Can UK listed companies attract the best global talent?

In recent weeks, there has been considerable Press commentary regarding the ability of UK listed companies to attract and retain the best global talent, particularly in the context of private companies choosing whether to list in the UK or elsewhere.

The issues which companies (and their investors) consider when deciding on the location of a listing are many and varied. Such questions may include: is the UK an attractive place to do business; has Brexit enhanced or detracted from that sense; does the Government’s position on immigration make us internationally attractive; and why has the FTSE100 significantly underperformed the Dow over the last 20 years? However, the UK’s approach to executive remuneration is, in our view, unquestionably a factor and our focus is on this aspect of the broader debate.

Julia Hoggett, the CEO of the London Stock Exchange recently said that “UK executives should be paid more if the country wants to retain talent and keep companies from shunning the City of London in favour of listings elsewhere.” Andrew Griffith, the Economic Secretary, agrees: “Remuneration here needs to be competitive. We need to attract the brightest and best to these shores — the last thing we want to do is drive them away.”

We support this sentiment and our view is that this needs to be considered as much from the perspective of retaining as well as attracting new talent.  However, we consider the problem to be more nuanced and not only limited to headline quantum.  Executives running UK listed companies not only come under fire for earning ‘too much’ but wider notions of fairness have led to contractual commitments being reneged upon (pension entitlements), pressure for discretion on variable pay outcomes to be mainly in a downwards direction and a seemingly never-ceasing push to build in more ‘shareholder protections’ to the design of pay which typically do not feature  either in  listed companies outside the UK or PE-backed companies.

Over the last five or so years in the UK, institutional advisory and proxy advisory firms have pushed the boundaries of practice to a level not seen elsewhere in the world. This in part led to the FRC making significant changes to the UK Corporate Governance Code (2018). In recent years we have seen:

• The requirement for executive directors to reduce the level of their contractual pension contributions to align with the workforce contribution level;
• Share ownership guidelines requiring departing executives to hold on to significant shares in their former employer for two years post cessation (even if they have resigned because they do not support the strategic direction in which the company is headed);
• Greater expectations of a scale-back of LTI grant levels and potential vesting levels even where a company has exchanged the variability of traditional LTIPs for the lower value of restricted stock awards; and
• Even after payment, extended circumstances in which monies can be recouped under clawback provisions.

To add to the complexity, there is no overall alignment amongst institutional investors; some are more sympathetic to the use of pay to retain and reward executives than others.  Even within a particular firm, there may be differences between individuals, particularly between fund managers in more active funds and their governance colleagues.

It is also worth noting that the UK’s competitiveness in terms of executive pay is not about whether British CEOs will relocate to the US for higher remuneration. This happens relatively rarely but as things stand many would be better rewarded by securing roles as UK-based regional MDs for large global multinationals and, as an ever-greater proportion of the UK economy is owned by a mixture of PE and sovereign wealth funds, whether they should accept UK-based executive roles in such enterprises.

These points raise a wider sense of societal fairness and, particularly, should senior executives be well paid and seemingly immune from the ‘cost-of-living crisis’ when so many are struggling? It may well be that a sense of social justice is a fair price to pay for the UK not attracting and retaining the best talent and, therefore, we might continue to see the FTSE100 underperform global stock markets, but we should at least recognise that this social justice objective could come at a price in terms of economic performance. At FIT we have seen a few examples of the investor-led push to align pensions with the wider workforce directly resulting in executives leaving the UK listed sector in favour of PE-backed companies. In each case, the PE-backed company recruiting the departing executive was happy to commit to at least the level of pension they were leaving behind.

What are the differences in UK v US executive pay and why?

Different reporting regimes which value pay on different bases make robust comparison difficult but, as a rule of thumb, total CEO pay in US listed companies is at least 2x higher than equivalent levels in the UK (principally through higher LTI awards).

Not only is this a stark headline number but US companies will typically pay the whole bonus upfront in cash (v partly in shares deferred for three years in the UK) and LTI is usually delivered through a mix of restricted stock (for retention) and performance shares (for incentivisation). In the UK, investors would not typically accept the need for the retention element.

Further, performance scales tend to be more onerous (at least at start to earn) in the UK.  For example, the single most common performance measure in Long Term plans is relative total shareholder return and, in the UK, there are no examples of companies delivering any level of vesting for below median performance whereas, in the US, the norm is to commence vesting at lower quartile.

The most common scale for UK companies is 20%-25% vesting at median (when measuring relative Total Shareholder Return) rising to 100% for upper quartile or upper quintile.  In the US, the logic flows that, on average, companies should gravitate to median TSR performance over time so a target (or 50%) level of vesting should arise for median performance and the UK’s 25% level of vesting for a level which does not reflect significant underperformance (i.e. lower quartile). To be fair, this logic also leads to maximum vesting of LTIs in the US typically requiring out-performance of the upper quartile.

While many other performance measures may be in play, this highlights the question of what the purpose of performance shares actually is. Is it to provide a balanced overall level of total remuneration (with a target value equating to average performance) or is it only to reward out-performance?  The former is the US view while the latter is the UK one.

The CEO of Liontrust, John Ions, was reported in The Times recently as saying that the US has a culture “where if you do a good job and deliver for shareholders, you are rewarded” whereas in the UK “there’s criticism towards it”.  

In this context, we would have to agree with the challenge raised by both Julia Hoggett, CEO of the London Stock Exchange and Liontrust CEO, John Ions.  Other countries provide a more benign environment for executives to earn a living but, not only that, the ever-increasingly important unlisted sector in the UK is tending to do the same.

Is it just the United States?

When comparing the UK and the US, differences in quantum grab the headlines. There are, however, also marked differences in approach between the UK and Europe. In our experience, the level of stretch applicable in variable pay programs and the pressure to reduce out-turns is, significantly less of a problem in mainland Europe than in the UK. 

Of the companies in the Eurotop 100 from outside the UK which operate an annual bonus, less than half defer some portion of the bonus paid compared to almost 90% of Eurotop 100 companies from the UK.

Variable pay is routinely subject to more scrutiny in the UK with questions raised over why execs should be rewarded for doing their ‘day job’ and, while most institutional investors favour balanced scorecards when assessing out-turns, they can challenge the out-turn if one element has under-performed.

So, while we agree with the CEO of the London Stock Exchange that UK listed executive pay is in danger of becoming increasingly uncompetitive, we would encourage all stakeholders to also be wary of further governance ‘gold plating’ of UK pay design.  This is invariably well intentioned but rarely followed globally and increasingly makes the UK relatively uncompetitive. We are paying UK listed executives less, for achieving more and with more ‘bells and whistles’.

What next?

We would conclude with these comments:

• We are grateful to the CEO of the London Stock Exchange for shining a light on executive pay;
• We urge the FRC, in its forthcoming consultation on a revised Code, to be sensitive to the risks attached to adding further additional layers of governance such as it did with making pension alignment a comply or explain issue;
• Institutional investors should recognise that, while they can continue to apply downward pressure on UK executive pay levels through negative voting, there is a real danger that this comes at a price in terms of the overall attractiveness of UK listed companies as an employer and, ultimately, in terms of corporate performance;
• The status quo may be appropriate in many (possibly the majority) of cases but may not serve some truly exceptional executives who could potentially more easily thrive outside the listed sector, especially in sectors where there is particularly significant PE investment.  Their retention requires more innovative approaches which may continue to lead to lower levels of shareholder support; and
• Further, concluding with the debate opened by the CEO at the London Stock Exchange, the status quo does not enhance the attractiveness of the London market as a place to list under a governance regime which is at the onerous end of the global scale.