Vince Cable’s (the UK's business secretary) recent warning to FTSE 100 boards regarding “excessive” executive pay raises serious questions about who should have the final say on defining “excessive” compensation for CEOs and other executives. Should the definition of “excessive” compensation be determined by a firm’s shareholders? Lenders? Employees? The government? The public?
Theory suggests that the task of defining “excessive” executive pay should largely be left to a firm’s shareholders. After all, shareholders are ultimately the CEO’s “boss”, and it is shareholders who ultimately foot the bill for executives’ pay. This means that shareholders also stand to lose the most from rewarding an executive with excessive pay.
Interestingly, UK shareholders have already spoken on the question of excessive pay, and their collective answer is at odds with Dr. Cable’s recent assertion that executive pay is “excessive and disproportionate.” Since 2002, shareholders of listed UK companies have been given an opportunity to vote each year on whether executives’ and directors’ remuneration is “excessive.” However, the overwhelming majority of FTSE 100 companies have “passed” their non-binding shareholder advisory votes on executive pay in every year since the “say on pay” rule was first introduced. To me, this indicates that CEO compensation is not wildly out of line with shareholders’ expectations, which in turn raises questions about just how “excessive” executive compensation really is in the UK.
Furthermore, Cable’s warning seems to be focused primarily on the level of executives’ pay. However, the components of pay should also play a significant role in the debate over executive compensation. For example, £1 million in cash compensation does not provide a CEO with the same incentives as £1 million in stock compensation because stock awards typically vest over a long period of time and are directly tied to firm performance. Indeed, a vast quantity of academic research shows that stock grants and other types of incentive-based compensation are a crucial component of a well-designed CEO compensation scheme because they explicitly tie the CEO’s current and future income to long-term firm performance. Furthermore, board members are almost certainly aware of this research, and I think most are largely on board with the notion that executive pay should be directly tied to long-term firm performance. As such, Cable’s apparent focus on levels alone is missing half of the story; levels and components are equally relevant in the compensation debate.
Over the course of his career, Vince Cable has had an enormously positive impact on corporate governance practices in the UK. Thanks in part to his work, shareholder say-on-pay votes are now legally binding in the UK from October 2013, giving shareholders the official right to “vote down” executives’ pay packages. However, these exceptional shareholder rights also make Cable’s recent warning all the more puzzling. Why does government need to dictate CEO pay? For now, at least, let’s keep shareholders in charge of corporate governance and executive pay.