Dr Hans-Christoph Hirt, Co-Head of Hermes EOS, discusses how this voting season is likely to highlight that boards and remuneration committees need to raise their game.
The majority vote of shareholders against BP’s remuneration report at the company’s AGM last week has brought comparisons with the so-called shareholder spring of 2012 during which a number of companies faced significant opposition from investors on pay packages. This in turn led to new legislation on executive pay in the UK in 2013: Shareholders now have a binding vote on a company’s remuneration policy, at least every three years, and an annual, non-binding vote on its remuneration report, which effectively describes the implementation of the policy.
We at Hermes EOS believe this voting season is a crucial test of how the UK remuneration law works in practice and, importantly, is likely to highlight that boards and remuneration committees in particular need to raise their game. After all, developing, thoroughly assessing and stress-testing, implementing and – if necessary adjusting the outcomes of – an executive remuneration policy is the responsibility of non-executive directors – not of shareholders. We take a robust approach on the election or re-election of individuals and groups of directors who do not live up to this responsibility and the expectations of long-term asset owners and their beneficiaries who we represent.
While we welcome the debate that was triggered by BP’s remuneration vote, we believe it would benefit from disentangling some of the underlying topics and looking at companies on a case-by-case basis, something we aim to do when we consider major voting decisions. We believe there are four key issues for remuneration committees to consider and communicate on to shareholders:
- Assessment: Remuneration committees must improve their assessment and stress-testing of remuneration policies and the disclosure and communications of outcomes of different, even unlikely, scenarios. If their members are unable to do so, this suggests that remuneration policies have become far too complex and unnecessarily complicated.
- Alignment: Remuneration committees must balance the understandable desire to set at least some targets that can be (fully) controlled by executives with the need to ensure alignment of remuneration and long-term value creation (shareholders should take a long-term perspective and not be obsessed with short term share price developments or profitability). We have long argued that paying a significant part of remuneration to executives in shares and requiring them to hold them well beyond their tenure with companies is a natural starting point to ensure the desired alignment.
- Quantum: Remuneration committees must form a view on what they regard as appropriate and acceptable quantum for executives in different scenarios and clearly disclose and communicate this to shareholders. Shareholders can then take a view on this important matter. This will be informed by the fact that asset owners, such as pension funds, in particular find it difficult to explain to their underlying beneficiaries the different development of executive and average employee remuneration and the resulting widening pay gap over the last decades.
- Discretion: Remuneration committees must be ready to use discretion to adjust the outcomes of policies, if implementation leads to results that contradict their underlying purpose, or simply fail the common sense test, specifically in view of the alignment of remuneration and long-term value creation. Indeed, they should be using discretion to safeguard their company’s reputation and social licence to operate in a given market.
As in previous years, the voting decisions of Hermes EOS on remuneration policies and reports in the UK and globally are based on an assessment of the governance and processes around them, related disclosure and communications, our intensive engagement on remuneration with many companies and – significantly – the practical outcomes we observe. We look forward to more and better dialogue with remuneration committees and boards on the issues outlined above during this year’s voting season and in preparation for the next generation of policies that will be presented to shareholders in the UK in 2017.
For more information on our position regarding executive remuneration, please refer to our policy document:
Remuneration principles for building and reinforcing long-term business success (September 2015)