Northedge: No I think actually it’s the same moral issue, but when you are talking about BHS who do you give it to if not yourself? Well, back to the customers.

Brown: I think it’s the capitalist system we live in and this idea that somehow businessmen are going to be good people and not be greedy is not actually in the interests of investors. What you want them to do is display certain characteristics in the way they run their company, but in the way that they then try to personal benefit from that you want a separate set of characteristics. I think that’s at the heart of the issue, you do not want your company to be run by wimps who are only too happy to accept very low pay and satisfy you, you want it to be run by red-blooded greedy people.

Skipper: Except that the balance has gone too far especially in the big companies.

Brown: Only in the sense of their pay, or you mean they are too greedy as businessmen competing with the Americans or the Japanese?

Rees: Its unfortunate that you are using the word greedy because actually the word we should be using is professional. If they are being professional, they are doing the job they are paid to do. There is a distinction between the principal and the agent. The principal, the Green’s of this world, go out and set  something up, or take a punt by buying it out, like British Home Stores. Fine, that’s then outside our immediate arena. Whether they can actually sell it back to us and crystallise the capital that way is a different issue. Then you have got the managers. If they actually want to participate in the kinds of returns that Green offers, go out and do it. if they are that entrepreneurial, go and do it. I have seen an awful lot of these managers and I have to say that one or two of them couldn’t set up a bouncy castle in their back garden. They are not up to it. However, they do want to participate in the kind of returns that they think they want. The problem is simply that there is no natural pressure against them to say look your job is to do this, we will tell you what you are worth, you don’t decide what you’re worth.  Unfortunately, the structure at the moment is entirely them with remuneration consultants  agreeing that that is what they are worth.

The consultants, I believe go out, and try and put opportunities to the management to say look have you thought about this.  You are appealing to them and that inherently puts a conflict of interest centre stage and that needs to be broken for a start.

Wilson: There is a duality in this debate where there is outrage at the Sid level and there is anxiety and concern at institutional level, and the institutions are there as the owners or as the owners’ agent to apply pressure to companies. 

I am just simply struck by the messages that we hear in private and the message we see published in the press and we know go on round the table in comparison with the analysis of the votes that we do on a regular basis on particularly contentious themes. The companies are going to continue to quote ‘get away with what they can get away with’ until they have an effective braking mechanism applied to them. The press so far has probably been one of the most efficient braking mechanisms because of what you were saying earlier about the catastrophe factor. It's what’s been known in the SRI business for a long time, that in damage limitation more can be impacted by the share price by adverse events in the press But how can you get to a situation where people feel brave. enough to just vote no? 

We have the most powerful company law in the world with votes, which are legally binding, while those in the States are only advisory. But we seem to be largely inactive. Lots of debate, lots of positions in the public arena but when it comes down to it the votes are overwhelmingly for the particular scheme. Is it that those who have concerned voices are continually being overwhelmed by the box tickers and how are we going to enable the serious investors to take it forward? Do companies not understand that when the likes of those on this side of the table are voting no or withholding votes then they really are seriously concerned and really take notice of what is going through the ballot box.

There are moral dimension to this, but in civil society we have constraint on individuals who outrage our morals. They could go to jail,  they can be arrested and their behaviour can be curtailed. How can we curtail excessive corporate behaviour? We know that in the auditing sector there is excessive individual behaviour. Wherever there is money there will be foul play. We are never as careful with other people’s money as we are with our own. How can you push this forward so what institutions are thinking is really taken seriously by the companies?

Emerton: I think I need to make a point about resources. There isn’t a great deal of resource among some of the fund managers. You look at the companies and they have got remuneration consultancies with 10, 20, 30 or 40 people, working on different projects, all with a great deal of brain power. They are coming up with complex designs of schemes, share schemes, pension benefits, salary levels, research to support that, writing a remuneration report writing circulars and being fairly creative in writing the circulars. That may be one reason why the institutions are not doing more where they may be able to. 

Skipper: I think that a lot of institutions, besides a handful, really aren’t that interested in executive remuneration.

Private Equity: Incentives that work?

