Governance Explainer - Executive pay

In May 2023, Julia Hoggett, chief executive of the London Stock Exchange, poured fuel onto the already combustible debate on bosses’ pay when she said that the top executives at UK listed companies should be paid more if the country wants to retain talent and deter companies from moving overseas.

Hoggett’s robust intervention came just as the AGM season was shaping up to become another bruising battle between company directors and some of their biggest shareholders.

The annual showdown is being even more closely watched this year as it is being fought in the teeth of a ‘cost of living’ and inflation crisis that has hammered earnings elsewhere in society.

Hoggett’s remarks followed an April 2023 report from Deloitte, which found total pay for bosses at some of the UK’s largest companies rose by more than a tenth in 2022. Deloitte reported that median overall pay (including salaries, bonuses and share awards) for FTSE 100 chief executives increased by 12% to £4.15m.

What are the risks of not paying executives top dollar?

CEOs of large corporations typically attract high quantums of pay, and many would argue that significant rewards are justified due to the responsibilities and demands of the job. Average CEO tenure in the UK is only 5.4 years, and there are huge pressures on CEOs to deliver performance.

Issues start to creep in when the UK-based bosses of global companies start to compare their pay with other bosses of global businesses that are based elsewhere.

US companies have always paid far more to their top executives than their British counterparts, and that disparity is still very evident.

Sébastien de Montessus, of Endeavour Mining, was the best-paid chief executive in the FTSE 100 in 2021, earning £16.85mn, according to the High Pay Centre. In contrast, the highest remunerated boss of an S&P 500 company in 2021 was Expedia’s Peter Maxwell Kern, whose total pay came to $296.2mn, according to S&P Global Market Intelligence.

Is there such a thing as too much?

Best practices are largely silent when it comes to defining the appropriate amount of total remuneration – although they stress the importance of aligning pay to company performance and strategy.

Rather, pay guidance focuses on ensuring that the decision-making processes and disclosures relating to executive pay are justifiable.

A key feature of the pay setting process is that it should be primarily determined by independent non-executive directors, and that no-one should be involved in setting their own pay.

Furthermore, employment contracts should enable the company to claw back or withhold payments or share awards – for example if poor performance or misconduct comes to light.

However, boards are aware that it is reputationally damaging if senior executives become branded ‘fat cat bosses’ after banking huge ‘rewards for failure’, following an average – or worse, an underperforming year for the business.

It is worth noting that the UK Corporate Governance Code requires that boards should consider bosses pay in the context of what is being offered to the wider workforce and its impact on the culture of the organisation.

And increasingly investors and other stakeholders are demanding that executive pay is aligned with meeting ESG-related performance criteria, including the achievement of net zero goals.

The 2023 AGM season is already pretty febrile, with a number of big shareholder revolts on executive pay. In April, Pearson, the education group, was given a bloody nose as 46% of shareholders voted against larger executive payouts in the future.

Ultimately the board has to determine if executive pay is incentivising the right kind of performance and behaviour from their management team.

The degree of alignment between these factors will determine if executive pay is a source of risk or opportunity for the organisation.