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The eye of the storm

27 September 2016 by Anthony Hilton

The eye of the storm - read more

The nominations committee dances as desired, says Anthony Hilton

Companies may not realise it yet but the Brexit vote has turned the tide for UK corporate governance – but this is little to do with the EU. Instead, the vote gave the public the opportunity to express an opinion on current economic arrangements. The fact that many feel left out in the cold, while the rewards of globalisation have been high-jacked by a privileged few, is reflected in the strength of the No vote.

Company boards are in the eye of this storm. Excessive executive pay is a major source of discontent and one of the ways in which people perceive the system to be unfair.

The referendum was political but the ripples are spreading. Politicians have woken up to the fact that they have ignored what has been happening in companies for too long; negative aspects of the way companies behave could now have adverse impacts for them at the ballot box. Accordingly, they have a new interest in how companies are run and have begun to look for ways in which these negative forces might be countered.

Thus the unforeseen consequence of the vote has been to move the debate about governance, fairness, pay and the rewards for economic activity into the political arena. Spare a thought for those whose life work has been self-regulation and voluntary codes, for the shadows are lengthening over those days. What companies have long sought to avoid is coming to pass. Protests on pay are no longer the left having a tantrum. Once Theresa May expressed her concerns about corporate behaviour, it was a signal for conservative politicians to get involved.

One of the first out of the stocks was Chris Philp, Conservative MP for Croydon South since 2015, who first worked for McKinsey before becoming an entrepreneur. He has floated one business on the stock market and started others in distribution, finance and property. In September he launched a paper with forewords from Lord Myners and fund manager Neil Woodford called ‘Restoring Responsible Ownership’. For the absence of doubt it is subtitled ‘Ending the ownerless corporation and controlling executive pay’.

Philp’s thesis is that the current system of governance has failed. Chief executive pay has gone from 75 times that of the average employee to 150 times in the past 12 years – far outstripping any conceivable measure of performance. This number is shocking in itself; it moves into the realms of insanity when research which shows that high pay leads to worse, not better, results.

Research published by MCSI in July found that over 10 years, companies paying their CEOs the lowest quintile outperform those paying their CEOs in the highest quintile by 39%. The measure was total shareholder return. Separate research shows that the longer the tenure of a CEO, the more highly paid and self-confident, the more likely he or she is to screw things up.

Philp believes the governance failure stems in part from the fact that shareholders are not involved in the appointment of boards. In theory they are, but you have to be naïve to believe that. The reality in the public company domain is that the chairman pulls the strings and the nominations committee dances as desired. Candidates disliked by the chairman do not get on the slate, yet it is unheard of for shareholders to vote down these recommendations at AGMs.

If someone independent does get on to a board, there is academic evidence to show they are kept in line by ‘social distancing’. Others behave because they want jobs on other boards and a reputation for rocking the boat would work against them.

Elsewhere, however, shareholders are more involved in appointments. The boards of private equity companies are closely connected to their shareholders. According to a recent survey by McKinsey, this delivers more effective boards and better results.

Philip’s conclusion is that we need to replace the nominations committee with a shareholder committee. This would comprise representatives of the top five shareholders, provided they had held stock for more than a year. Should shareholders not want the job, it would be passed down to the next largest in line, but those refusing to serve would be publicly identified and have to explain to their clients why they do not want this responsibility.

The shareholder committee would have three jobs: to identify and nominate board members, to set the pay of the chief executive and to question the board on corporate behaviour, strategy and performance. It does not sound much, but it amounts to a revolution in
the way companies are run.

Anthony Hilton is Financial Editor of the London Evening Standard

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