Corporate Governance and the Problem of Executive Compensation: The International Response to the Compensation Problem (The High Pay Commission)

The United States is not the only country wrestling with the problem of executive compensation.  The issue has been much debated in Great Britain, with the country's approach providing possible lessons for the United States. 

Britain has had say on pay in place since the early part of the new millenium.  So Britain has had almost a decade of experience with the practice.  Say on pay may have caused a shift in practices, causing compensation to become better alligned with performance.  But what say on pay did not do was restrain the amount of compensation.  This was made clear in a study by the High Pay Commission late last year. 

The Commission was tasked to examine the issue.  The Commission viewed its mandate broadly.  Billed as non-partisan, the High Pay Commission focused on the escalation in executive pay and the harm not only to investors but also to employees (the disparity "undermines trust and [employee] commitment to the business"), the economy (describing the resulting wage inequality as a "toxic form of free market capitalism") and "society as a whole." 

The Report included a number of findings and recommendations.  Among other things, the Report took issue with a number of standard justifications for high levels of compensation.  The argument that increased compensation was needed to avoid a global brain drain was dispatched. 

Our findings also show that the argument used by many senior figures in British business, that pay must escalate in order to attract the best talent from abroad to UK companies, is a myth. Our own evidence shows that global mobility is limited, with only one successful FTSE 100 chief executive officer poached in five years – and even this person was poached by a British company.

The High Pay Commission issued a number of recommendations, including the need to simplify the pay package.  Most interesting, the recommendations took aim at the "closed" system for determining compensation.  As the Report described:

[R]emuneration committees remain a closed shop. Many continue to be made up of current or recently retired chief executives. This contributes to the dramatic growth in top pay, and the dislocation we have witnessed between average pay and the rewards given to some CEOs.

The closed shop did little to retrain the escalation of executive compensation.  See id. (the "current model of corporate governance locates absolute control in the hands of the owners, the shareholders and their representatives the nonexecutive directors. In the UK this model has failed to restrain escalating top pay.").

The solution?  Rather than leave the matter entirely to directors, the Report called for employee representation on the compensation committee of the board.  As the Report stated:

We believe that greater engagement with employees may help restrain executive pay and help mitigate negative impacts on morale as well as encourage a greater engagement with the workforce. We therefore call for employees to be represented on remuneration committees as a first step to better engagement and accountability.

In effect, the Report, in a mild way, argued for a stakeholder approach with respect to executive compensation.  Under the thinking of the Report, executive compensation would cease to be an issue between owners and managers, but would have require participation of other segments of the broader population.   

J Robert Brown Jr.