Peter Montagnon of the Institute of Business Ethics explains why simplification of executive pay should be high on Theresa May's agenda
Rarely has the somewhat dry subject of corporate governance attracted so much public interest. The government has had over 400 responses to its Green Paper on corporate reform, including one from the Institute of Business Ethics.
The rush of responses owes something to the way in which Theresa May has elevated the subject. On her appointment as Prime Minister, she said that something needs to change in the way companies are run to ensure that they serve the interests of the community as a whole, not just the “elites” who run them. Her statement makes a clear connection between governance and ethical behaviour, which is also why the IBE felt impelled to respond.
The immediate impulses for the government were the scandals at BHS and Sports Direct; these have exercised the minds of politicians, whose own analysis of the Brexit vote suggested that many voters feel left behind by globalisation creating a “them-and-us” society. Initially Mrs May was suggesting radical solutions, like putting workers on boards and a further binding shareholder vote on executive remuneration.
In its response, the IBE has tried to look beyond these immediate issues to some basic questions about how the corporate world can make itself more trustworthy and learn from the lessons of scandals at companies – not only Sports Direct and BHS but also Tesco, BP and now also BT, which last year uncovered accounting irregularity in its Italian operations.
Licence to operate at risk
Some of the issues raised require careful thought and more public debate. Central to this is the need for the public, policy-makers and business to reach a common understanding of what companies are here for. It is no longer sufficient to say that their purpose is simply to make money for their shareholders. Unless they deliver something that is valued by society – and are therefore themselves valued by society – their social licence to operate will be at risk and their business may not be sustainable.
At present, however, there is no consensus around this. The IBE argues that rather than rushing into “sticking-plaster” regulation the government should facilitate debate around the issue of purpose, so that a consensus can be reached. That debate needs to encompass two other difficult issues: reform of executive remuneration and sanctions that might be used to deter serious anti-social behaviour by companies.
Executive pay is broken
The system of executive remuneration is pretty seriously broken, according to the IBE. It is so complicated that even the executives on the receiving end do not always understand what they are getting. Yet the performance conditions can drive them into short-term decision-making, including the deferment of much-needed investment – and lead to highly variable outcomes, ranging from not much money to enough to provide for themselves, their children and grandchildren forever.
The IBE suggests a simpler system whereby complex instruments such as share options and performance shares, as well as much of the bonus arrangements, would be dropped in favour of a single cash salary figure. Top executives would be required to invest half their salary in shares of the company and hold them for a long period, including after they had left the company.
Subject to certain safeguards they could receive dividends. This would create a cash income, which would reduce the emphasis on bonuses and create an incentive to run the company for sustainable long-term cash generation. There would be a large incentive to behave responsibly and avoid scandals that might destroy the franchise, punish the share price and lead to the dividend being cut or suspended.
As to the sanctions for anti-social behaviour, these need to hit unlisted companies like BHS, which currently largely escape the corporate governance net. The Green Paper describes the concept of limited liability whereby shareholders are not held responsible for their company’s debts as a privilege. It certainly brings useful confidence to entrepreneurial investors, but if it is a privilege it cannot be an inalienable right.
This suggests we should have a discussion about the circumstances in which it might be withdrawn and what companies would have to do to prevent this threat being carried out. Some argue that the removal of limited liability is a nuclear option. The IBE says it would rarely, if ever, be carried out but, like nuclear weapons, it could act as a deterrent.
Again, this might make companies more careful. When the dust settles on this debate, the proof of the pudding will be whether behaviour has changed.
Peter Montagnon is associate director of the Institute of Business Ethics. www.ibe.org.uk