Andreas Whittam Smith: The shareholder revolution is at last under way

Why did shareholders let so many years pass by without trying to halt the rise in the remuneration of directors?


So many chief executives have been sacked in recent weeks for failing to deliver the performance promised by their high salaries that you might think the brief reference in the Queen's Speech to directors' pay was unnecessary. The top person at the big insurers Aviva was forced to step down on Tuesday after a shareholders' revolt. The boss of the printers and newspaper owners Trinity Mirror suddenly left last week, and the same thing happened at the drugs giant AstraZeneca last month.

The Government is now to bring forward legislation to "strengthen the framework for setting directors' pay by introducing binding votes". At present, when shareholders vote on remuneration reports at annual general meetings, the result is advisory rather than binding. The vote shows what the balance of opinion among shareholders is, but it doesn't dictate. Even so, as recent events show, shareholders' existing powers can be effective if vigorously deployed. How can that be?

The reason is not so much that shareholders have substantial reserve powers to remove a board of directors and install a new team, but that they are the suppliers of fresh capital. You can hardly defy an adverse advisory vote on directors' pay one day, and then the following week expect the same shareholders to support a fund-raising exercise. It is hard to believe that a company that was permanently at odds with its shareholder base could prosper.

But there is a greater mystery. Why did the big shareholders in British businesses, who comprise pension funds, life assurance companies, fund managers and endowments, let so many years pass by – until last month – without once trying to halt the remorseless rise in the remuneration of the directors of the large companies? The process has been under way since the 1980s. Were big shareholders really asleep at the switch for 30 years, as they appear to have been, or was something else going on?

A number of influences were at work. Directors' pay is a tiny part of total costs. It doesn't really weigh in the balance between profits and losses. Moreover, rather than make an issue of directors' pay, turn up at the annual general meeting, make a speech and cast your vote, there is a simpler route: sell your shares if you don't like what is going on. And there has been a further complicating factor. Many investment managers are also in receipt of very high pay. So, when one asks why professional shareholders haven't got a grip of high pay in the companies they own, you are really wondering why the City, the temple that worships outrageous rewards, doesn't add hypocrisy to its bad practices.

Yet, something did change recently in the minds of big shareholders. They began to sense that they were losing control of the companies of which they were the legal owners. Boards of directors weren't any longer behaving primarily as the managers they were supposed to be, but as if they themselves were the shareholders, albeit without having had the bother of purchasing large blocks of shares. Professional shareholders began to think that they had become a species of what is known in estate law as a residuary legatee, the person to whom the residue of an estate is bequeathed after everybody else has had their cut.

Shareholders certainly won't feel like this any longer if the measure announced in the Queen's Speech becomes law. It is not just that the vote that was once advisory has now become binding and "whoops" says the board at the annual general meeting when shareholders don't approve, "we will have to fall into line and change our plans". Life doesn't work like that. Rather, companies will strive to make pay awards to directors that will not excite controversy and so be approved. They are bound to wish to avoid an adverse vote that would only serve to advertise their impotence. They would, therefore, want to enter into private negotiations with shareholders.

This needs thinking through carefully. Shareholders could refuse, but this wouldn't result in a tidy situation. It would be better, first of all, if the binding vote applied to pay deals before they came into force rather than afterwards. Furthermore, in making their case to shareholders, particularly as regards the rewards for the chief executive, companies would want to make shareholders privy to information that was not publicly available. But the shareholders who engaged in such talks would thus have been turned into "insiders" and be forbidden from trading in the shares for a lengthy period, which might not suit them.

Apart from this, shareholders would have other problems. As matters stand, they wouldn't really have the knowledge to be effective negotiators of executive rewards. And they would begin to wonder how they could so organise themselves that a small group of them could speak for all. The notion of a binding vote on remuneration is not the simple, no-brainer, what-could-be-easier proposal that it at first appears. It is a good deal more complicated than that.

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