Executive remuneration is out of control in the United Kingdom. The final report by the High Pay Commission concluded that “there is rarely a link between directors’ incentives and the way a company performs. In the past 10 years, the average annual bonus for FTSE 350 directors went up by 187% and the average year-end share price declined by 71%”. The average pay levels of workers rose only by 10% during the same period.
The Cameron Government is now promising to clamp down on executive pay. Details will be announced later in the year, but the key idea is to empower shareholders. The British government could follow the Australian two-strikes law, which ensures that a 25% vote against executives’ remuneration packages at two consecutive annual general meetings triggers a compulsory re-election of the board. However, laws developed in particular social and economic contexts can rarely be exported.
The UK government assumes shareholders are the owners and main risk-bearers of companies. This is not the case. Most shareholders are traders and speculators and have little long-term interest in invigilating companies.
The average duration of share holding in UK-listed companies has fallen from about five years in the mid-1960s and about two years in the 1980s to about 7.5 months at the end of 2007. The average shareholding periods for banks has fallen from about three years in 1998 to about three months in 2008. This does not suggest any long-term commitment to companies or corporate issues.
Since the 1980s, governments have privatised state-owned industries and given shares to UK citizens at knockdown prices. Governments have given tax incentives to individuals to buy shares in companies. None of this has expanded share ownership.
The table below shows the structure of shareholding in the UK listed companies.
The biggest change is the massive reduction is share ownership by individuals and the increase in foreign ownership by rich oligarchs, sheikhs, sovereign funds, hedge funds, offshore funds and private equity investors. Even 100 years ago, foreign companies were listed on the London Stock Exchange and UK and foreign individuals could hold shares in them. But with the increased mobility of money, their numbers have expanded.
There is little evidence to show they are interested in corporate governance issues. If foreign investors choose not to vote on executive remuneration packages, the UK government is hardly in a position to impose sanctions.
Individuals also indirectly hold shares through insurance companies, pensions funds and banks, but in these cases they do not have the right to appoint directors or mandate managers of these organisations to vote on AGM resolutions. Besides, corporate pay levels elsewhere form the benchmark for remuneration of mangers of financial institutions. Their incentives for curbing executive pay are low.
At the moment, the outcome of AGM resolutions is advisory rather than binding on directors. Even if that was changed and shareholders mustered some courage to shackle directors, they can easily be defeated because directors and their representatives are permitted to cast thousands of delegated proxy votes.
Voting rights should be given to other risk-bearers too and to those with a long-term interest in companies. Banks provide an interesting example. The leverage ratio of many banks shows that shareholders do not bear the main risks or provide most of the risk capital.
A bank with 10 billion pounds of equity and 100 billion pounds of assets in its balance sheet is said to have a leverage ratio of 10:1. In other words, for every 10 pounds of investment by shareholders, it borrowed 90 pounds.
In 2007, Barclays Bank had a leverage of around 39:1; Royal Bank of Scotland 31.2:1; HSBC 21.3:1; Lloyd’s TSB 31:1, Lehman Brothers 31:1 and Bear Stearns 33:1. Most of the long-term finance to banks is provided by savers and lenders.
Therefore, they should have the right to vote on executive remuneration, as well as for appointing directors. Employees have a long-term interest in the wellbeing of companies as their jobs and pensions depend on them. They are in a strong position to know whether the bosses deserve high rewards and should the right to vote too.
As UK politics is drifting to the right, democratisation of corporations is unlikely. Shareholder empowerment is unlikely to solve the problem of excessive executive pay.