rather than anything criminal. But shareholders will be given additional information about directors' contracts and will have a chance at annual meetings to express their opinions on the board's remuneration.

How well might this work? Boards will be required to publish a separate report on their own pay. They will have to explain to shareholders their procedures for setting their own salaries, the role of the remuneration committee and the criteria for any long term incentive schemes together with graphs showing how the company's performance has turned out in relation to these tests. In addition, details will be given of each directors' remuneration package in the preceding financial year.

In matters of corporate governance, disclosure is a powerful technique. It strengthens the power of non-executive directors in relation to the executive members of the board. "I do sympathise with you, old chap," says the non-exec to the grasping managing director "but you do realise that if we accepted your demands in full then we would have to disclose two company cars, your wife's clothes allowance for corporate entertaining and the membership fees for your golf club near your holiday house in Portugal. And I am not certain that shareholders would be impressed, would they?"

For the final stage in the new procedure would be the tabling of a resolution asking for acceptance of the remuneration report at the annual meeting. Much more detail would be available than ever before. Even so, the vote on this resolution would only be advisory. Shareholders would be asked to approve the report itself rather than individual arrangements. They wouldn't be able to reduce the fees of any individual director then and there.

Suppose, however, that shareholders declined to back the report on directors' remuneration. In one sense, nothing significant would have happened. Board members would still receive their salaries at the end of the month. Yet a rejection by shareholders would be a devastating event. I don't see how the chair of the board would be able to continue in such circumstances. For shareholders would have expressed no confidence in the way they had carried out an important part of their duties. All the non-executive directors must resign in such an eventuality. This is a nightmare scenario, which is why, of course, it would never be allowed to happen.

It is important to be clear, however, what these new powers would achieve and what they won't touch. They would bring to an end well-padded contracts, replete with ingenious perquisites. The test would be: what would this clause look like in the cold light of the annual general meeting? Excesses would be struck out. Good.

But what would happen when the pay arrangements are conventional and the chief executives does badly. In these circumstances it is extremely hard to make out a case that would stand up in the courts to the effect that the director had broken the terms of his or her contract. So many extraneous circumstances can be brought into play. So many board minutes can show that the chief executive's action received full approval at the time. So many other people can share the blame; so many plausible excuses; so much that is outside the control of any chief executive, however powerful. The Lord Simpsons would still get substantial payoffs.

That is, unless the bulk of chief executives' pay in the future, perhaps up to 90 per cent, becomes unambiguously linked to the performance of the company.

About a quarter of Lord Simpson's pay last year was a conditional bonus in this sense. But it would be possible to devise contracts which would make a clearer and more significant relationship between salary and shareholders interests. Objective criteria would be set and agreed. To compensate for the increased risks, pay for an excellent outcome would have to rise even higher. But if that is what shareholders in British companies would like, they had better start saying so loudly and clearly. Legislation can only do so much.