In this Green Paper the Government floats a number of potential reforms in the area of executive remuneration (the main area for consideration in the Paper), making companies more responsive to stakeholder interests and the governance framework for large private companies. The third, but least analysed, issue has the merit of some novelty. On the other two, we have been here before, many times.
Government has been fussing about the levels of executive remuneration for the past quarter of a century, at least. Having tried to outsource the solution to the Corporate Governance Code via the Report of the Greenbury Committee in 1995, without noticeable impact, the Department itself issued a consultation document in 1999 on the topic. That document indicated the topic’s high political salience. By issuing its own document, the Department took the issue away from the independent Company Law Review which was sitting at this time. Since then the Department has come back to the issue a number of times and this is its latest effort. Is it likely to be more successful than its predecessors? There are reasons to be doubtful.
As has been pointed out before, there are two potential problems with high levels of executive pay. The first is that the pay is unrelated to performance. This can be regarded as the shareholder perspective on executive pay. In short, the executives are ripping off the company and, through it, the shareholders. The other is that executive pay is a very high multiple of the remuneration paid to the ‘ordinary’ worker (however defined) employed by the company. There is good evidence that high levels of inequality in societies lead to social dissonance, of which the Brexit vote might be a consequence. The Prime Minister in her preface seeks to ride both horses. She will “build an economy which works for everyone, not just the privileged few” but her government will be “unequivocally and unashamedly pro-business.”
If the problem is perceived to be that executive pay is both unrelated to performance and too high on a comparative basis, then, for a short while, both horses will be trotting in the same direction. The Paper has some nice tables showing that, in the course of this century, CEO pay in FTSE 100 companies has quadrupled, whilst the share price remained pretty stable, whilst as a multiple of the average pay of full-time employees, CEO pay moved from 47:1 to 128:1. Ultimately, however, the horses are likely to canter in different directions, and the policy question is, which horse to back? From a shareholders’ perspective, high pay is not a problem if accompanied by high levels of performance, but it remains one on a comparative basis. Indeed, if high pay induces high performance, shareholders have a positive incentive to award it, so that the comparative issue is exacerbated. Whilst comparativists might prefer low executive pay even if there is a cost in terms of low corporate performance.
Most of the Paper’s proposals focus on increasing shareholder control over pay, suggesting that it is pay without performance that it perceives to be the bigger problem – the traditional Departmental line. There is a weak proposal that remuneration committees should consult employees before finalising their recommendations and another proposal to pick up the US idea that the executive/ordinary worker pay ratio should be published. If this second idea does not shame remuneration committees and shareholders into moderation, it will simply make social dissonance worse.
The second section of the paper is entitled “Strengthening the employee, customer and wider stakeholder voice”. The questions here are not well framed either, mainly because the paper seems to misunderstand the present law. The paper tells us, correctly, that s 172 of the Companies Act 2006 requires the board “to promote the success of their company for the benefit of its members” but it then goes on to say that the directors must “must also have regard to a number of other specified stakeholder and wider issues.” (2.6) This is not quite right. The directors must “promote the success of the company for the benefit of its members as a whole and in doing so” have regard to the wider range of issues. In other words, the wider issues are to be taken into account so far as doing so promotes the shareholders’ interests. The wider interests do not have an independent value but value only so far as shareholders’ interests are furthered. It is not a balancing act between shareholder and non-shareholder interests. This was how the Company Law Review presented the reform (as rejecting pluralism) and how it was presented by ministers in Parliament.
There is no reason why this issue should not be re-visited. It might be valuable to do so. But re-consideration needs to be based on an accurate understanding of the current law. Otherwise, respondents will have false idea of what can be done without changing a core section of the Companies Act 2006, which the Paper does not suggest the Government has in mind. As it is, the proposals put forward for consideration wander uncertainly between shareholder-centric and pluralist views of directors’ duties.
We are told (2.2): “Many companies and their boards recognise clearly the wider societal responsibilities they have and the enormous benefit they gain through wider engagement around their business activities. However, some have said that companies need to do more to reassure the public that they are being run, not just with an eye to the interests of the board and the shareholders, but with a recognition of their responsibilities to employees, customers, suppliers and wider society.” So, which is it: better decisions for shareholders through better engagement or public reassurance that shareholders are not placed first?
The next following sentence is not re-assuring: “Improving the diversity of boardrooms so that their composition better reflects the demographics of employees and customers is a part of this, ensuring that a broader range of social perspectives, talent and experience can be brought to bear on decision-making.” One might have thought that shareholders would want to choose non-executive directors who could keep a critical eye on the management’s strategy. Many a company has failed because of the addiction of its management team to its current product despite the rise of challengers. It would seem unwise to reinforce inertia by stacking the board with another set of potential enthusiasts for the status quo.
Of course, the Paper is a set of proposals, not concluded policy options. However, respondents will waste less time and the Department will receive more useful responses if the issues are framed initially in the most useful way. The Paper cannot be said to pass that test.
Paul Davies QC (hon) is a Senior Research Fellow at Harris Manchester College, and a Fellow of the Commercial Law Centre at Harris Manchester College. He was the Allen & Overy Professor of Corporate Law from 2009 to 2014.