Executive pay - taking a wider view

How do you build trust in a business, and how do you motivate top executives? For the UK-listed companies, these are issues that the Financial Reporting Council is addressing with a revised corporate governance code. The aim is 'restoring public trust in business', starting with the criticism of executive pay which for those top 100 companies is typically 160-times the pay of the mainstream worker. The recommendations, reported in the FT, are that shares paid as bonuses should be held for at least five years before they can be sold, and the bonus turned into cash, and also that companies should consider ethnic and social diversity when choosing their members and tighten the definition of an independent chairman to exclude those who have served more than nine years on the board.

The revised code also requires boards to establish a mechanism to gather views from the workforce, which could include putting an employee on the board, setting up a formal workforce advisory panel, or assigning a non-executive director to liaise with staff. It also states that companies should “promote the long-term sustainable success of the company, generate value for shareholders and contribute to wider society” - in other words, that shareholder value should not be seen as the only guiding factor, but equal to the contribution to wider society.

Bonus shares is often given as a good way to reward top managers of a business and members of the board, but only works well if they have to wait before they can sell the shares. It is an attempt to encourage decisions that build sustainable growth of the business. It should address the Divorce of Ownership and Control - the gap in objectives that can emerge in a public limited company between the owners, or shareholders, who are looking for profit plus an increase in the long-run capital value of a business, and the managers who run the day-to-day operations and whose objectives may be more to do with their personal salary, departmental budget and performance bonus. 

Giving shares as a bonus means that the manager benefits if the share value rises - the more the share is worth, the bigger the bonus becomes, and as those making strategic decisions are in the best position to influence the value of the shares, their personal objectives should then match the objectives of the shareholders. But a problem can arise if they can sell those shares quickly, as then the profit and share price may have been 'falsely' hiked up by short-term effects like currency movements, or other factors which have nothing to do with the quality of the strategic decision making of the executives who are being rewarded with shares.

Will this code help to address the issue of public trust? It gently suggests that boards should assess whether pay for the mainstream workforce, including contractors, is 'fair', and whether the pay of those at the top truly reflects their value to the firm. It is not mandatory but encourages compliance by requiring those who don't follow it to explain their reasons. The most radical addition to the code sounds like the inclusion of some form of employee representation on the board. Time will tell whether this can achieve the objective of building public trust.