Executive Remuneration Part 1

Regulating Executive Remuneration: What’s Needs to be done? – Part 1

 

Regulating Executive Pay: What’s needs to be done?

1.0  Background and Rationale

Since the 2008 financial crisis and the subsequent banks' bail-out by taxpayers, there has been public outrage over hefty pay packages accorded to bank executives and other senior managers. The scrutiny of the banking sector also generated concerns about executive pay and bonus package paid by other companies in the non-financial sector. As a result, most of the board of directors around the world are now reassessing their remuneration policies. In the UK, the reassessments of executive pay began with the financial sector. After the 2008/2009 financial crisis, the Financial Services Authority (FSA) began an inquiry into what could have led to the crisis. The conclusion of the review was that “inappropriate incentive structures played a role in encouraging behaviour which contributed to the financial crisis”. According to the review, led by Lord Turner, the incentives accorded to the executive in the period leading to the crisis seemed profit-making “but subsequently proved harmful." The existing regulatory authority, including the FSA and the bank regulators, had not realised how incentive and pay structures encouraged risky behaviour among the top management. From then henceforth, there has been a concern as to how remuneration policies encourage risky behaviour, not only in the banking sector but also in the other non-financial sectors.

Although banks continue to justify the payment of hefty bonuses to their leading investment bankers, there has been a near consensus that something needs to be done in regard to executive compensation. That “something” may include a review of the egregious pay packages and the long-term incentive plans. It may also include revisiting or scrapping altogether the complicated bonus mechanisms. When all this is done, the current remuneration mechanism has to be replaced by something else. But even after doing all that effort, it is possible that the outcome may not be different in substance even if the pay structure is reviewed. The result of such an outcome would be that modern pay structures are complicated and pay levels for top companies officials are uncontrollable. Such a conclusion may seem defeatist, but it points to uncertainties in attempts to regulate executive pay.  Research on this topic will look at these uncertainties and expose the challenges that hinder regulations.

Regulating executive pay is a hot topic not only in the UK but also in other major countries. That notwithstanding, regulation, albeit cautiously, is an area that has to be looked into since executive compensation is at the heart of good corporate governance. The UK government has come a long way towards attaining this goal. In 2002, the government enacted the Directors’ Remuneration Report Regulations which intended to compel disclosure of a company’s remuneration policy and how that policy was linked to performance. The Companies Act 2006 is one of the major laws that made attempt to guide executive remuneration in the UK. The Act required directors of quoted companies to prepare directors' remuneration reports for each financial year of the company. As per the Act, any director who fails to prepare such a report commits an offense. This section made an attempt to regulate executive pay. Other regulations towards this goal such as the Companies (Summary Financial Statement) Regulation 2008, Directors Remuneration Report Regulations, the Green Paper-The EU corporate governance framework by the EU Commission, the Walker Review, and the UK Corporate Governance Code had been enacted to try and control the executive remuneration policies among listed companies. The Walker Review for instance advised that the “levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than it is necessary for this purpose”. Despite these efforts, executive pay still remains a major concern in the UK. Companies have not been able to link pay with performance. The kind of existing regulatory framework has been termed as one of “comply or explain”. This means that companies are not obliged to stick to a specific remuneration policy since they can pay more and still explain how they came up with their remuneration policy. The court on the other side is still reluctant to intervene in executive pay disputes as it considers companies remuneration policy to be the discretion of the company’s directors.

In short, remuneration policy in the UK has adopted a soft law approach – comply or explain. The soft law approach has not been able to regulate executive pay. This has generated public outcry since the 2008/2009 financial crisis and the subsequent bank bail-out is still fresh in the minds of the citizens. This does not sit well considering that the difference between the executive pay and the average worker is too high. Most of the average workers in the UK complain that executives are being overpaid. According to a survey carried out by the Chartered Institute of Personnel and Development (CIPD), half of the UK employees cited the high level of chief executive pay as demoralising. Responding to this crisis, the government has published a green paper to invite debate into how executive pay can be regulated. One of the goals of the green paper is to ensure that executive remuneration policy is properly aligned with long-term performance. While introducing the green paper, the government is welcoming “an open discussion with business investors and the public about what needs to be done”. My research will aim at contributing to this debate. This is in recognition that executive remuneration is at the heart of good corporate governance. It is important to note that the UK is recognised across the globe as a leader in corporate governance. Finding a solution to the spiraling executive compensation will go a long way in maintaining this status.