Sykes: Do you think institutions with respect can actually redress any imbalance here? By the time they get to work the scheme is already imposed. Even 40% votes against by institutions have little effect and opposition dies very quickly. We have seen that time and time again. 

It seems to me that you have to come back to the fundamental question that Raj asked. What is it for? The whole basis of shareholder capitalism should surely be that directors and seniors managers are there fundamentally to look after shareholders interests which means long-term interests. They cannot do that without actually looking after employees, customers, society and all the rest. The first requirement is to do that, yet that link has somehow died in the last 10 or 15 years. 

I come back to the fact that  you should pay CEOs a very very good salary for the risks and the pressures involved. However you choose to categorise the incentives they need to be aligned with delivering sustained performance over four or five years. There is nothing wrong with CEOs in the the top ten largest companies in the world walking away with what may seem obscene sums of money if in fact they have delivered appropriate value to their shareholders. What I think sticks in people’s throats, (and we have seen many examples particularly in America, although we also have them here) is that time and again companies that have seen falls of 95% in share values, indeed many of them have gone bankrupt, yet the top men have walked away with hundreds of millions of dollars. Now, and I speak as a lifelong businessmen, as a free market economist and fairly rightwing conservative, you cannot defend that system as the market system. The market system actually equates reward with value. It does not do the opposite. What we are looking at is the fact that there has been too much power for CEOs, particularly in America, who determine their own pay with compliant boards and remuneration consultants for whom the CEOs are the paymasters. 

To have a fair system  look at firms that are financed by venture capital companies particularly management buyouts. I have chaired such companies and indeed done well out of them. The system is very simple. The venture capitalist puts up most of the share capital. They demand of the top team of half a dozen that they typically put a year’s salary at risk. A year’s salary is enough to make them concentrate on the job. They don’t want to lose it. They are committing five years of their time, their reputations and a year’s salary. That is enough to make them pretty careful about what they do. Above all else it makes them very very careful in choosing who the other members of their inner group are. They don’t take the former chairman’s nephew, they don’t take old Fred who no longer cuts the mustard. They take the best team they can get. When I was chairing one of these companies twice we had to dismiss a finance director. I was just gearing myself up to tell my colleagues that this was not working but they anticipated me as they had too much at stake to put up with an avoidable risk. The venture capitalists put up all the money apart from the investment of a year's salary by the management team. The management got something like 20%, if they delivered on their five year plan. If they delivered more than that it could be ratcheted up. This wonderfully aligned the management activity to those of the shareholders. There were no corporate jets, there were no plush London headquarters.  Managers concentrated on what mattered to make the business a success.

What you have to do in the large companies is you have to have independent directors who have the power to put in the equivalent of that kind of scheme. The job of the fund managers is to encourage that process. It is not to second guess people and say it should be 10% higher or a slightly different format. It is not, with respect, the job of fund managers. The job of fund managers I feel is precisely to support those kind of sensible initiatives and they exist. That is the way through that particular jungle.

Rees: As a fund manager I would disagree fundamentally with that kind of structure. Those private equity schemes are predicated on certain returns that may not be available to the market as a whole. They are predicated on an attrition rate at the venture capital fund with some of those entities not working out and actually going under. I would want something that comes back much more on to the concept of directors understanding their responsibilities. Yes, you pay them well, but you pay them well up front. If they are seen to be doing that in terms of salary and a very straightforward bonus that is acceptable. You remove them if they are not doing their job and I think to overincentivise gets them back into the same old problems that you are manipulating the movement in prices. If at the end of the day it’s all to do with the share price, many companies in the market over the last two years,  certainly in the last few months, have not performed well - there’s not a linkage there.

Sykes: But you are using the word incentivise with the adjective 'over' incentivise in front of it. There’s nothing to stop you if you have been paid in long-term shares to choose your moment when you sell. Sandy Weill at Citicorp is absolutely adamant that people are not allowed to sell more than a quarter of their shareholdings as long as they remain employed by the company.  I have seen examples of this work very well. In the case of the company I was the chairman of, the same share incentives went right through staff. They all had the same incentives. There was no division in type of incentive between the half dozen at the top and the others. I saw secretaries walk away with over a year’s salary, something they could never dream of. The atmosphere in that company where people worked unasked for long hours and put in huge effort was truly remarkable.

