Heads I win, Tails I don’t lose: Executive Compensation and the Pursuit of Fairness
Charlotte Dicker
Partner | Head of Client Relations & Responsible InvestmentCharlotte Dicker joined Oldfield Partners in 2022 as Responsible Investment Lead. Charlotte previously worked in Consultant Relations, with a focus on ESG and Defined Contribution solutions, at State Street Global Advisors and Wells Fargo Asset Management. Charlotte holds an International BA in History and an MSc in Management from the London School of Economics and Political Science (LSE).
Samuel Ziff
Partner | Portfolio ManagerSam Ziff joined OP in April 2013. He was previously employed by J.P. Morgan Cazenove working in the UK Industrials Corporate Finance team for a total of 4 years. He graduated from Oxford University. He manages the global equity and global equity income portfolios, and contributes to the overall investment selection.
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A contentious debate about executive compensation continues to rage, with rising CEO pay becoming a cause of broader societal dissatisfaction. The interests of shareholders, CEOs and directors, appear often to be at odds, and navigating these differences risks conflict and dissatisfaction on both sides. At Oldfield Partners, we find ourselves voting against both management and proxy advisors on compensation related matters almost three times as often as we do for other governance related topics. As a high conviction manager with an open dialogue with many of our investee companies, we explore our approach, with reference to investee company easyJet. For greater context, we leverage the insights of UK focused research from Edmans, Gosling and Jenter in CEO Compensation: Evidence from the Field[1].
According to the Economic Policy Institute, in 2021 the CEOs of the top 350 US firms were, on average, paid $28m. At 399 times the average worker’s compensation, this has risen from 20 times in the mid-1960s. There are many possible reasons for this, including the emergence of Reaganomics in the 1980s, and a bias towards the use of market forces to set compensation. Additionally, the knock-on effects of the growth of private equity, and the large associated rewards, has impacted public companies, requiring them to pay more in the competition for talented leaders. In the UK too, the ratio is high and is close to 109-to-1. Such levels of disparity are causing societal unease, with yet no clear solution.
Attempts have been made to manage the situation through increased levels of disclosure, the emergence of compensation consultants, rules-based approaches and even broader government led limits. However, the inadvertent effects of these well-intentioned reforms may have helped to reinforce the high levels that they were built to control. As Warren Buffett highlights.
“Corporate CEOs, as a group, would be being paid a lot less money if proxy statements hadn’t revealed how much other people were getting paid.”
Through their research, Edmans et al. provide context to help substantiate this claim. Their conversations with non-executive directors and institutional investors in the UK identified that the comparative levels of pay at peer firms is the single most important factor for setting pay. Their research highlights that this is driven by a CEO’s perceived sense of fairness.
“There is first a test of pay fairness by the CEO, then after that, for most CEOs, it is about building reputation for the company and latterly themselves.”
Edmans et al. find that CEO fairness concerns aren’t rooted in monetary amounts for the ability to finance consumption, but instead, in achieving a level of recognition when compared to their peers. The importance of pay is further amplified by the impact it has on a CEO’s level of intrinsic motivation.
Edmans et al. share additional insights into the differing views of boards and investors, underscoring cause for potential conflict. Overall, 77% of investors believe that pay is too high, which they attribute to boards being too weak. Whilst institutional investors think that boards can cut pay, directors disagree. 59% of directors agree that a pay cut of one third would lower the quality of an incoming CEO, however only 18% of investors believe this to be true. With a fractious backdrop, we recognise the concern that issues are coming to a head at a time of a growing cost of living crisis.
At Oldfield Partners, we are interested to understand how misalignment impacts our own interactions. This is of particular importance in recent years where we recognise that compensation schemes have been adjusted for the effects of COVID, and often to the detriment of shareholder interest. Although the pandemic was outside of the control of management teams, their response, and the determined incentive structures, were not. We highlight the impact of this through a case study with one of our investee companies, easyJet.
easyJet, the European low-cost airline, chose to raise what we thought to be an unnecessarily large amount of equity at a discount, whilst rejecting a takeover approach from a rival airline at a premium. Following this capital raise, the directors altered the incentive plan, moving the long-term structure from options to restricted stock units, in effect, guaranteeing management stock rewards. The underpins were based on liquidity, ESG issues and committee discretion. Crucially, it omitted any focus on relative or absolute financial or operational performance. Our frustration was amplified in the context of the recent takeover rejection.
In discussion with the Chair of the Remuneration Committee, we highlighted our dissatisfaction with the changes, sharing our concerns that management no longer appear to be incentivised by a plan that aligns them with shareholders. The discussion included our discomfort with the length of the vesting period of three years, whilst we thought five was more appropriate. Their final proposal did reflect some adjustments; however, they did not go far enough to achieve the alignment we sought between management and the interests of shareholders. We therefore used our vote to provide feedback of our ongoing discomfort.
Our interaction with easyJet highlights an area where we experience regular disagreement with directors on remuneration packages, namely, the length of incentive plans. On this topic, it appears that among investors, we are not alone. Edmans et al. show that 95% of investors believe that extending the length of an incentive plan would not impact the effectiveness of these incentives detrimentally. This compares with 43% of directors, who believe that it would. Whilst 78% of investors thought that a longer-term horizon would support the CEO in making better decisions, only 22% of directors believed this to be true.
Possible solutions to the problem of executive pay are complex and we believe that attempts to cap CEO pay may have made matters worse in the UK. Following excessive high-profile rewards, such as the pay out of £100m to the CEO of Persimmon, we have seen the UK pivot in its model of compensation. Historically, larger pay-outs, contingent on hitting higher performance hurdles, have been replaced with a lower cap but a greater level of certainty of achieving it. Once again, we do not believe this supports alignment between a CEO and their shareholders, nor does it resolve issues of inequality, as the payments still total to many times that of the average workers’ pay.
In 2021, on the topic of remuneration, we voted against management or Institutional Shareholder Services (ISS) 25% of the time. Whilst the issue of executive compensation is a longstanding debate, we have noted that on more than one occasion adjustments made through the COVID period did not achieve what we perceive to be an appropriate level of risk sharing, or alignment between the parties. With an imbalanced impact favouring CEOs, Bloomberg columnist Matthew Brooker described the result as “heads I win, tails I don’t lose[2]”.
Effectively managing executive compensation has proven to be a challenging problem to solve despite the best efforts of many stakeholders. Given the complexity of the issue, taking a nuanced approach is important. Our concentrated portfolios, coupled with a long-term investment horizon, support our ability to do this. Standardised policies can provide guidance when voting on compensation, but we do not believe they should be solely relied upon. Engagement provides a bridge between shareholders and directors, as we continue to navigate what has become both a social, as well as a financial issue.
[1] Edmans, Gosling, and Jenter, CEO Compensation: Evidence from the Field (July 2021).
[2] Brooker, Matthew, British CEOs Snared Big Bonuses. For What?,The Washington Post, (November 2022)
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