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Hermes calls for overhaul of CEO and executive remuneration models

14 November 2016

Hermes Investment Management (Hermes), the £28.6 billion manager focused on delivering superior, sustainable, risk adjusted returns to its clients – responsibly, is calling on large publicly listed companies to overhaul current executive remuneration models.

In its paper ‘Remuneration Principles: clarifying expectations’, Hermes outlines why well-structured remuneration practices are key to aligning the activities of management with a company’s purpose, strategy and long-term performance. In the paper, Hermes also emphasises the need to address the question of fairness and give it a social licence to operate.

Hermes particularly examines the rapid expansion of CEO compensation over recent years. Analysis by the High Pay Centre suggests the ratio of CEO pay to the average worker has doubled in a little over a decade – from 70x in 2002 to 140x in 20151.

This phenomenon has clearly led to escalating public resentment, with a recent survey by PWC suggesting two thirds of the population believe executive pay is too high and 72% are “angry” as a result2. Politicians have noted the public’s ire, with new UK Prime Minister Theresa May recently outlining her intentions to clamp down on executive pay.

Hermes has long held the view that executives have to be aligned with the long-term fortunes of a company and therefore consider how it delivers returns to its multiple stakeholders: including customers, the employees and society in addition to shareholders. Moreover, Hermes has long engaged on this issue through its stewardship and engagement team, Hermes EOS. Hermes is therefore proposing a fundamental shift in the structure of executive remuneration packages towards much simpler, more transparent, more performance than share price driven and less-leveraged with greater accountability by the board and its remuneration committee.

The proposed reforms, as outlined in the attached paper, should help promote the long-term success of a publicly listed company for all stakeholders, while avoiding paying more than necessary. In addition, Hermes suggests further measures publicly listed companies should adopt – including the development of closer links between CEO/executive compensation and the pay of average worker. Hermes believes the chair of the board should write annually to employees to explain the basis for the CEO’s awarded pay for the current year – while the company should publish and comment upon the ratio of CEO to median worker pay – using both internal and external comparisons.

Saker Nusseibeh, Chief Executive, Hermes Investment Management, said:

“We strongly believe the time is right for companies and investors to fundamentally rethink their approach to executive remuneration. Moreover, we are encouraged that many of the ideas we suggested in 2013 are re-emerging and are confident that there is now a significant appetite for change among many to consider how they may more closely align pay with the interests of their long-term owners, as well as broader society, in order to restore trust and position themselves best for future success. The investment management industry must recognise its responsibility to engage with companies effectively as interested owners and, where necessary, use shareholder rights collectively and consistently. We stand ready to work with companies to support efforts which we believe are in the interests of the company and their long-term shareholders.”

Hans-Christoph Hirt, Co- Head of Hermes EOS, Hermes Investment Management, said:

“The combination of simplicity with increased certainty of outcome should result in lower average payouts, without changing the value of the award in the minds of individual executives. Importantly, we believe pay packages should avoid incentivising unintended behaviour and encourage the creation of sustainable value for all stakeholders. A shift away from heavy reliance on performance-related pay should assist with this.”

1Just Do It, High Pay Centre, 2015.

2Opinium research for PWC, June 2016, as reported in PWC paper: Time to Listen, June 2016.

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