Rees: And it is probably matched by the depression that is now probably there if the share price has subsequently collapsed, so there are risks.

Sykes: You can't be rewarded if your job is to maximize the value of a company and for some reason you fail, what is the case for the major award?

Wilson: But the failure in the share price is not always the fault of the company. Markets will behave illogically and commentators are agreed that there is nothing that relates  those that work in the company and stock market performance.

Sykes: You don’t have to sell this week, this month or this year.

Northedge: The other half of that point is that when markets are up why are we rewarding these managers for what the market has done?

Thamotheram: I feel we are getting into a quite detailed about different options. I think the interesting thing about both of those options are that they begin to address the more substantive question of what is pay for? It is for long term durable growth and responsible corporations that are stable. That’s where I think we should be addressing energy and that’s where I think if remuneration consultants could link in  the performance aspects with a more balanced approach then you start to get some interesting input as opposed to taking devices to validate the salary people are getting.

Enough Executive talent?

Little: You have got to get to the root of what Allen Sykes is talking about. We have not got a free open competitive market in senior executives. At Selfridges, at the level of the ordinary person on the shop floor, they know what they are worth. They know what they could get going next door to BHS or going next door to M&S. There is a pretty competitive market. At the very top level there is not a free open and competitive market. You can’t necessarily compare Chris Gent with Mr. Green they are doing different jobs for different types of company they are not interchangeable there is not a free open supply where you can get another one off the shelf. Because of that, whatever you get to substitute for the market is artificial in different ways and what we are talking about is how to tinkle with these artificialities if you can’t get the conflicts of interest out you are at a huge disadvantage.

Kerr: I sense that there is a significant difference in point of view here between those who believe that there is a ready supply of capable individuals and those who believe that higher awards are necessary to capture the very limited pool of talent.

Thamotheram: One of the leading American academics in this field, Jim Collins,  has done two excellent books, Built to Last, and the most recent Good to Great. He has looked at the companies that have consistently performed well above average. His conclusion is that the key factors that create these highly profitable stable well run companies are not saviour CEOs plucked from elsewhere because they are brilliant but it’s actually management which is over time incentivising good leadership so that you do have internal candidates who are well able to deliver share value over that time. I would really encourage you to read his last book from Good to Great because it shows what kind of management we should be incentivising and the wonderful thing is when you look at the chief executives of these companies that have delivered amazing shareholder returns they are getting less than their peers.

Craighead:  If you insist on external recruitment, then the definition of a future finance director is that you must already be finance director of a FTSE company. This creates a sellers market for the candidates and that is one of the things that has driven pay upwards and upwards. What is needed is appointment boards with the courage to go for internal promotion. Funnily enough, those guys come cheaper. One of the reasons for some of the reactions to executive pay is that there are many people inside these companies. They are aware that while some of their leaders are exceptional, some of their leaders are not so exceptional, and quite often somebody lower down is outstanding and occasionally gets promoted. This has two effects. One, we have suddenly got a supply of more leaders. Two, the price just went down because the supply went up. So this is not to disagree with you but I think there is a really important issue about 'oh we are the appointments committee we must choose somebody who has already got this job' which is creating part of the problem we are dealing with.

Northedge: Perhaps Peter would like to tell us something about the process so that when you are in a company and you are suggesting that a chap should be paid £500,000, why it is £500,000 and not £400,000, is there a market there? Are you saying that for £400,000 he wouldn’t come but for £500,000 he will?

Brown: There’s a market there but the whole structure of British industry has changed. I can remember when we were largely a manufacturing economy. The timescales of manufacturing economies and the big oil companies are five to 10 years between having an idea, developing your source and benefiting from the idea. We have moved into a service economy where I have to say the timescales are much shorter. A lot of these companies do not plan to exist for more than four years. You may not want to hear this but their business plan, which they don’t tell you, is to sell up. Now  some when they go public make it fairly clear that they are going to develop some concept and the venture capital business is an expert at this and develops or builds on some concept but it builds on it to then pass it over to a much bigger management team and a bigger company that can develop it further. They know they can not develop it themselves. They know they haven’t got the interest. They want to retire at 45 as a millionaire. 

