'Fat Cat' Pay and Rewards for Failure

Written by Vincent Cable MP and published in General Article on Thu 17th Jul 2003

The government is consulting at present on whether or how to use legislation to discourage 'rewards for failure' to departing senior executives. The issue of 'fat cat' pay has become a major concern to active shareholders, as reflected in heated AGM's, to employees and to the general public.

The anger is particularly strong where tax payers money is involved - as in the pay-off to the former head of Consignia, the Post Office, and the guaranteed end of contract payments to the new head of British Energy, currently seeking government financial help.

The reputation of business in general has suffered seriously and the CBI - to its credit - has acknowledged that business has to put its house in order or it will face unpalatable regulation.

The issue is not primarily about high pay as such. There is a broad public recognition that if Richard Branson, Luciano Pavarotti or David Beckham are able to exploit their talents or their brand image to earn extremely high incomes that is right. And if, genuinely scarce, management talent earns a high reward through wielding major responsibility and taking risks in a corporate environment that is also, surely, legitimate.

There are however two qualifications. The first is that a sense of equity in society demands an element of redistribution to counter major inequalities in rewards. Top rates of tax should however not be penal and international mobility would make very high tax rates inoperable in any event. A top rate of 50% on incomes of £100,000 seems both fair and practical.

A second point is that there is no perfect market in top management. Many top executives come up from the ranks; and often rightly so. It would be extreme to say that they would be unemployable elsewhere but their value is not set in a management 'market'.

Moreover, in PLC's their pay and conditions are set by remuneration committees of varying degrees of independence from management. There is a classic 'agency' problem: management has its own agenda - to obtain generous pay and perks, security and influence - which may be independent of or even at the expense of the owners, the shareholders. Recent remuneration packages, rewarding corporate failure and under-performance, suggest a total indifference to shareholders in some companies.

What is the solution? There is no need or call for highly prescriptive regulation of executive pay. The main way forward is to empower shareholders. The government has introduced legislation requiring executive pay to be reviewed by AGMs. That is a positive step, but the shareholders vote should be binding.

Shareholder activism is patchy and many institutional shareholders are passive or collude in management excesses. For that reason, they should be required to record publicly their votes at shareholder AGMs, publishable on the Internet. In parallel, the independence of remuneration committees should be strengthened as part of wider reforms of corporate governance in the wake of the Higgs Report.

Even the CBI is now proposing that companies should get rid of payments to departing directors and make contracts more transparent; failing that, companies should 'comply or explain'. After the current round of consultation, the government must act.