Executive Pay – Again
The Governor of the Bank of England has weighed in to this never-ending debate:
“The succession of scandals means it is simply untenable now to argue that the problem is one of a few bad apples. The issue is with the barrels in which they are stored.”
“Compensation schemes overvalued the present and heavily discounted the future, encouraging imprudent risk taking and short-termism,” he said.
“Standards may need to be developed to put non-bonus or fixed pay at risk. That could potentially be achieved through payment in instruments other than cash.”
BBC News Website 17 November 2014 : Carney puts bankers’ pay in spotlight after misconduct shockwaves
He goes on to suggest that pay should be in the form of some form of bond which could be clawed back if necessary.
I think there is an easier solution.
Mr Carney noted:
“Last week, the UK’s Financial Conduct Authority, US CFTC and Swiss FINMA fined six banks $3.3bn for misconduct in FX markets: misconduct that went on long after banks had already been fined for abusing interbank interest rate benchmarks..”
The question to ask is who bears the cost of these fines? It is not the senior traders who miss-conducted themselves; it is not the directors who have a fiduciary duty to manage the banks; it is the shareholders.
In the early days of limited companies this may have been reasonable. Relatively small numbers of shareholders directly invested in companies and tended to keep a close eye on what was going on. Nowadays most shareholding is indirect through various pension or investment funds or through nominee accounts at stockbrokers. With the exception of the big funds, the shareholders are almost expected not to take a close interest in what is going on.
As a direct shareholder in Lloyds Bank, I cannot stride in to head office and demand to know what is going on and expect to see changes as a result – that would cause chaos (even if I was competent to judge what was going on and to demand changes)! My role is limited to:
- receiving an annual report either:
- in a form so abbreviated as to make the concept of accountability irrelevant, or
- in a form so obtuse that working out (in hindsight) what has been going on is near impossible.
- receiving an auditor’s report that is now next to useless
- voting at an AGM – usually being urged to give the chairman my proxy to vote as he sees fit!
The idea that I as “owner” should be “responsible” for the running of a bank (or any other corporation) is totally outmoded. Therefore the idea that I should be the one who suffers the impact of fines is also outmoded.
It is the directors that run the major corporations and it is very rare for a director to be forced out by the shareholders. (There may be cosy clubs where the big fund managers are consulted as to who should be appointed – from a select group – to fill casual vacancies and then automatically confirmed at the next AGM.) If it is the directors who “in effect” control these corporations it is the directors who should therefore bear the cost of fines.
I think this is the conclusion that Carney has come to. The question then is what mechanism to use.
I have previously proposed (3 March 2013):
- Getting the shareholders to vote annually – in advance – for the size of the executive remuneration pool (to cover salary, benefits, pension, bonuses, golden parachutes, golden handcuffs, golden hellos and all other such payouts etc. etc.)
- Any losses made should be recovered from this pool
- Any fines charged against the company should be paid from this pool
- Should losses or fines exceed the pool, the deficit should be recovered from previously awarded deferred bonuses (share options etc.)
Thus if Network Rail gets fined for Safety failures, the fines are paid by the directors (from their remuneration pool) and not by the taxpayer which in effect is what happens now. Likewise fines due to PPI miss-selling and Libor Fiddling by the banks (particularly the state-owned ones) are paid by the directors and senior executives and not by us as shareholders (Lloyds and RBS) or as customers (the rest of them).
So in effect the shareholders vote a sum to be paid into a form of escrow fund (a “directors’ remuneration and responsibility pool”), and that this fund should be used to pay (in order):
- Fines imposed on the company (e.g. Libor fiddling)
- Compensation paid out to customers (e.g. PPI)
- Executive Salaries, benefits in kind (including pension contributions)
- Golden Handshakes, Golden Parachutes etc.
Deferred Bonuses are held in this fund until paid and are therefore available to pay fines and compensation.
There are two aspects that are most debatable from the above.
- Should normal operating losses be paid from the pool before directors salaries etc.?
- What happens if the pool is either too big or too small?
The implications of paying losses from the pool is that if a company makes losses, directors potentially don’t get paid. An argument may be put up that losses can be due to external factors and that this is unfair as it expects directors to take liability for something that they cannot control. So this may be a step too far to expect losses to undermine directors’ base salaries.
If in a particular year fines and compensation exceed the size of the amount voted by the shareholders, what happens? Amounts previously put into the “directors’ remuneration and responsibility pool” for deferred long-term bonuses get used to pay the fines and compensation.
What if the “directors’ remuneration and responsibility pool” is totally emptied (the annual vote and deferred amounts being used to pay fines and compensation) – do directors get paid? Answer: No. Directors of most of our major companies are already fairly wealthy so they can either take that risk or use some of their wealth to take out insurance against the incompetence of themselves and their past and present board-room colleagues. Note that such insurance is privately and individually funded and not paid for out of the “directors’ remuneration and responsibility pool”!
What if the “directors’ remuneration and responsibility pool” builds up a substantial surplus due to shareholders being persuaded year on year to vote a pool excessively large (presumably in anticipation of having to pay fines and compensation?)? There must be a clawback mechanism should the total value of the pool at year-end exceed the value of the deferred bonuses and explicitly declared provisions for anticipated fines and compensation.
One would also hope that there would be press speculation if shareholders were being asked to vote a “directors’ remuneration and responsibility pool” well in excess of the agreed executive remuneration. It is quite possible that some companies may regularly do this. If directors really want to claim that they should not be responsible for fines and compensation they have to include provision for such payments in the amount that they ask shareholders to vote into the “directors’ remuneration and responsibility pool”.
- Directors of construction sector companies may accept “as a cost of doing business” fines from the health and safety authorities. If this is really the case they should publicly budget for such costs.
- Directors of chemical and energy companies may likewise wish to try and claim that some environmental damage and associated fines is also a “cost of doing business” and publicly ask shareholders to fund such fines by voting a suitable provision into the “directors’ remuneration and responsibility pool”. Greenpeace and the like may then wish to buy a single share so that they can debate such provisions at the AGM.
- Directors of Insurance and Power companies may also want to try (!) and persuade their shareholders that misleading the public and miss-selling are practices for which directors should not be held responsible and therefore shareholders should vote to take financial responsibility for any fines and compensation and relieve the directors of all such liabilities.
- Directors of banks may also wish shareholders to acknowledge that “fiddling the system” is part of the business and that fines for doing so should be met by shareholders and not by the directors. Another interesting moment at the AGM when the “directors’ remuneration and responsibility pool” is up for debate!
Directors of major financial institutions may feel aggrieved at having to take responsibility for the buccaneering acts of some of their traders. They have a number of options:
- Reset the culture in their organisation so such acts are clearly out-with normally accepted behaviour.
- Set traders’ remuneration to disincentivise such acts.
- Discipline and if necessary sack traders who step out of line (and risk the directors’ remuneration!)
If they can’t do any of the above, perhaps they should recognise that the traders are running the shop and not them and therefore appoint the traders as directors. Then the traders will be subject to the above proposals.
No doubt there will be ways of subverting such a proposal – for instance, paying directors salaries for work as “normal employees” is one obvious loophole that would need to be explicitly plugged. However the idea that “directors’ remuneration and responsibility” should be explicitly linked has to be one worth exploring.