Influential report calls for more transparency in the way senior leaders are rewarded – and will recommend wider disclosure of pay ratios
Businesses should end their reliance on long-term incentive plans (LTIPs) in a bid to simplify and reduce the size of executive pay packets, according to a new report backed by some of the UK’s largest shareholders and investors.
The Executive Remuneration Working Group, chaired by Legal & General chief executive Nigel Wilson, is demanding a shake-up of the way senior executives are paid, as it responds to a wave of shareholder rebellions this year against remuneration packages.
The report will call for a focus on base pay and annual bonuses rather than LTIPs and other share schemes, which align reward with longer-term performance. It will encourage businesses to publish the ratio between executive and average workforce pay, and may make a firm recommendation that they set annual binding pay votes, rather than the current annual advisory votes.
LTIPs had limited effectiveness, the panel warned in an interim report published earlier this year. And Dr Almuth McDowall, senior lecturer in organisational psychology at Birkbeck University, said she agreed executive pay needed to be “radically rethought”.
She said LTIPs were introduced to motivate business leaders to stay with companies and work towards their long-term sustainability, but that the schemes often relied on financial targets.
“It is essential that you benchmark against intangible assets,” she said. “Look at health and safety data, employee turnover, engagement data. It is not the infrastructure or technology that separates companies, it is the human capital – the knowledge in people’s heads – that gives competitive advantage.”
McDowall added that executive pay had risen beyond effective levels. “If you look at the behavioural science, there is a ceiling effect beyond which more money does not make us more engaged,” she said. “Delayed incentives also do not really work because of how we are wired as human beings.”
She said employers would reap the rewards of reigning in the figures they paid top bosses: “We would have expected executive pay to fall during the recession but by 2010 it was back to where it was.
“It limits the amount companies can spend on infrastructure; on doing bold, innovative things; on other human capital.”
High Pay Centre director Stefan Stern said a greater proportion of chief executive salaries should be fixed, and that cash was preferable to shares when it came to bonus schemes.
“Performance-related pay is hard to operate successfully,” he said. “To claim one individual has effectively been solely responsible for a big company’s performance is ridiculous.
“People are free to buy shares in their company, but to use them in pay is flawed.”
Research from the CIPD last year found that six in 10 employees believed the high level of chief executive pay across the UK demotivated them at work.
CIPD reward adviser Charles Cotton said when the research was published:“It’s crucial that chief executive reward packages are simpler and more clearly aligned to both financial and non-financial performance measures.”
The working group interim report said companies using LTIPs found it challenging to set targets that would be relevant to their strategy and the wider economic environment three years later.
It added that remuneration committees often resorted to boosting fixed pay to attract people to chief executive roles.
Alternatives considered by the panel at that stage included deferral of bonuses into shares, basing share awards on previous performance and replacing targets with share price performance.