08 September 2016
How much should a CEO earn?
Employing the Swedish model may just make a difference.
by Frank O’Nomics
I have long been an admirer of Ben & Jerry’s. Not just because of their highly calorific, wittily titled ice cream, but rather because of the policy that they adopted (at least at the outset) on executive pay. When they established the company, Ben Cohen and Jerry Greenfield pledged to their employees that the highest salaried executive would not be paid more than 5 times the lowest paid worker. They kept to this promise for 16 years, when the ratio had to be increased to attract new talent, and it was ultimately abandoned when they were taken over by Unilever in 2000. For low paid workers at Ben and Jerry’s this is a shame as, on the basis of the current pay of the CEO of Unilever, they would be earning £1.38 million on the original formula, or a mere £405,000 on the last pre-takeover multiple. Clearly, either of these pay levels would make a business untenable, but it does raise the question of how much should the CEO’s of public companies be paid? This is a question that has been brought to the fore by Theresa May’s commitment to address the imbalances in our society, by some recent significant pay awards (average pay for a FTSE chief executive was £5.48 million in 2015, £1.3 million higher than in 2010), and now by news that we may be moving towards a regime that will put some proper checks and balances on executive pay. Whether such a regime will work is a matter for debate, and it is worth considering the extent to which it might discourage key executives from taking roles in the UK – particularly if the prospects for unfettered remuneration appear better in other markets, particularly the US.
In a report produced for the High Pay Centre, Chris Philip, a backbench Tory MP and a member of the Treasury Select Committee, has argued that the UK should follow the Swedish approach on corporate governance and impose a shareholders committee on public companies. This committee would consist of the 5 largest shareholders and have non-voting seats for both the company chairman and an employee representative. The committee would replace the nominations committee in recommending the approval and removal of directors to the main board, the idea being that directors would feel accountable to the shareholders and not to the board chairman. The pay rationalization element would come as a result of the panel of investors having the authority to approve pay policies and specific pay packages before they were voted on by shareholders. Also, they would be able to question the board on both strategy and performance. The High Pay Centre wants companies to be forced to publish the ratio of average pay to that of the chief executive as another barrier to excessive rewards – not quite the old Ben & Jerry model but the spirit seems the same – with remuneration packages subject to binding shareholder votes annually, rather than the current triennial basis.
At first sight this would appear to address the PM’s priorities of curbing excessive pay and, to a lesser extent, introducing employee representation, but there are problems. First, the prospect of annual votes on remuneration packages has been criticised by the likes of Royal London as potentially leading to short-termism, with chief executives and others being discouraged from adopting a strategy that might be in the better long-term interests of both shareholders and employees. Second, the focus on chief executive pay may not resolve the issue. Martin Sorrell is undoubtedly the most highly rewarded individual at WPP, but this is not the case for all chief executives. At M&G for example, the highest paid employee in 2015 earned £17.5 million – almost 50% more than was paid to the CEO. Third, it is still not guaranteed that the Swedish model would curb excessive pay. Some investors will be well aware of the competitive market for key executives and would be wary of creating a succession issue (they may well also be conscious of the implications for their own remuneration). Others will argue that a long-term commitment to grow a company deserves a high reward that goes beyond short-term performance. Many investors in WPP will be content that Martin Sorrell has built a £22 billion company over 30 years and will not begrudge him his £70 million pay award (although 1/3 weren’t). Similarly, just because a company has lost money it does not mean that the CEO has not done a decent job. The Post Office was recently criticised for paying their CEO £600,000 when losses (before the government subsidy) were £24 million last year. Unite described this as a reward “for a catelogue of failure”, but the company said: “All salary and payments to our senior directors are subject to full and appropriate governance”, and some would be impressed that the loss had been reduced from £57 million in the previous year, with the financial support needed from the government down by £50 million. Finally, it is not as if investors do not get some say in CEO remuneration; in April of this year a record net loss of $6.9 billion was sufficient to cause 59% of BP’s shareholders to vote against the company’s decision to award a 20% pay increase to the CEO, and this prompted the company to look at ways of changing its remuneration policy.
It would be nice to think that remuneration consultants would help the process, but Lord Lawson once said that “they are a profession that makes prostitution seem thoroughly respectable”, on the basis that, if they recommend a low number they are unlikely to be employed by that company again. Saker Nusseibeh, the chief executive of Hermes Investment Management, has said that he believes corporate remuneration to be “out of kilter” and “well beyond what could be considered reasonable for doing their job”. His argument that the role should not just be about money, with the respect for the position a significant benefit, might seem a little naïve when one remembers that the average managerial life expectancy of a US CEO is around 6-7 years, but high rewards for an indifferent performance cannot be justified even when part of a long-term plan. In this sense, any new initiative to tackle the issue of excessive pay should be welcomed by shareholders both large and small, and the recommendations of the High Pay Centre, if adopted, would seem to be a significant improvement. A survey in the US in 2014, which asked what people thought should be the correct ratio of the lowest paid employee to the CEO came up with an answer of 7 times, still very close to the Ben & Jerry concept. Such a number is never likely to be achievable in anything other than a very moderately sized company, but a greater degree of accountability is surely possible.
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