Fund Management

Corporate Governance Debate Hots Up Over Remuneration

Stephen Harris, 30 March 2005

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Fund managers should take note of the strong opinions about corporate governance and executive compensation that were recently aired at the ...

Fund managers should take note of the strong opinions about corporate governance and executive compensation that were recently aired at the Shareholder Activism World Conference. Robert Monks’ veteran corporate governance campaigner and founder of the Lends Fund made an incisive comparison between US and UK style corporate governance. In the US voting for directors is like voting in old-style Eastern European elections – you’re simply given the opportunity to ratify. As for non-executives he commented that “how can a product of a self-perpetuating system be independent?”. Shareholders have so little power so they make more noise. In UK, on the other hand, shareholders can call an EGM something that is denied to their American counterparts.

The takeover is the method of ultimate accountability – if you don’t like what a company is doing, buy it. In US it is now virtually illegal to take over a company. It’s also very difficult to fire directors or tell them what to do, as there are no binding shareholder resolutions.

Another problem is the tendency towards a triple bottom line with accounting, social and environmental priorities in competition. Managers need a single bottom line otherwise failure in one area can be blamed on a concentration on the others.

In the Disney case Delaware judges must assert themselves as they are now seen to be too closely aligned towards the interests of management. In Mr Monks’ view the Disney management was so obviously negligent that if shareholders do not win the case they will loose credibility and with it the State’s franchise as the place of preferred incorporation in the US.

Paul Coombes, former global head of McKinsey’s corporate governance practice thought that the corporate governance debate is going astray. Welfare activism often interferes with corporate purpose and value creating activism i.e. wealth creation opportunities are being lost.

According to Mr Coombes, code activism has been accentuated by the Higgs Report. This process of bureaucracy does not produce wealth. Although when Sir Derek Higgs himself said “A code is not an end in itself but a means of optimising corporate performance” he aligned himself with an opposing view.

The law of unintended consequences is taking hold in the world of corporate governance with people confusing business risk taking with legal risk taking which is a mistake.

Mr Coombes identified seven deadly sins of corporate governance. Five of these are self-explanatory:fraud; greed; bias; recklessness; misrepresentation. The sixth, empire building, is misguided acquisition and is much more disadvantageous in terms of wealth creation than the more obvious sins. Similarly, “moribunding”, sitting on board of underperforming assets for years is a crime against wealth creation. “A core requirement of a corporate governance regime is that it should facilitate efficient reallocation of capital from sunset to sunrise industries”.

Remuneration Issues
Are options best way of aligning interests of shareholders and management? For Robert Monks, options are an unmitigated evil. In US they are a one-way street – if they don’t pay out the executive will get paid another way as a company can never loose a key employee.

On re-pricing of options, speakers were unanimous that companies should reject this temptation completely, but recognised the pressure to incentivise good employees. The UK tends towards fairness in this regard i.e. not to reprice options, whereas it is more common in the US where people are more concerned with incentivisation. Phased, yearly grants of options would be good to mitigate all an executive’s options being under water in a bear market.

The right criteria should be used and turnover is often not the best measure. With LTIPs there is a way of rewarding relative success but managers often choose criteria to suit their circumstances. As for benchmarking, the concensus was that relative TSR is a superior measure and the longer the period the better. Robert Monks was quick to point out that whatever formula you adopt it is capable of being misrepresented, especially with the emotional strain of confrontation.

He went on, that in the US there is a magic circle on remuneration committees and that pay is clearly rigged. Non-executives are paid too much for what they do and too little for what they don’t do. As it presently stands there most important job is to express an opinion on the emotional competence of the CEO who is subject to a huge amount of stress.

Non-executives are getting higher pay but they should not be granted options as this would challenge their independence.

All supplemental executive compensation should be deferred for three years after leaving the company, according to Robert Monks, so that long term policies can be assessed and the success of succession planning evaluated.

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