We lose about two clients a year because we simply will not go along with what they suggest we should tell them. We are small, I own the business myself, and we can be independent and that is very very important. We can say to a client sorry we would rather not do the business, find somebody else, because you can afford to say that. There are some quite extreme situations in which, you are appointed by the remuneration committee but effectively it is the company secretary that does it. It is the company secretary who is the secret weapon in this whole argument about non-executives. It is the company secretary who ought to be the servant of the board but is in fact the servant of the chief executive or he may be the servant of the finance director because in terms of his actions he answers to the finance director. Therefore the independent member of the executive team is in fact not independent and so he briefs you and he’ll go we have always used these comparative companies in the past, the words are all done. 

I have to say we are opposed to comparator groups as an organisation. I know the institutions like them. I know why they like them and I think there is a lot of rationale in why they like them but there’s also a lot of danger. They collapse because of takeovers and after two years you have only got two comparator companies left and this sort of thing, so what happens? Well they say to us we want a review. They may say they want to review everything or just review the incentive scheme or the option scheme or the salaries. We tend to try and persuade them that they should review everything as it’s very difficult just to do one section of a remuneration package. In most cases we are not under a lot of pressure but the danger is when we come before a remuneration committee with a draft report - as consultants we’d do a draft then final report - we don’t get enough questions we don’t get enough of why haven’t you thought about this and why haven’t you thought about that? We’d probably give them the right answers but for instance they don’t say why don’t we have a share scheme rather than an option scheme and often they should. We may have suggested a share scheme . If we have changed everything they say why have you changed it?  We are changing from options to share schemes quite a lot, if we can, because they are much better. But there has been a  traditional view that British directors can’t afford to buy shares which is increasingly not true. They have been well paid after 10 years and they can afford to buy shares.

Northedge: Do they say ‘What is the lowest rate that we could pay that will retain them’?

Brown: No, the remuneration committee will say how can we be generous and fair? I would have said that is their basic attitude.

Northedge: So it is not market led?

Brown: Not in the slightest.

Northedge: You have a list of comparators but you don’t have any idea that the person may go to one of those competitors.

Brown: No and if he goes it is almost certainly not the money, it is because of job opportunity. I have seen very very few senior people leave for the money.

Rees: Can you think of anyone?

I struggle to think of anybody who has left simply because he says I haven’t been paid enough and he’s walked out.

Weight: I can think of somebody actually. He went into a private equity fund.

Rees: But in the quoted area?

Weight: He was a chief executive of a FTSE120 size company. I can think of several people actually who have decided to take their talent and move into the private equity area because they can get very much more significant rewards there. That issue is interesting. You talked about 20% of the equity being totally available - up to 30% in some cases whereas in executive share option schemes 5% dilution is all that the institutional investors will allow except in some extreme cases they might go a little above 5%. There is a huge chasm between what the private equity industry is doing, they find that particular model does work and it comes back to this question of what are we actually asking management to do? I think its situational you have got to distinguish here between entrepreneurial businesses, transactional-related businesses and the ones where you want administrators. We have heard quite a lot of people talking about businesses which have a five to 10 year investment profile that’s rather different to if you go and buy another business over the side of the pond for £40bn. You are asking for different skills of management so a fundamental question to ask is what is it you are trying to achieve?

Wilson: But surely the 20% of a small business and 5% of a bigger business there is no comparison.

The right incentives for executive pay

Sykes: I think that some people have expressed very reasonable worries about paying people based solely on share values even over five years. That has its weaknesses. I didn’t mean to give the impression that that’s the only way you can do it. It might be better to use earnings. It is very interesting that in companies in Britain and America the p/e ratio in the last 10 years went up by a factor of three i.e share prices rose three times faster than underlying earnings. Nor are earnings now falling out of bed the way share prices are. Share prices are down in the order of 40%- 45% in Britain and America from the peak in 2000. So one can relate it to earnings if one wants to, that’s perfectly legitimate. I think the essence of what I am trying to argue is that we should try and relate it to something that is meaningful to the underlying investors that managements are to be aligning their interests with. It should be something like five years compared with only two year stock options in America and three year stock options in Britain. I am sure we can do better than that. Some people may say well let’s have a combination of earnings and share values. My fundamental point is, let’s make the incentives relevant to the people on behalf of whom they are exercising their power and something like four or five years related to performance is surely the appropriate test.

