September 2, 2008
Hermes Equity Ownership Services
Comments on Jeff Gordon’s paper “Say on
Pay:” Cautionary Notes on the UK
Experience and the Case for Muddling
I am pleased to respond to the request for
comments regarding Professor Gordon’s paper.
By way of background, Hermes Fund Managers
Limited is owned by the British Telecom Pension Scheme, the UK's largest.
Hermes manages the portfolios of over 200 other clients including many major
pension schemes. In total, Hermes manages approximately US$70 billion.
Hermes Equity Ownership Services (EOS) also advises clients on governance
and corporate engagement matters in respect of about US$120 billion of
Based in the UK, representing clients from
around the globe, we have experience engaging with issuers on an
international basis on compensation matters. As such, we are well-placed to
provide insight regarding the advisory vote on compensation, how it works in
the UK, how it may work in the US and other markets, and how other
jurisdictions have still different versions of it (e.g. Binding votes on pay
in many continental European countries).
Since the advisory vote rule was
introduced in the UK in 2002, it has successfully provided shareowners with
a basis for dialogue with remuneration committees and boards of companies
where there are concerns regarding compensation. We note that the purpose
of the advisory vote in the UK was to enhance the link between pay and
performance – not primarily to address issues of quantum – and more
importantly, to limit the potential of pay for failure. As Professor Gordon
points out, this goal has largely been achieved.
It is true that both disclosure and
governance regimes differ significantly from the UK to the US. The UK has a
principles-based approach to both disclosure and governance requirements.
UK-based investors adopt a pragmatic approach in evaluating what companies
do. This is largely driven by the disclosure regime which does not require
incredibly detailed information to be provided by companies on issues
As a result of this more flexible
disclosure requirement, companies provide, on an annual basis, a narrative
explaining the rationale of the compensation committee that underlies the
final decisions they make. The Directors’ Remuneration Report tells the
story of the committee’s decision-making process and, in most cases,
clarifies that the directors have taken the company’s long-term strategic
objectives into account and have structured executives’ pay in such a way so
as to incentivize the executives to achieve these objectives. This explains
how pay is linked to performance.
The narrative and comparatively brief
nature of this disclosure allows investors – both institutional and retail –
to review remuneration plans and render a decision as to whether or not to
The complication in the US context derives
in part from the SEC’s very complex disclosure rule that requires so much
detail, making it next to impossible for a shareowner to evaluate properly
whether there is a link between pay and performance. The average CD&A is
now about 50 pages in length. Moreover, the SEC neglected to require the
disclosure of objective performance measures and corresponding targets, to
the extent that either exist, which further impairs shareowners’ ability to
determine whether there is pay for performance at a given company.
As such, even if shareowners know what to
look for – and can sift through the plethora of rather detailed information
that the SEC requires – in many cases it still does not exist.
This difficult task has resulted in
shareowners turning to proxy advisory firms to look for digestable
information regarding compensation. The trouble is, these advisory firms
don’t tend to look for the important narrative disclosure either – they put
numbers into formulas and produce a voting recommendation. Now, this is
understandable because these advisory firms have a particular mandate:
establish a clear-cut policy and implement it. They are not shareowners,
they do not represent shareowners – they are merely service providers to
shareowners. The advisory firms do not – and cannot properly be expected to
– evaluate compensation on a company-specific, pragmatic basis.
But it is precisely this sort of
evaluation on a case-by-case basis which companies deserve and which owners
should be prepared to give them. At the moment, because they feel
constrained by the limitations of the SEC’s detailed rule-making, companies
do not give their owners the information necessary to make company-specific
decisions. Where companies do not provide the level of disclosure we
require to evaluate whether there is a link between pay and performance,
investors need to engage with them in an attempt to find out if this does
exist. When we do this, we also press for improved disclosure and explain
why that is so important to shareowners.
Professor Gordon also points out other
structural governance distinctions between the US and the UK. Shareowners
of UK companies are considerably more empowered at law than those of US
companies. To us, this further highlights the utility of an advisory vote
in the US context. Withhold/vote no campaigns against compensation
committee directors, in electoral regimes where shareowners still do not
have the final say as to whether or not someone is elected to a board, are
of limited value. More concerning for companies and their owners, these
campaigns may not target the right people on the board. It is difficult for
shareowners to know who sat on a particular committee when various pieces of
complex compensation plans were approved. Moreover, shareowners are not
given sufficient information to know which directors on a committee came
down on which side of an issue so withholding support from all directors on
a particular committee is a blunt sword.
Shareowner proposals are also inefficient
mechanisms for the most part for a variety of reasons, including strict
wording limitations, expense, and the sometimes destructive effect they can
have on relationships between companies and their owners.
With respect to the issue of whether or
not to legislate an advisory vote in the US, we would prefer to see
companies voluntarily empower their owners with this right. That being
said, discussions with several companies have led to the conclusion that
issuers are generally unwilling to adopt an advisory vote without everyone
else following suit. Legislation thus seems to be the realistic answer to
Hermes Equity Ownership Services Ltd