PAYnotes on transparency in executive remuneration

About 18 months ago I wrote a piece about transparency, or the lack of it, in executive remuneration. At the time I suggested that the evolving regulatory environment would increase openness on directors’ reward but that it might not succeed in bringing greater clarity. Instead, I argued that a trend towards ever more complex packages for senior executives might actually make it harder to see what was actually going on.

Since that time, I’m pleased to report that the picture has evolved and largely for the better. 

The reporting regulations have had an impact. Annual reports and accounts now contain detailed explanations of how executive pay is arrived at, what the aims of each element are, how each is measured, and so on. There is a pretty common interpretation of the regulations which has led to a high degree of similarity between one report and the next. Some may be more tastefully laid out than others, but they all basically show the same information in pretty much the same way.

One requirement which was particularly focused on increasing clarity was the need to provide a “single total figure" table. In essence, this gives one number we should be able to hang our hats on. It includes basic salary, any annual bonus, the value of any benefits such as a car allowance and medical insurance, the contribution made to the executive’s pension and a valuation of what’s due under any long term incentive plan (LTIP).

The LTIP element is somewhat complicated as, by their nature, they operate over more than one financial year and awards made in one year may not be realised until subsequent years. They are usually subject to performance conditions, which are also spelt out in detail in the remuneration report. Fortunately there are some excellent accountancy firms happy to work through the intricacies of such matters to collate all this into a single figure.  

In theory, the single figure approach is extremely attractive. It looks simple, even if its calculation isn’t quite so easy at it might first appear. It enables an immediate comparison between one organisation and another and also between one year and another - the table has to show last year’s numbers for comparison. Shareholders and investors have no doubt found this a great starting point when evaluating how their executives are paid.

It is a little disappointing that so far the wider public and the media don’t seem to have taken to the measure to any great extent. There remains an obsession with base salary and annual bonuses. I suspect that was almost inevitable. We can all quickly relate salary and bonus to our own. Few of us have an LTIP. Additionally, few of us have a real feel for the value of our benefits and pension, although perhaps this is changing as total reward statements become more common.

The focus on salary and bonus levels is a pity. It tends to cloud what is really happening and can give a very false impression.  

Right now we seem to be going through an almost unprecedented degree of restraint on directors's salaries. There is a common, albeit not universal, acceptance that executive salaries shouldn’t be increasing at a faster rate than everyone else in an organisation. As pay rises are widely held in the two to three per cent range, this means that executive directors are also only getting low single digit rises.

Bonuses have been an extremely emotive part of executive reward. They became the target for much criticism, especially in the finance sector, around the time of the 2008 financial crisis. Banks’ bonuses were the epitome of everything that had gone wrong with executive remuneration and became synonymous with excess and inequality. Consequently it’s unsurprising that they receive the attention that they do.

With base pay and short term incentives remaining under close scrutiny the other elements risk disappearing under the collective radar. In particular, long term incentives and share holdings are potentially extremely valuable, but considerably less well understood.  That is not to say that these cannot be sensible components of a balanced package or that they are not sufficiently regulated. The annual reports go to great lengths to describe them in considerable detail. The trouble is they are rarely straightforward and come with so many conditions and caveats as to make them pretty much a mystery to the casual observer.

You may well say that this is a problem with the lack of knowledge or analytical skills of the reader rather than the fault of the author. Maybe so, but personally I find it quite depressing that we have reached a point where we must rely on the degree of complexity which is now seen in pretty much every FTSE 350 organisation’s annual report.  

Is there a better way? Maybe not, but I hope that something like the total single figure starts to become the real measure that we naturally look at to assess whether our senior executives are paid appropriately.

In my blog back in March 2014, I suggested a proxy measure for clarity in the executive remuneration section in annual reports. I noted the expansion in the length of these sections over the last ten years. I’ve revisited the reports of two blue chip organisations I cited back then. Their latest reports have moved in different directions. One has almost halved the size of the remuneration section in their latest report from 26 pages down the year before to just 16 pages. Meanwhile, the other one had continued to grow year on year since 2010 and now had a packed 25 pages explaining what the directors are paid.

I’m tempted to conclude that my measure isn’t particularly useful, especially as the shorter report used a decidedly smaller font, albeit the same as it had used the previous year. Is one report clearer than the other? It’s hard to say.  I didn’t find either particularly clear as the whole section was littered with notes, footnotes and dependencies.

More positively, it is apparent that increased openness coupled with strengthened regulations on their mandate, has meant that shareholders have been more able to flex their collective muscle. The increased requirements for them in relation to remuneration policy have been useful and have helped drive a positive level of more active engagement. For shareholders, the detail contained in annual reports is valuable even if it is hard to penetrate.

Ultimately complexity may just be the price we now have to pay for the abuses of the past. As I concluded before, full disclosure may help with transparency. Simplicity would be a bonus. I’d also like to believe that clarity is still something worth aspiring to.

By Peter Brown

Paydata news…

Last week saw the departure of Joe Price from the Paydata team. Since joining us as Reward Consultant in 2012, Joe has become a popular and valued colleague. We wish him all the best in his future endeavours.

May we take a moment to welcome a new Joe to the team, Joe Hoten. Joe joins the Data Services team, as Data Analyst. Since leaving university in the summer, he has been doing volunteer work with the Citizens Advice Bureau. Joe is a keen musician, who also teaches music in his spare time. Welcome to Paydata Joe!