Kerr: Cliff actually introduced a slightly different slant on that which is to look situationally. I would be quite interested to know how comfortable people are with that idea. For example, if you put a management team in place because you want to drive a transaction or a number of transactions do you incentivise specifically on that? Or if you are in a situation where it is to build for the longer term should you incentivise on that? Let’s not get too bogged in how you do it, but is that more appropriate rather than having a blanket approach to remuneration?

Sykes: You shouldn’t have a transaction bonus because most of the firms in America, which have crashed, have gone on mad acquisition sprees, which have actually brought them down. Vodafone even is down 75% but it was sensible enough to fund takeovers with shares not the debt, which finished off Marconi. Management ought to be rewarded only if the deal they did was successful as opposed to getting a transaction bonus for having done a deal, regardless of its ultimate success. The majority of deals are unsuccessful. The transaction bonus is quite wrong in principle. But you should reward people for a takeover if it works and 60% plus of them don’t, they actually destroy value. You should have a different incentive but if you can double your salary by some poor value or risk takeover  even if you get dismissed in two or three years time then you will probably do it. What CEOs are maximizing is what ever the incentives are within their scheme. Unless that scheme also happens to equate with the long term interests of the shareholders they are being given the wrong incentive.

Skipper: I think the problem is the conflicts of interest go so deep. We are all agreed that long term measures are the right measures. But when everyone is being incentivised, from fund managers to directors to remuneration consultants,  on a short-term basis, how do we remove those conflicts? It goes back even to pension funds because the reason why fund managers are so short term is because pension funds are so short term. Where do we start?

Brown: The reason these deals are driven is because of the  merchant banks. It’s all the people who earn huge deal-driven fees. If they were paid in company shares rather than in cash would you get them thinking about the longer term? If you chair a public company once a month you have some guy call you up saying, 'why don’t you take over x why don’t you take over y'. It is continuous and increasing at the moment because of they’re a bit short of work. There is this continual pressure of whether or whether or not you are in the takeover stakes.  Dawsons is a very solid, very stable company. It is focused on the long term with five year contracts with all the publishers and we have dropped options. But I am so conscious of the fact that so much of this really stems out of the banking parlours in the city everybody’s on the deal. So what happens to your lawyers now? Your lawyers go and make c if you fail and get a y deal if you succeed. There is nothing about professional services or your paying for skills.  Everybody’s on the take at the deal stage in cash.

Weight: Take the Vodafone example; I think Goldmans got a billion for the hundred billion takeover of Mannesmann. A billion is quite a lot of money and it tends to influence the way people behave. Even people at Goldmans who are quite well remunerated. And that does tend to have an influence on the executives around the table who are participating in this debate the sad thing is when Airtouch was taken over by Vodafone I think that one director cashed in 61 million of options wisely noting that Vodafone price was about £3 at the time. Let me try and give you a solution. It’s very radically different from what happens at the moment, it comes back to one of the pertinent issues about the fund management community having a conflict of interest because they do over focus on relative performance and as a result of that they have introduced a lot of incentive plans for managers of companies that is based on relative performance. It adds an added level of complexity to the executives, we all agree in alignment to long-term shareholder value I think that is one thing we have achieved. I think the board should set absolute targets for what it wants to achieve.

Skipper: But the conflict is still there with the pension fund requirements.

Thamotheram: It doesn’t need to be. It’s because trustees who are part-time and well-meaning but not well informed are told very clearly that the way to exercise fiduciary duty is to look at the quarterly and yearly results of their fund managers. Some trustees are experienced enough, like ours, and well informed enough to know that that’s not the case.

