Directors’ Remuneration – A Political Football?
By Christopher J Sherliker

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On 22nd November 2011, the High Pay Commission (HPC) published its long-awaited report entitled Cheques With Balances: why tackling high pay is in the national interest. This independent body was set up by the think-tank Compass and the Joseph Rowntree Charitable Trust to investigate high pay and boardroom pay across both the public and private sectors in the UK. The report has caused quite a stir, as Solicitor Paul Collins, who has recently joined our Company Commercial department, explains.

The report contains revelations that some top executives’ pay has soared more than 4,000 percent in the last 30 years and that, in 2010, the remuneration of one particular former Chief Executive of a FTSE 100 company was allegedly 169 times greater than the average worker in Britain today.

The report also concluded that in the last year alone, executive pay in FTSE 100 Companies grew by 49 percent. Upon publishing the report, the Chairwoman of the HPC, Deborah Hargreaves, stated that runaway executive pay is “corrosive” to the British economy and that at a time of “unparalleled austerity”, there was an urgent need “to tackle top pay”. The report included 12 recommendations for reforms to corporate governance and disclosure requirements, with the following points being perhaps of most interest:

• Greater transparency in the calculation of executive pay to end the ‘closed shop’ on pay decisions. At present, executive pay can be made up of various complex elements such as annual salary, bonuses, long-term incentive plans, employee benefits, paid expenses and insurance, all of which can sometimes effectively hide the final amount due and owing to the executive from inter alia shareholders, employees and the public. The HPC’s report has recommended a radical simplification in this regard, with pay to compromise of basic salary and ‘one additional performance-related element ... where absolutely necessary’
   
• Inclusion of employee representatives on remuneration committees so that there is greater awareness of the pay difference between executives and the average employee
   
• Publication of a pay ratio between the highest paid executive and the company median, along with confirmation of the total pay earned by board members and the top 10 individual pay packages earned by executives below board level
   
• Establishing a new national body to monitor, comment and report on executive pay

Whilst it remains to be seen what actions the government will take in 2012 to deal with executive pay, the above-listed points do raise an interesting question, namely whether the inflated pay received by directors contravenes any of the fiduciary duties that they assume under the Companies Act 2006.

In particular, it is worth considering the terms of Article 172 relating to a director’s duty to promote the success of the company, which states that a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to the:

• Llikely consequences of any decision in the long term
• Interests of the company's employees
• Need to foster the company's business relationships with suppliers, customers and others
• Impact of the company's operations on the community and the environment
• Desirability of the company maintaining a reputation for high standards of business conduct
• Need to act fairly as between members of the company

Short-term v Long-term

Given that, in some instances, the average employee is earning up to 169 times less than an executive of a company and that the average employee’s annual remuneration may have had little or no increase in recent years, it is not clear that directors are taking into account the interests of the company’s employees when accepting such inflated pay. Such actions are clearly bad for morale in a company, especially when the company is not performing particularly well and it can be hard to see any justification for the level of pay received by executives.

It could also be argued that accepting such large sums in times of hardship is harmful to the reputation of certain companies, as it could give the public the impression that a company’s executives are effectively rigging the system for their own gain. The rising resentment and loss of trust in British executives by members of the public and potential investors is damaging to the community and the economy as a whole, and is certainly not conducive to promoting the success of a company.

Finally, by accepting such large pays from a company in the current economic climate, executives could be accused of short-termism, something which goes against the idea that directors should consider the likely long-term consequences of any decision they make on behalf of the company.

The long-adopted justification for increasing executive pay in order to compete with the US market and to halt a talent drain in executives would appear to be wearing thinner and thinner. Indeed, the current business secretary, Vince Cable, has already spoken of the need to link increases in top executive pay more closely with the actual performance of companies so that they cease ‘to act against the interests of shareholders and consumers’. He has openly welcomed the publication of the HPC’s report and the government’s next moves are awaited with interest.

Added: 29th November 2011