For Cedric Brown, then CEO of British Gas, the executive pay debacle of 1994 was not a happy period. Cedric looked extremely uncomfortable in the spotlight as politicians, shareholders and the media attacked his ‘excessive’ pay package at every opportunity.
But Cedric’s plight meant that companies were falling over each other to ensure their senior executives’ pay packages did not attract the same sort of negative attention. And for Peter Brown (no relation), chairman of executive remuneration consultants Top Pay Research Group, that meant more money. Ironic, really. Perhaps Cedric should have spotted the entrepreneurial opportunity.
Peter Brown has been spotting them throughout his career. In the early 1970s he founded Synergy Group to produce facilities management and logistics software packages. Synergy was sold to Gap-Sogetti in 1980 by which time Brown also had another company up and running. The Reward Group specialized in publishing salary surveys and offering staff assessment consultancy services – Brown and his colleagues sold out to a public company in 1988.
Three years later, Brown was back in the remuneration business, this time focusing on what he terms ‘the niche market’ of independent directors. The consultancy markets itself as providing ‘independent advice for independent directors’ on all issues of board remuneration. Brown points out that designing a pay package to correctly incentivize a team of directors is a job for professionals, yet the majority of non-executive directors charged with fulfilling the task are amateurs in this regard.
At the time the Top Pay Research Group was established, Adrian Cadbury was in the process of preparing his report on corporate governance and had consulted Brown on a number of remuneration issues. The need for independent directors to act as a check on the power of the executive board was at the top of the agenda, so Brown saw a gap in the market for a specialist director compensation consultancy.
Sure enough, Cadbury kindly gave the business a significant boost with his recommendations on non-executive directors and remuneration committees within his report. A few years down the line and Sir Richard Greenbury was helping things along in a similar fashion. The Greenbury committee on executive pay was hastily established in the wake of the trouble at British Gas and other privatized utilities. Among other things, Greenbury and his colleagues recommended a move away from simple option schemes towards the usually more complicated long- term incentive plans (L-Tips).
New Opportunity
Brown is hoping that this year’s Hampel committee recommendations will be just as favorable to his business. And with executive pay excesses still top of the news in the UK, there’s a strong likelihood that Hampel will touch upon the issue in his draft report expected in July. Brown’s submission to the committee is a mixture of common sense and self-interest.
‘It is obvious to us that the chairman and members of some quoted company remuneration committees are not up to the job,’ suggests his letter bluntly. It goes on to qualify the statement: ‘In small and medium size companies, it is quite understandable that non-executive directors are chosen for skills other than their remuneration knowledge. However, they are too often overawed by a determined and thrusting CEO, determined to force through over-generous payments.’
Brown argues that remuneration committees are too inclined to ask for suggestions from the CEO and only then commission independent advice on executive packages. ‘Boards should be able, and encouraged, to appoint non-executive remuneration committee members, who are not full non-executives, to overcome this problem.’
The solution certainly smacks of an attempt to codify the service provided by the Top Pay Research Group. And Brown also suggests that remuneration committees should seek advice from consultants which don’t have any other fee-paying relationship with the company. That conveniently rules out much of the competition – such as accounting firms with compensation divisions. In his defense, he points out that if such a proposal was accepted there would immediately be a number of independent competitors on the horizon.
‘Remuneration advice should come from an untainted source,’ states Brown, failing to note that among his clients he counts the Wace Group, of which he is also chairman. ‘Remuneration committees don’t want to be different – they want to be about the average, to avoid any criticism. We say: Be braver, be more proactive.’ He firmly believes that if you really want to drive a company forward then remuneration for executives should be more tailored to individuals within the team rather than decided on as a group package. And take into account the age and expectations of directors, too.
‘How old directors are is absolutely critical to whether their pay should be in cash, shares or some other form of deferred remuneration. We’re great believers in payment by stock but there’s not enough individual assessment of teams in this game. Remuneration is a subtle business – you need to know the people you’re remunerating and they need to know you know them.’
