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Money talks – Reforming executive remuneration

Home / EOS Blog / Money talks – Reforming executive remuneration

In our engagements with companies across sectors and regions, we continue to push for reforms to executive pay.

Setting the scene

In 2012, UK companies found themselves caught up in the so-called shareholder spring. Unhappy with what they perceived to be excessive amounts of executive pay or packages that were too complex or out of sync with the economic climate and value creation, shareholders started voicing their frustration by voting more frequently against remuneration reports at company AGMs.

The shareholder spring was perceived to be a game-changer. In the UK, it led to new legislation in 2013, resulting in a binding vote on a company’s pay policy by shareholders at least every three years. Together with the Pensions and Lifetime Savings Association, the BT Pension Scheme, Railpen Investments and the Universities Superannuation Scheme, Hermes EOS developed a set of remuneration principles for executives in the aftermath of the shareholder spring. 3

However, the impact of the 2012 shareholder spring turned out to be short-lived and executive pay has continued to increase, particularly in comparison with the rest of the workforce [see table]. Often this has led to higher levels of remuneration for average performance and reward for failure. To the ultimate beneficiary of institutional investors this trend has been difficult to justify and frustration about the widening pay gap and related divisions in society may have contributed to the decision made by UK voters to leave the EU.


The annual bonus and long-term incentive plans of executives typically pay many multiples of their base salary, even in years where companies underperform. Often the root cause of overly generous pay and reward for failure lies in the remuneration policies of companies which are supposed to align the remuneration of the CEO with the performance of the company he or she is leading. Executive pay plans have become increasingly – and unnecessarily – complex and difficult to understand even for members of remuneration committees. At the same time, remuneration committees have mostly failed to fulfil their responsibilities by using their discretion to reign in ever-increasing pay awards.

Voting season 2016

In the 2016 voting season, similar to 2012, a large number of shareholders opposed the pay policies and reports of companies and called for reforms, reflecting the public anger to high levels of pay. We at Hermes EOS played a part in this, by complementing our engagement on high pay with votes against management proposals on remuneration.

Although remuneration frameworks vary by country – most notably with regard to disclosure, pay caps and, crucially, the existence and legal effect of shareholder votes on pay policies and reports – and concerns differ accordingly, several trends have stood out this voting season.

First, we observed the misalignment of executive pay to the experience of shareholders and creation of long-term value. Due to the downturn in the commodities sector, this applied especially to extractives companies, such as Anglo American and BP, and those providing goods or services to the industry, such as Weir Group. Secondly, we witnessed the overuse of discretion upwards by remuneration committees when it should not be used or lack of discretion when it needed to be applied, for instance where quantum is already large. We, for example, opposed the pay package at Tullow Oil for failure to use discretion downwards in a year, which, in our view, displayed poor performance. In addition, we recommended voting against remuneration policies where the assessment and stress-testing of pay packages and policies by remuneration committees was in our view flawed and quantum was inappropriate and unacceptable to us.

One of the most controversial votes cast against in the 2016 voting season was at the AGM of UK multinational advertising agency WPP, with which we have a longstanding engagement on independent board leadership, succession planning and the responsibilities of its remuneration committee. The proposed £70 million pay package for 2015 has to date been the second-highest pay package ever received by a FTSE CEO. The large quantum could primarily be attributed to a legacy equity incentive plan introduced in 2009 which is to be phased out in 2017. However, while we appreciate that the quantum was primarily a result of the company’s strong performance in recent years, we had historic concerns about board composition and the remuneration committee’s apparent lack of vigour and stress-testing when the legacy plan was devised. We urged the chair of the remuneration committee to draw the right lessons from this controversy when developing a new remuneration policy in 2017 and, like last year, opposed the proposed pay package for assessment and quantum reasons. Another highlight of the voting season was the AGM of Deutsche Bank, where we commended the supervisory board for not paying any bonuses to the members of the management board in 2015. However, we were concerned about the significant increases in base salaries in recent years, the apparent lack of consultation on the proposed changes to the management board remuneration system, the inadequate transparency in relation to performance criteria and targets of the proposed division performance award, as well as the high level of discretion of the supervisory board with regard to variable remuneration. We were therefore part of the 51.9% of shareholders who opposed the new remuneration system.

