In recent years, two questions have become prominent in companies’ discussions on governance: How much should we pay executives, and how should we pay them?
In answering those questions, remuneration committees (Remcos) face the age-old problem of reconciling perceived business needs with the perceived requirement of executives. So, they turn to specialist remuneration consultants for help with these complex decisions.
Could an examination of this largely overlooked relationship shed some light on the current battle over executive pay? We interviewed some of the leading UK executive pay advisors to explore how pay is determined and reveal how they view their clients. This research uncovered some illuminating results.
A rising role
Specialist executive pay consultants have been working in the UK since the 1980s, but they have become more widely used and more visible over the past decade.
Although there is no formal qualification needed to become an executive pay consultant, and no professional body as such, some individuals and firms have become recognised as leading practitioners.
Following the financial crash, consultants were blamed for the complexity of bankers’ pay packages and their high level of performance-related reward, both of which were perceived to have led to excessive risk-taking.
Various regulatory and governmental bodies in the UK, US and EU all conducted investigations into the consultants’ conduct, arguing (not always with good evidence) that the consultants were too close to companies’ management and that their independence was compromised.
One outcome of these reviews, in the UK, was the formation of the Remuneration Consultants Group (RCG), representing the majority of executive remuneration consultancy firms advising UK-listed companies. Its members include some global multi-disciplinary consultancy firms, some UK-based mid-sized firms, and some experienced individuals—all named advisors to FTSE350 companies.
The RCG produces a voluntary code of conduct for its members, setting out how they should behave in terms of acquiring clients, managing their assignments, and avoiding conflicts of interest. All of the 20 interviewees in our research were from member firms of the RCG.
What specialist pay consultants do
Consultants could be employed by management or by the Remco, although there is some overlap in this area, as, whatever the reporting line, the consultant needs to liaise closely with management to establish the company’s context and needs.
The advice given can be wide-ranging. For example, it could include the design of pay policies; providing benchmarking data on peer companies; modelling or calculating bonuses and awards; advice on regulation, pensions or tax; or assistance with liaison with institutional shareholders.
Some Remcos use just one consultant to advise on several different areas; others choose to employ several advisors. However, companies should be aware that using several advisors can lead to a less “joined-up” scheme, and overlaps between different pay aspects. Even if all the advice comes from one firm, it is common for Remcos to seek benchmarking data from several sources.
Indeed, some consulting firms send benchmarking data, unsolicited, to potential clients in the hope of generating assignments, although this practice is frowned upon by their code.
Some of the findings from our research were anticipated—it is no surprise that executive pay is influenced by the company’s size and industry, or whether it is global or just UK-based. However, other influences were more unexpected. Here are three of the most significant:
1. Following the UK Governance Code
Executive pay in the FTSE350 is governed by the UK Corporate Governance Code. The consultants talked about two separate influences affecting how rigorously their client companies followed the code.
Companies with a high public profile tended to have quite conservative pay schemes, so as not to attract opprobrium from customers or the media. So, for example, retailers would be a lot more concerned about bad publicity than business-to-business providers, whose commercial operations would be less impacted by public disapproval.
Some companies choose to ignore the UK code to great extent. Examples of this included organisations with a significant shareholder who was not of UK origin and had not previously worked under UK governance traditions. These blockholder individuals felt less need to comply with expectations, and their significant shareholdings meant that they were less concerned about being voted down.
2. Influence of internal advisors and the CEO
Although the Remco is charged with advising the board on the level and structure of pay, this committee of non-executive directors does not possess enough detailed knowledge to be able to brief the consultants to the extent needed.
Setting a pay scheme involves a detailed understanding of organisational strategy, down to the granular level of relevant performance measures, and then appropriate targets. This needs executive knowledge, and thus most of the information informing the advice will come from senior management. Accordingly, much of the consultants’ time is spent with the executives.
In addition, the executive pay schemes need to fit in with what the company already has, which means that the consultants need to understand current schemes. For this, they need input from the relevant internal advisor, perhaps a compensation and benefits manager or an HR director.
This internal advisor often serves another important function, acting as secretary and gatekeeper to the Remco. This means that the Remco’s internal advisor can have a very significant influence on what the committee does and how, who it sees and when, and on the parameters of the schemes eventually proposed and adopted.
Our research produced examples of internal advisors who displayed a breadth of thinking in executive pay, combined with good organisational skills, and who supported their Remcos and the consultants in a very professional manner.
We also heard of instances of advisor incompetence or, more seriously, internal advisors who, being ultimately employed by the CEO, clearly saw their role as securing as much money as possible for their boss.
Quite apart from the influence of the HR advisor, the CEO can sway the remuneration decision. Although some CEOs were spoken of as “reasonable”, several interviewees talked about “aggressive” or “greedy” CEOs who were very vocal in expressing their desires.
Among those statements included this: “You care very much what you get compared to your peers. It means that you’re prepared to have quite heated arguments with your committee over what you think is reasonable.
“It means that you might be prepared to risk relationships with some people on those committees to get your own way … You might be prepared to have arguments with your shareholders and risk that to get your own way.”
Remco concern about the dangers of losing a good CEO over a pay dispute meant that in many cases those vocal individuals were rewarded with more generous packages.
3. Quality of the Remco
The quality of the Remco will influence the pay-setting process and outcome. The consultants all discussed the characteristics of good and bad Remcos and their chairs. The more successful committees showed great engagement with the process, and were willing to engage with the complexity of pay.
They also displayed independence of mind: “A good remuneration committee is ultimately one that is prepared to make independent decisions for the good of the business, even if management doesn’t like them.”
However, a good remuneration committee might implement a pay scheme that was not compliant with “good” corporate governance, but it would do so in the knowledge that this was in the best interests of the company.
Overall, our research has illuminated an area of corporate governance that has previously been unseen, and provided findings of interest to managers, regulators and to the consultants themselves.
Professor Ruth Bender and Dr Monica Franco-Santos research executive pay, governance and performance at Cranfield School of Management. The full research report can be downloaded from icaew.com. The authors would like to acknowledge the support of the ICAEW’s charitable trusts in funding this research.