In the wake of several fat cat ‘rewards for failure’ scandals, HR is ideally
placed to help prevent future executive pay excesses by ensuring greater
transparency and accountability over remuneration policy, writes Jane Lewis
Even the most die-hard laissez-faire capitalists admit that the
GlaxoSmithKline (GSK) shareholders’ revolt last month was a wake up call for UK
business to get its house in order over the question of executive pay, in
particular, the vexed issue of ‘rewards for failure’.
The ‘Fat Cat’ debate has become a regular fixture over the past decade.
Successive outbreaks throughout the 1990s inspired a series of reports – from
Cadbury, through Greenbury to Hampel – which all introduced valuable reforms,
including the establishment of independent remuneration committees. Yet it is
clear these have not only failed to curb the worst excesses, but that the
stakes in question have quietly risen considerably.
The furore over GSK chief Jean-Paul Garnier’s now legendary £22m
‘jewel-encrusted parachute’, makes previously reviled fat cats, such as British
Gas chief Cedric Brown and Railtrack’s Gerald Corbett, look cheapskate.
Each row has burned brightly, before fading fast. Consequently, said Will
Hutton, chief executive of The Work Foundation, "an extraordinary culture
has grown that has permitted salaries to get to this level without much
complaint".
There is now a perception across the board that the issue has to be tackled
head-on. As an Institute of Directors’ (IoD) spokesman admitted last week: "This
is not something that is going to go away."
The main difference this time is that institutional shareholders, who
previously maintained an almost Trappist silence on the subject, have weighed
into the debate, galvanised by a combination of the hammering they have taken
on the markets and new powers to vote on directors’ pay.
The shareholders’ votes may not be legally binding, but a ‘No’ vote (however
slim the margin) certainly confers a high degree of embarrassment.
This year’s AGM season has turned into an almost weekly showdown between
angry investors and plc company boards.
As well as the celebrated GSK coup, there have been mutinies at Reuters,
Barclays, Schroders, BAE Systems and Shell. And shareholders, having tasted
blood, now claim to have executives at Tesco, ICI, HSBC, Geest and Alfred
McAlpine in their sights.
At the heart of the debate is the question of whether shareholder activism
alone is enough to stimulate reform, or whether more binding legislation is
required.
The Department of Trade and Industry (DTI), shortly to publish a
consultation paper on the subject, has yet to show its hand, though trade and
industry secretary Patricia Hewitt has already decisively rejected the most
radical proposal to date – tabled by former Asda chief Archie Norman – which
would have given shareholders the legal right to limit ‘golden goodbyes’ paid
to failed executives, regardless of what was in their original employment
contract.
Leaked reports suggest that options under consideration at the DTI include
forging tighter links between pay-outs and performance, reducing directors’ contracts
from a year to six months, and requiring pay-offs to be staggered to prevent
huge sums being released a week before a director finds a new job.
Unsurprisingly, employers’ groups like the Confederation of British Industry
(CBI) and the IoD are opposed to any formal government interference and are
lobbying hard to enshrine any new reforms under the existing ‘Combined Code’ of
corporate governance best practice.
The CBI is pushing for what it calls a ‘pre-nuptial agreement’ between
directors and shareholders that would outline what an executive would receive
if performance targets were not met.
But even if a solution is found to tackle the worst excesses of rewards for
failure, the question that will continue to bedevil HR directors is the growing
disparity between pay rises, pension entitlements and perks granted at board
level, and those being offered to the rest of the workers.
Everyone accepts that those at the top deserve greater rewards, and few are
in doubt that paying the market rate is the only means of securing the best
talent. But there is bound to be trouble when the ratios between top directors’
pay and that of ordinary workers get out of hand.
"Once you get to a ratio of 25-30:1, it’s getting pretty high,"
said Hutton. Yet the ratio in many UK plcs is now approaching 50:1, and in the
US (the originator of so-called world-class remuneration) levels have now hit
500:1.
The question, then, is how do you go about securing top talent without
alienating the rest of the workforce in the process?
HR directors like Neil Hayward at Serco, believe that a primary new function
for HR is to get more involved in selling remuneration deals to shareholders
and investors pragmatically.
For example, he said: "If you’re listed in the UK, but the bulk of your
shareholders are in the US [where higher pay deals are the norm], you may be
justified in raising pay higher." Moreover, while "external
transparency is very important", it is not so critical internally. Hayward
believes that criticism is easily headed off by the fact that "we can
demonstrate to employees that my CEO earns less than the average".
Pay transparency is also frowned upon at Carlson Wagon Lit Travel, where HR
director Sue Kavanagh believes it is "not helpful" for employees to
know what others are paid. Here too, the solution adopted when setting
executive pay is to research, and stick closely to, market rates.
"We look cross functionally to make sure a certain function is not
getting out of line with market rates, and we have a system of double checks in
place. I put recommendations to the managing director, but I also report to the
HR director for Europe, who looks at all board-level proposals and might veto
if he thinks any are excessive," said Kavanagh.
But independent advisers like Watson Wyatt partner Richard Cockman and the
Chartered Institute of Personnel and Development’s resident remuneration expert
Charles Cotton, believe the climate is changing rapidly. Unless HR directors
are prepared to push for greater transparency and accountability internally,
they are sitting on a powder keg.
Cockman goes further. He believes the current furore will force companies to
review their whole pay structures from top to bottom. The only way to strike
the right balance between pay structures that attract key talent at board level
but do not undermine other stakeholders is "to put executive compensation
into a broader HR/business context than it has been in the past."
The upshot is that a growing number of Watson Wyatt’s FTSE 100 clients have
instigated ‘root and branch’ reviews of pay – and not just at senior levels.
Reforms include integrating annual bonus schemes and long-term incentive plans
into employee programmes across the organisation.
One organisation well on its way down this route is the Co-operative
Financial Services, where HR director Tony Britten has outlined plans to
‘anchor’ all pay and reward schemes downwards.
"Any bonus schemes at the top of the company will apply, with different
calibrations, throughout the organisation. We want to make sure the measures
that are used to measure senior performance are the same as those used across
the company. We’re introducing bonus schemes that reflect individual
performance much more," he explained.
For many HR directors, the path ahead is likely to be fraught with
difficulty, but there may be a significant payback for those who embrace the
challenge. One obvious ramification of more visible pay negotiations and
settlements, says Cockman, is that the HR director "will become a much
more influential player" both within companies and externally.