2.0  Research Questions

(i)             Is regulating executive compensation a realistic objective?

(ii)           Should the judiciary intervene in executive pay disputes?

(iii)         What impacts will be regulating executive pay have on UK corporate governance?

(iv)          What is the best practice in executive remuneration?

3.0  Research Methodology

The research will combine both secondary and primary research. There are numerous books and journals covering the subject of executive compensation. These books and journals will help in giving a background understanding and general information about the topic. More importantly, these sources also contain numerous citations that can be relied upon to gain more understanding of the topic. Due to the nature of this topic, secondary research is more important. It is notable that the law regulating executive compensation is more of a soft law than a hard law. As such, much of the details of this topic can be found in best practices than in hard law. This is because decisions on executive compensation are business judgements vested in the board of directors rather than strict laws cast in legislation and case laws. But when the knowledge of best practices and different arguments is sifted, it is possible to know what needs to be done to unlock this legal impasse. Once this research is informed of the topic from reading an overview of it in secondary sources, the topic will be explored further by looking at a host of primary sources. In this regard, primary sources such as case laws, statutory law, and regulatory law will be examined in deep. Other sources like the government green paper on corporate governance reform and the existing Corporate Governance Code will add more understanding to this topic. The challenge with the primary law is that there is no hard law on executive compensation; remuneration policy in the UK applies on a “comply or explain” policy. Nonetheless, the little attempt that has been made to regulate executive compensation will be explored to discern what needs to be done in terms of regulating the executive pay structure.

 

Bibliography

Avgouleas E and J Cullen, ‘Market Discipline and EU Corporate Governance Reform in the Banking Sector: Merits, Fallacies, and Cognitive Boundaries’, [2014] 41 Journal of Law and Society 1, pp.28-50, at p.33

Bebchuk L and J Fried, ‘Pay without performance: The Unfulfilled promise of executive Compensation’, (Harvard Business press, 2006).

Bertrand M and S Mullainathan, ‘Agents without principals’, [2000] 90 American Economic Review, pp.203-208

Canyon M, ‘Executive Compensation and Incentives’, (Academy of Management perspectives, 2006) at p. 24

CIPD, ‘What employees think of their CEO’s pay packet’, (CIPD, 2015)

Core J et al, ‘Corporate governance, chief executive officer compensation and firm performance’, [1999] 51 Journal of Financial Economics, pp. 371-406

Department for Business, Energy & Industrial Strategy, ‘Corporate governance reform: green paper’, BEIS/16/56, at pp. 23-31

Financial Reporting Council, ‘FRC Response to BEIS Green Paper consultation on corporate governance reforms’, [Feb 2017]

Financial Reporting Council, ‘The UK Corporate Governance Code’, (FRC, June 2010)

Gregg P, ‘Executive Pay and Performance: Did Bankers’ Bonuses Cause the Crisis? (University of Bath, 2011) at p.2

Hermes Investment Management, ‘Corporate Governance Reform Green Paper’, [Feb 2017]

Hill C and B McDonnell, ‘Executive Compensation and the Optimal penumbra of Delaware Corporation Law’, [2009] 4 V. L. & BUS. REV 2, pp.333-374

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Norris K and R Kelly, ‘Economics of Australian Labour Markets,’ (Pearson Education, 2005) at p.103

The Law Society, ‘Law Society Response to the BEIS Green Paper on Corporate Governance Reform’, (The Law Society, Feb. 2017) at p.1

Tomasic R, ‘Company Law Modernisation and Corporate Governance in the UK- Some Recent Issues and Debates,” [2011] 1 Victoria Law School Journal, pp 43-61, at p.58

 

Statutes and Case laws

Companies (Summary Financial Statement) Regulations, 2008

Data Protection Act 1998

Directors’ Remuneration Report Regulations, 2002

Freedman v Adams, 58 A.3d 414 (Del.2013)

Green Paper-The EU corporate governance framework

Human Rights Act 1998

The Freedom of Information Act 2000

The UK Corporate Governance Code (September 2010)

The UK Corporate Governance Code (September 2012)

The UK Corporate Governance Code (September 2014)