Weight: What management has got to do is actually take their capital and they’ve got to invest it in a way, which produces a return on capital greater than their cost of funds. If that happens over the long term share prices are going to up and so you have got to set managers absolute targets. I think you have got to measure them on a mix of leading and lagging indicators. We have been too keen for too long at measuring lagging indicators of shareholder value. Many many incentive plans, particularly the annual incentive plans, are looking at lagging indicators. Customer services is going to be a leading indicator, the quality of management those are the sorts of things non-executive directors should be setting targets for the executive directors to deliver against and then measure their performance. That’s what I think should be driving the annual performance plans and the annual incentives come from that. If that, in the long term, does deliver shareholder value, then you should get further rewards in the future. It’s an analogy with the transaction bonus you take over another company but you only get a reward if it’s a successful takeover. For business strategy, paying people for achieving their business strategy is more significant than shareholder value in the long term. It’s up to the non-executives directors to actually provide that governance of the organisation but it is quite a lot different from what we do at the moment. Share ownership I think  provides an alignment on the downside.

Moxey: I think there is a great deal in what you are saying Cliff and I think what Raj was saying. 'Let’s focus on what are the directors for', I think you are elaborating on that. 

I think there is one issue that we also need to address which is, what really do we mean by shareholder value? Until a couple of years ago it was very easy to say the share price was one key indicator. But the last two years have demonstrated that’s not the only indicator and is possibly far from the best indicator. It’s also highlighted how share price is almost completely delinked from the underlying performance of companies and the underlying effectiveness of boards. So I think what we need is some mechanism to work out what really is shareholder value. Clearly share price is one ingredient but I think it can’t be the only ingredient. I think it is significant that this debate is now so important after we have had these markets corrections over the last couple of years and, particularly recently. No one probably would have argued about the pay of Vodafone executives when the Vodafone share price was at its stellar figures. Now it’s come back to something perhaps more approaching reality then people say well perhaps the directors are being overpaid, well overpaid in relation to what? In relation to what Vodafone was or in relation to what Vodafone is now or in relation to what Vodafone will become? I think it is what it will become that has got to be the key thing because we have got to be looking at the future and we have got to be looking at indicators for future performance. Maybe it’s time to go back to some of the fundamentals like cash flow, dividend yields and profitability. Of course companies are different and the point was made very well earlier that there are different types of companies. Some exist for a few years and make an awful lot of money for certain people. Others are basically there to run a fairly stable operation, more of an administrative type thing. So I think different indicators of effectiveness or success will be appropriate for different organisations. But I think that the debate needs to be brought back into shareholder value. I think we all agree that we need to link directors pay to shareholder value. I think the debate maybe need to focus a little bit on what we mean by shareholders value and it will be different for different organisations.

Kerr: There is a huge amount of agreement around the table that in our executive lives whether we are running businesses, managing funds, whatever, we necessarily have a short term focus because we only do those jobs for a relatively short time. But  as investors we have a very long term perspective so all of us have the problem that our behaviour is in the short term and not necessarily being incentivised for the long term. We are starting to see some differences around the table about how you can measure what that long-term value position is, indeed the question is, can you do so? It’s interesting Cliff talked about looking at leading indicators. The problem with leading indicators, I suspect, is because they can’t be measured as absolutes we probably disagree around the table about how to measure them and how much reliance you could place on those measures at any point in time. So I guess the question for me is, if we are going to base this on something that is longer term have we got the capacity to measure it and can we agree on those measures and therefore pin rewards to them?

Thamotheram: I think this is a fascinating conversation because I can see a way forward. There is a solution here I think. You are both mentioning what might be called intangible assets, employee motivation, brand value, reputation. They are not easy to measure but actually truth be told we are not terribly clever with financial accounting yet are we? After just a few years of practice! So is asking the right questions to get approximately the right answers in the right areas better than ignoring the right area completely just because we don’t have a perfect tool. Company by company, I think competent boards and competent fund managers should be able to work out how important the employee base is to the company, how important the customer base is, how important the supplier base is and  how important the brand value is with NGOs (non-governmental organisations). You should be able to work out a rough idea of what those intangibles mean to the company’s future success and linking that in to the reward package is appropriate. It should be part of the core business strategy shouldn’t it and shouldn’t reward and core business strategy be linked? So I think we are beginning to tie up a complex debate.

