April 10, 2012 The Composition of Remuneration Committees and High Pay
Recent reports from the government and the High Pay Centre have suggested that the homogeneous make-up of remuneration committees is partly to blame for ‘excessive’ executive remuneration. Whether this is actually the case though is a very difficult question.
In a speech in January of this year, Vince Cable specifically highlighted the make-up of remuneration committees as one of the causes of executive high pay. He suggested that the wealth of experience of most non-executive directors on remuneration committees is admirable in many ways but queried whether this should be the case. He then went on to advocate a ban on current executive directors of one company serving on the remuneration committee of another company. Mr Cable also endorsed the establishment by Deborah Hargreaves of the High Pay Commission (technically an independent organisation, but one with the explicit backing of the government).
The High Pay Centre recently released a new report titled ‘The New Closed Shop: Who’s deciding on pay’ looking at the make up of remuneration committees. This report highlights the fact that, in their study:
- 9% of FTSE 100 companies have a current FTSE 100 lead executive on their remuneration committee; and
- 33% of FTSE 100 companies have a current lead executive on the remuneration committee.
The report also notes that through the common process of benchmarking current executives may have an indirect financial interest in increasing pay in other companies. Although it should be noted that the conflict would be fairly indirect as it is very unusual for an executive to serve as a non-executive at another FTSE company which would be included in a benchmarking process (due to these companies generally being competitors of each other).
The High Pay Centre also looked at the experience and gender of members of the remuneration committees. The results are fairly startling (for example, only 16% of remuneration committee members are women) until you compare them to the same figures for boards in general which are almost identical. This is not to condone such woeful figures, but just to point out that they are no different from the figures for the general boards of the company.
The fear of those who criticise the composition of remuneration committees in this way, is that group-think and similar phenomena cause homogeneous committees to veer towards decisions that they may otherwise not have made, i.e. to increase executive pay further than it otherwise would. In the words of Vince Cable, ‘it is [difficult] to appreciate the typical viewpoint if you breathe such rarefied air [as most committee members do]’. Or in the words of the High Pay Centre ‘The fact that remuneration committees comprise individuals from similar backgrounds appears to lead to a lack of challenge over decision-making around pay’.
This view is clearly very appealing. It is a relatively straightforward problem that can be clearly understood and it offers a distinct and viable way of reducing executive salaries. Yet, just because a view is appealing does not mean that it is accurate. If it were true that a more diverse remuneration committee were better at limiting executive pay, then the solution to limiting executive pay would be simple. However, the evidence presented for this view tends to be academic articles looking at the concept of group think rather than concrete examples of remuneration committees that have taken a different approach to the norm. It is at best a theory that should be investigated further, rather than a conclusive view from which policy should be based upon.
The High Pay Centre report in fact offers its own alternatives in two very telling paragraphs of its report:
If non executives are doing their job properly they should believe that they have the best executive team in place and understandably wish to reward them appropriately. Additionally fears over the executive leaving or being poached by a rival, can drive the remuneration committee of one company to increase pay awards, rather than risk losing their lead executive. While this may seem logical for one company, it results in a ratcheting effect as each company benchmarks against its competitors.
Even without the threat of flight from the executive, most boards seek to pay above the median for salary and increasingly make awards in the upper quartile of the pay scale for performance related rewards. This results in a spiraling upwards of pay packages. It takes a very brave remuneration committee to seek to pay its executives below the median. It is seen as the equivalent of admitting they are mediocre or not up to the job.
Of course, the problem with the above analysis is that there is no easy solution. It suggests that remuneration committees and, indeed companies, are acting entirely rationally when they are adopting the pay policies that lead to escalating executive pay. Of course, there should be a limit to this rationality as at some point the pay of executives will start damaging shareholder returns. However, the actions of shareholders suggests that this point is far from being reached.
There will no doubt be further research into this area and perhaps it will transpire that a more diverse make-up of remuneration committees will help limit executive remuneration, but this author remains sceptical that there are any easy fixes to this issue.