Reform proposals

At the beginning of this year’s AGM season, we issued additional guidance to clarify our expectations of remuneration committees. We highlighted that developing, thoroughly assessing and stresstesting, implementing and – if necessary – adjusting the outcomes of remuneration policies is the responsibility of remuneration committees – not of investors. (4)

To effectively discharge their stewardship role, remuneration committees must take a more robust view on pay.

They 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. A simplification of remuneration policies and plans – which allows outcomes to be understood by investors, boards and executives – has thus become necessary. If remuneration committees do not understand the potential outcomes of a pay policy, or would struggle to rationalise proposed quantum, they should veto it. And if the actual outcomes of a policy cannot be explained convincingly to the average member of the public or implementation leads to results that contradict the underlying purpose of a remuneration policy, they should use their discretion to adjust them. At all times, they should use discretion to safeguard their company’s reputation and social licence to operate in a given market.

Remuneration committees must also balance the desire to set some targets that can be controlled by executives with the need to ensure alignment of remuneration and long-term value creation. We have long argued that paying a significant part of remuneration to executives in shares and requiring them to hold these well beyond their tenure with companies is a natural starting point to ensure the desired alignment. In addition, 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.

Pay escalation is often linked to succession plans, as companies believe they can hold onto their CEO by paying excessive amounts to the individual. However, in our view the head of a company should not be purely incentivised by money, as this is neither in the interests of shareholders nor the company. At times this excuse has been used to increase pay when there was little chance of the CEO leaving. While we recognise that companies want to pay their CEOs more than their competitors, businesses need to realise that remuneration alone does not attract great talent. Ideally, some form of fairness test should be applied to explain CEO pay and how it compares to the rest of the workforce and why it is justified.

In short, the objective of remuneration policy is no longer to attract, retain and motivate an individual but to pay what is necessary while rewarding delivery of great performance.


We believe that there is a significant appetite for change and urge companies to consider how they might align pay more closely with the interests of their long-term owners in order to position themselves best for future success.

The ownership chain should endeavour to understand and reflect the views and interests of the ultimate beneficiaries, including with respect to the question of what executive remuneration levels are acceptable. In the absence of direct involvement of beneficiaries, boards or trustees of asset owners could develop a clearer view on executive remuneration, including on quantum, and instruct their fund managers to communicate this to companies and exercise voting rights accordingly.

The conflicts asset managers can face, specifically when they are listed or are part of a financial group, ought to be addressed, for example through better disclosure on how published policies on executive remuneration can be implemented through voting at AGMs.

Fresh thinking

To address inequalities and the rise in quantum, pay ratios, which will come into effect for US companies in 2018, should also be considered. Under the rule adopted by the US Securities and Exchange Commission as required by the Dodd-Frank Act, large companies will have to disclose how salaries at the top compare to their median compensation level for employees worldwide.

Furthermore, pay-for-performance ought to be disentangled, in other words it has to be clearly defined as to whether it is about individual or company performance.

Engagement and voting

However, engagement reinforced by voting is likely to be the most effective means of bringing about positive change when it comes to remuneration. With another round of binding shareholder votes on pay policies taking place in the UK in 2017, we will continue our intensive engagement on remuneration for the remainder of 2016.

We seek to support companies and their directors embracing change as we believe pay arrangements that reward long-term value creation instead of average performance – and are acceptable within the wider society – are in the interests of companies and their investors.



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Hans-Christoph Hirt Dr Hans-Christoph Hirt is an executive director and board member at Hermes EOS and as Head of the organisation responsible for the sustainable success of the business. He leads and oversees the global engagement programme and the quality of the services Hermes EOS provides to its clients around the world. Hans also leads some high-profile stewardship activities, including priority engagements with major companies in Asia and Germany, as well as interactions with key regulators and organisations. Prior to joining Hermes EOS, Hans worked with international law firm Ashurst. He is the author of numerous publications on corporate governance and law, responsible investment and stewardship. Currently, he is a member of the Steering Committee of the UN PRI Investor Engagement Clearinghouse and the Shareholder Responsibilities Committee of the International Corporate Governance Network. In 2015, he joined the Institutional Investor Council in Malaysia. Hans is a UK-qualified lawyer, holds degrees in Business Administration from universities in Germany and the UK, the ACCA qualification and a PhD from the London School of Economics (LSE). He continues to be involved in academia as a Corporate Governance Fellow at the LSE’s Financial Markets Group and a Teaching Fellow at University College London. Hans speaks French, German and Mandarin.
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