Moxey: Companies have different objectives and I think there has been a fair bit of talk about the benefits of boards stating publicly what their objectives are. Now maybe what would be a way forward would be for all boards to state in their annual reports, or wherever, what basically the organisation is there to do. It would include something about the board’s strategy for attempting to achieve that and then they can come up with remuneration schemes which are related to their stated objectives. They can report in their annual reports on how they are doing in relation to those objectives. That brings the whole thing open to the public. Then investors can choose whether they like it or whether they don’t. If they don’t they can take their money and put it elsewhere and that will have an effect.

Skipper: They probably will have to do soon - in the company law review – won’t they have to do that in the OFR (operating and financial review).

Moxey: It’s one of the suggestions, yes, and it is not clear quite what it will turn into - whether it ends up being a boiler plate statement or something that has actually got some quality. Hopefully investors will  say we want something that means something rather than a boilerplate.

Kerr: I sense not everyone is quite comfortable with this proposition.

Craighead: The problem in practice for those schemes is that as long as the executives win, they’re operated and when they lose they say they are going to leave so they stop operating them. So it’s great, it’s heads I win tails I spin again. If you have a scheme, which, is related to a set objectives, it’s a formulaic approach.

There are two ways of paying people, one is at the end of the year the boss takes a view and says “you did a great job here’s your bonus here’s your pay”, which is what we do with staff and what I think Tim is after for executives. The other way is to set out a formula which tries to replicate the world in detail, and whatever the outcome that’s what you get. With these it’s possible to shoot the lights out. The problem with those formulae is that if the lights do get shot out it may be by luck or original miscalculation. Over the last few years markets have been very good and many schemes have performed brilliantly. I think this is where the public is coming from. They are not entirely happy and they may not be entirely wrong either. When the share price goes down or whatever the driver is, when the scheme will fail to pay out, the management suddenly say, 'we have got to abandon this or we don’t earn enough to stay'. This classically happens in brokerage firms. When the bonus scheme doesn’t come in with a good bonus, the guys leave. So actually it’s a win only scheme and I think there is some justification in saying we should be aware of the asymmetry at the very least if we introduced this scheme.

Skipper: Presumably this is where the remuneration consultants can come in. There should be some way of structuring the plan in order to retain these people.

Wilson: Isn’t there a problem that many companies are operating inside very constrained boxes in order to meet institutional guidelines which have in the past almost tried to create one size fits all schemes when there are certain aspects which are particular to that company’s growth. Some investors will find it difficult to start thinking outside the box and actually analysing schemes and instead of having to rely on a tick box approach they are going to have to apply some initiative to it. We saw recently with BHP Billiton introducing a very novel scheme, which is quite a departure from some of the schemes, we have seen in the past. It is in fact producing a kind of scorecard of what managers are trying to achieve set against their business plan. The problem is it doesn’t fit neatly into the tick box approach which the institutional guidelines in recent years have set up.  So do we need to create guidelines which are more sets of principles to give companies the opportunity to develop? I am not sure that at present companies could create the types of schemes that companies are talking about in the present quasi-regulatory framework. I know that the institutional guidelines aren’t legally binding but they have been a very powerful force in the last ten years. 

Weight: I know some remuneration consultants who as soon as they see some new guidelines they ask how can they get round this or how can  they actually take it to the very very limit. I am not sure that these guidelines are always really helpful

Rees: The idea of having a much more complicated system fails on simplicity and transparency. As a fund manager the hardest question I am always asked by consultants and advisers is, how do I pick stocks? They want some simple methodology and the reality is if there is a simple methodology it is immediately broken because everyone else could use it and it falls flat on its face so there’s no sustainability in that. The reality is there’s a whole host of means that I have to use. One of the things that I have noted over a number of years is the role of dividends for instance. We tell companies that we place immense importance on dividends because we believe that is a true statement of what that company feels is a sustainable distribution from the company. They are not likely to do something stupid with the dividend because it commits them to future years.  If only you could have some kind of remuneration that is based on that, where there are real cash flow implications from their decisions, as opposed to being given targets. Just as I said about being a fund manager you give them the opportunity to go down a certain line they will abuse it rather than use it. they will push it to the extreme.  With the dividend there is a cost involved. It’s money out of the business that actually threatens the structure.

