With billions under management, local government pension funds have an opportunity to influence governance at the companies in which they invest. Kieran Quinn argues for measures that bring excessive executive pay under control.
The current system of executive remuneration is broken.
That is the view at the heart of the response of the Local Authority Pension Fund Forum (LAPFF) to the Department for Business, Energy and Industrial Strategy’s green paper on corporate governance.
The Local Authority Pension Fund Forum (LAPF), which I chair, is a voluntary association of 73 local authority pension funds. In total, the members of the forum have combined assets of £200bn. The forum exists to promote funds’ investment interests and maximise their influence as shareholders.
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In doing so LAPFF seeks to promote high standards of corporate governance and corporate responsibility among the companies in which the funds have investments. The corporate governance green paper therefore sought views on the very issues that LAPFF was set up to champion.
Clearly, simply identifying the problem, particularly one that is so obvious even to a lay person, is not a constructive or useful response to a consultation. The press coverage of “payments for failure”, some of which could be described as exorbitant, has registered the issue of executive pay in the minds of the general public, and many would now agree that executive pay is simply too high. However, it falls to organisations like LAPFF to suggest how the issue could be tackled.
In response to the consultation we began by looking close to home, at us, the shareholders. Shareholders, as individuals or organisations with voting rights, should be both afforded stronger powers to exercise over executive pay policy and encouraged to exercise those that they already have.
In the case of the former, LAPFF supports the idea of an annual binding vote on remuneration reports focusing on the variable element of executive pay. In practical terms, this would have only limited implications for executives’ service contracts, whilst giving shareholders a say over the main driver of pay inequality, variable pay.
LAPFF also supports a binding upper threshold for total pay, which would cut through much of the complexity of pay packages that currently renders them almost impenetrable to the average reader of a set of company report and accounts. Would lower pay reduce directors’ motivation? Not in our view. Other factors such as a desire for a challenge, mastery, and personal satisfaction are vital motivating factors beyond simply pay. We believe that when pay is fair, employees concentrate on these other goals.
In the case of the latter, in order to increase accountability, fund managers should disclose more details of the rationale for their voting decisions. Research by LAPFF has found that fund managers have often sided with management and sometimes there has been no obvious logical reason for doing so. If fund managers were required to provide justification for their decisions then there would be greater transparency and understanding by their clients, or perhaps even different decisions taken.
Next, giving consideration to remuneration committees, we are firmly of the view that consultation with shareholders and employees is essential prior to the preparation of pay policy.
With employee consultation we would encourage companies to have employee representation on the remuneration committee and formally canvass employees views. Regardless of the mechanism chosen, this consultation should be backed up by a formal process to feed the findings in to the deliberation of the remuneration committee, and then to report back to shareholders how the committee considered those views.
The gap between highest and lowest paid employees within companies is another matter that could be tackled within the remit of remuneration committees. This gap undermines workforce morale and motivation.
LAPFF therefore supports the publication of pay ratios within organisations. This data should be published annually and show the ratio between average employee pay and average executive pay as well as the ratio of pay between the 10% highest paid and the 10% lowest paid.
In order to understand the trends (and prevent the gap between highest and lowest paid from widening further) a graph charting the pay ratios of the current year and the preceding five years should also be produced. These actions would make the remuneration committee more accountable for making appropriate pay distributions.
There are therefore many ways in which the government could tackle excessive executive pay and the poor corporate governance that allows it to go unchecked. The green paper has some helpful suggestions and many of those, coupled with our responses will require significant cultural change within companies. However, if the government are serious about creating a country that works for all and not just a privileged few, then this is one issue that they cannot sweep under the carpet any longer.
Cllr Kieran Quinn is chairman of the Local Authority Pension Fund Forum and executive leader at Tameside Metropolitan Council.