Bring Them In
Recent years have seen a greater alignment of the interests of executive directors with the performance of their companies by increasing the amount of pay they receive through options, stock or the like. Yet, in the UK, non-executives have remained largely outside of this debate – the argument being that it might somehow taint their ability to monitor the company, preventing them from resigning to show their dissatisfaction.
‘I’ve always thought that was rubbish,’ says Brown. ‘If there was some system whereby if they resigned they didn’t get paid their shares then I’d accept that argument. But that’s not what anybody’s suggesting. We’re just saying that non-executives should be paid a part of their fees in shares or options. Such a system wouldn’t stop non-executives from resigning on a point of principle’ Brown claims.
But isn’t their job to monitor the company rather than directly share in its success? ‘I don’t accept that job description. In practice, there is a proactive role for non-executives. Good non-executives are not just monitors, they are alternative strategic thinkers on behalf of the company.’
He believes this applies particularly to small and medium size companies which cannot justify having non-executives solely in a monitoring role. ‘In many cases, nobody on those boards will have much experience outside of the one company – an entirely home grown management team. The job of recruiting a non-executive to that company is not just to monitor – they have to be capable of that – but as an alternative strategist. You want someone who says, Look you really need to think about forging an alliance with a Japanese partner, or Have you considered going into this sort of product? The idea that you should just be a monitor means there’s an awful lot of dead wood sitting out there on boards.’
Brown believes that many non-executives are ‘dead wood’ in other respects too. He thinks that having too many ‘professional’ non-executives on a board can be a problem. But surely that’s a good thing? Not according to Brown’s definition. He is talking about non-executives who have retired from their normal occupations and are doing a spot of ‘advisory’ work in their retirement.
In such cases their whole status in life is dependent upon their non-executive positions, making them harder to give up as a point of principle. Brown argues that an executive director who also holds a non-executive position at another company is in a far stronger position to state his or her case. And stick to it. After all, if you are a finance director elsewhere it’s no great shakes if you have to walk away from a non-executive position.
‘There is a shortage of good non-executive directors who currently have an executive appointment and for whom this is something on the side rather than defining their lifestyle.’ That said, Brown stresses that the principal responsibility of executive directors is to their shareholders rather than touring the country as a non-executive. ‘I do think quite a lot of medium size and large companies should look at a wider group. At the moment they only want someone who has been the chief executive or is currently the chief executive of a named FT-SE 250 company. That’s ridiculous. There are some highly competent business people elsewhere.’
Options Open
So what does Brown think the future might hold for executive remuneration? He forecasts a comeback for option schemes over and above L-Tips. Indeed, he’s in favor of such a move. ‘The idea from Greenbury that an option scheme was undesirable, and that an L-Tip based on shares was good, was a bit naive. There’s nothing wrong with option schemes as long as they are structured against the right performance measures. The trouble with option schemes prior to 1995 was that, in the main, they had no performance triggers other than share price.’
Brown adds that he thinks, on balance, that the overall effects of both Cadbury and Greenbury have been positive. ‘But they could have been better – particularly Greenbury.’ He criticizes the recommendation of the Greenbury committee that companies make external comparisons to gauge the right level of remuneration.
‘Greenbury said one of the things you must do is prepare a table of what other people pay. That’s what I term ‘upper quartile syndrome’. It’s an absolutely cast-iron inflationary system. If everybody wants to be upper quartile and they all compare to the same people, it’s going to get out of hand. In some areas it already has. The areas most out of hand are in the electricity and water companies – the areas Greenbury was meant to stop. Of course, all they did was put the other electricity and water companies into their comparator group.’
Does high executive pay really matter? Yes, it most certainly does, according to Brown. ‘Excessive and unjustifiable pay is a danger to society,’ he intones. ‘Many people would say you shouldn’t start taking moral views, but I do think you have to have some code by which you operate. Some of the stories endanger the capitalist system and might even endanger future privatizations.’
That said, Brown warns against the danger of going too far. ‘I’m in absolutely no doubt that the board of a company is terribly important. A single unitary board is a very powerful instrument indeed. I don’t want you to get the impression that I don’t think anybody should get rich out of this – I do. Some remuneration packages at some companies are nothing like generous enough if they are to be successful. These people are making a huge impact on the performance of a company. And that should be rewarded.’