Brown: They better not be heavily borrowed with their banks. Because some banks are extremely difficult about allowing you to increase your dividend if you have big borrowings. It’s a real management problem inside companies.

Emerton: If directors are only there for three to five years anyway will there be increased dividends in the last few years and load the effect on companies?

Rees: You can put cover issues in. You could put in sensitivities about how much cover you could have.

Sykes: Can I suggest we are going down a very dangerous line here that doesn’t work? I urge caution. If you have companies choosing their own standards and targets which are subjective, particularly in the short term, which can be subjectively reported on, then there’s a very real danger they will be unsatisfactory. The whole point about going to longer term performance indicators such as five year ones, whether it’s earnings or share price or some proper combination of the two, is that all these other wider considerations are automatically taken into account. If you haven’t satisfied your employees, you haven’t kept your customers, if you have been driving your suppliers into the ground, if you have driven your banks to despair, if you have got an environmental record that stinks to high heaven, then it shows up in that sort of period. That’s what earnings do they are net of all these other costs. Graham Sergeant, a distinguished financial journalist on the Times, put it superbly when talking about stakeholders. He said, 'you will look in vain for a company where stakeholders prosper while shareholders languish.'

I do believe we if we focus on the longer term and measures to look at that correctly there are all sorts of ways you can do this. Going back to takeovers and mergers, when there’s a whole firm management buyout the non-executive directors are always independently advised financially and legally. They have to recommend action to shareholders because obviously the management have the most impossible conflicts of interest. Given that roughly 60% plus, let’s call it two thirds just for simplicity, of mergers and acquisitions destroy shareholder value, if the non-executives as a matter of routine had to be separately advised legally and financially and then make a recommendation to shareholders and the management were incentivised only for delivering longer term performance, this would have a massive effect on reducing those poor value takeovers and mergers which merely boost short-term gains but cannot deliver long-term value. There are other ways of doing it but I counsel that we stick to the standard measures like properlydefined earnings. I don’t mean earnings before interest, tax, and amortisation and all those other factors that seem to have crept in. I am talking about genuine net earnings. I believe that is the right way. I think if we were addressing the City or Wall Street and instead put up schemes, which included employee satisfaction I think we’d be laughed at quite frankly.

Rees: I agree entirely but interestingly just on the observation of earnings per share if you actually look at the US market and you look at the divergence of the national accounts profits on an national account basis and reported profits it is nearly five years since they parted company and they had been very very closely tracking each other.  Then they moved apart so even over a five year period it would appear that it is not beyond the capabilities of overincentivised and I will use the term overincentivised in the context of the US market, overincentivised executives  keeping the game going for a very long time.

Sykes: But they are not usually there for a very long time.

Kerr: There’s a definite divergence of views between those who believe a range of forward looking measures are possible and those who believe that ultimately actual performance as reflected in cash or as close as you can approximate to it whether through dividends or some other measure is the right way to go. There’s a distinct difference there, but there is a real issue emerging which is, if it’s for the long term, however you measure it, and the average tenure of, certainly chief executives, is shortening particularly in the US but no one’s tenure is long enough to test whether the performance is sustainable in the long term then I guess you raise issues of what you do on exit with these people. We have had pensions mentioned and that’s a neat way of boosting of executive income, particularly in the last year. We have heard about the idea that you  can’t cash in your options or your shares that they will  be held for a longer period. There is also discussion about perhaps clawing back previously awarded rewards if subsequently things are found to have deteriorated. How can you deal with those issues once those people are no longer in charge?

Countering short-termism

Skipper: It’s a sort of chicken and egg thing. It’s because the incentives are so short that the tenure is so short. If we could measure them by longer-term performance periods then perhaps we will be a bit more willing to wait for that longer term before we oust chief executives because we are looking to the longer term. It’s how you get the ball rolling.

Kerr: And more willing to countenance extending service contracts?

Skipper: Well, that is all part and parcel of the package. I mean there must be safeguards there because if somebody is definitely not performing then you can not afford to pay them too much under a longer term contract.  I think part of what’s happened is because the quantum of pay has gone up so much the quid pro quo is that the investors have required that performance to come from them so the whole thing has got out of hand. I think it has just got to come back down, to level out again and be a bit more sensible.