Fund managers do not have a good track record at fighting ‘fat cat’ executive pay in the non-financial world, so what chance do they have against the banks, asks Angele Spiteri Paris...
If fund managers and institutional investors wield their shareholder power against bonuses for executives at failed banks, will they get anywhere? There has been longstanding concern about high levels of pay in several sectors, particularly in large corporations such as Vodafone, Siemens and Vivendi.
The financial crisis has now spectacularly thrown the focus over pay and bonuses to the banking sector.
Daniel Summerfield, co-head of responsible investment with the Universities Superannuation Scheme (USS), says: “Events are presenting investors with an opportunity to look afresh at remuneration and challenge the status quo.”
But Professor Ismail Erturk, an economist at Manchester Business School, says: “Fund managers were not successful in dealing with those managers in non-financial companies getting high salaries when the companies did not do well, so I am sceptical that they will be successful in banking. Their track record in this is not very good.”
The sway shareholders will have on any financial institutions is based on the proportion of their shares. The UK’s National Association of Pension Funds (NAPF) says pension funds own 13% of the UK stock market.
Role of government
But governments are now majority stakeholders in a great number of financial institutions. Whether this will be of support to minority shareholders is still to be seen.
“It is a double-edge sword,” says Karina Litvack, head of corporate governance at F&C Asset Management. She notes that the consequences of government stakes in banks and how they will play their role still needs to play out. “This is all still in the initial stages.”
Her colleague, George Dallas, director of corporate governance, says that as a general rule, the state has no interest in being a long-term owner within these institutions and therefore would work to make them sustainable and attractive to other investors. “In this, there is alignment with the interests of minority shareholders,” he says.
“It is a balancing act which we hope at the end of the day will result in an exit strategy that will ultimately bring about a positive development.”
Mark Hoble, principal at Mercer Human Resource Consulting, says: “We hope that governments will act as shareholders rather than policy makers. At the end of the day, they are politicians and they have a dual agenda and they will make statements about policy.”
Several initiatives regarding executive pay by governments have already come into play. The German government announced banks asking for financial aid cannot pay their top management more than €500,000.
In the UK, Chancellor Alistair Darling announced bonuses at the Royal Bank of Scotland would be cut from £2.5bn paid out last year to £340m. Also, future bonuses are to be paid in shares rather than cash.
Newly incumbent US president Barack Obama also addressed the issue of bankers’ remuneration. He unveiled plans to introduce a $500,000 cap to executive compensation and rumour has it that shareholders are due to have more power when it comes to making decisions on bankers’ pay packets.
Fabrizio Ferri, assistant professor of business administration at the Harvard Business School, says: “In the US there seems to be a consensus that the ‘Say on Pay’ will become legislation. Everybody in Washington seems to think that it’s going to be one of the next moves.”
This means it will come into effect in 2010. Ferri continues: “If these types of proposals get the support people expect, then shareholders will be provided with a strong weapon in the upcoming proxy season.”
‘Say on Pay’ is a catchphrase that refers to a board policy which calls for an annual shareholder advisory vote on a company’s executive pay policies and practices. The concept originated in the UK in the early 2000s and mandatory shareholder advisory votes on executive compensation have since been legislatively adopted in Australia and Sweden. ‘Say on Pay’ has also been implemented in the Netherlands and Norway in the form of a binding annual ‘vote of confidence’ on executive compensation.
Few other countries have considered introducing this policy and the EU has yet to take a stance on the matter.
“There has been no EU initiative, although there should be,” says Erturk of Manchester Business School. He goes on to explain that across Europe regulators are working with banks and remuneration consultants to introduce risk-related bonus schemes.
Although this may sound like just the ticket to solve the compensation conundrum, it is no silver bullet as a lack of standardisation can put banks at a competitive disadvantage, which in the long run is hampering to the economy as a whole.
Old dog, new tricks
Although some progress has been made, the overhaul of remuneration within banks is still in flux. An example of a step forward has been made by ailing Swiss bank UBS.
It was the first European player to introduce what Litvack of F&C calls a trailblazing new scheme.
The bank revamped its executive pay structure in an effort to make it more transparent. Top managers’ bonuses will now be held for at least three years, instead of being paid immediately, and executives will receive variable pay, as warranted by UBS’s results. UBS executives also agreed to retroactive claw-backs of previous years’ bonuses.
Litvack says: “Hopefully this will be replicated by the rest of the market. If not, UBS will have trouble keeping its best talent.”
She explains that this is one of the reasons why reform of remuneration packages within banks needs to be carried out very carefully. “There is the danger of the pendulum swinging to the other side and choking off growth,” she says.
Litvack says that the concern of putting a financial institution at a competitive disadvantage is very real. If a bank like UBS makes top executives more accountable while its competitors make few changes, then UBS will risk losing staff.
According to Hoble, at Mercer, this danger also rings true where banks have governments as majority stakeholders if governments introduce more restrictions. However, he notes that in the current dire job market, even highly talented individuals have little choice but to stay where they are. As long as they still have a job.
Therefore governments, regulators, shareholders and the banks themselves need to work together to find middle ground and draw up principle-based standards. That way, banks like UBS, that are making an effort to change their remuneration culture, will not be left to eat the dust of their competitors.
Summerfield, of USS, says: “Companies and investors are now far more likely to review remuneration arrangements and they are asking the question: Are they working as intended, to incentivise the behaviours we want to encourage?”
Now is the time
As the carnage caused by the crisis continues to unfold and shareholder voting season looms, Summerfield believes this is a time to try and make changes. “With so much attention focused on the issue and in the midst of such poor performance now is the time to act. Human nature tells us that if we wait for a recovery we’re going to treat remuneration with less urgency than it deserves.”
Ferri, at Harvard, says: “Historically fund managers have viewed compensation as an ordinary ‘business as usual’ process. On some level they never wanted to interfere with it, but over time there has been a growing realisation that there are a number of side effects to excessive compensation.”
So, arguably, investors may have had a hand in allowing bankers’ bonuses to get so out of hand.
Erturk says: “Institutional investors are lazy too. They tend to not be scrutinising of the management when things go well. As long as the share price is increasing and companies pay dividends and do share buybacks, they don’t ask questions of top management.
“For the last six years before the crisis, banks were generating huge profits, which meant the share price of financial institutions and banks increased.”
In the banking sector, when things go well it may mean banks are taking excessive risks to produce high returns. According to Erturk, institutional investors did not understand how those returns were generated.
Although this may be true of pension funds and some other institutional investors, the same cannot be said of fund managers. Money managers are very much aware of the elevated risk needed to generate above-average returns.
“Internationally, fund managers have now accepted their guilt,” says Ferri.
Erturk continues: “They were not asking hard questions of the bank managers in the past because things were doing well.”
©2009 Funds Europe