Covid-19 and Executive Pay: the reputational risks in defining company performance

This year was always likely to be a pivotal moment in the debate around executive pay. New corporate governance regulations which came into force in January 2019 mean that for the first time all listed companies in the UK with more than 250 employees must disclose key information about their executive remuneration schemes. This includes the ratio between the Chief Executive’s pay and that of the average employee.

From the moment the Government first announced these measures, commentators were predicting that this additional degree of transparency would serve to vindicate the belief of many politicians, campaigners, and investors, that executive pay is spiraling out of control to the extent that it has become grossly disproportionate to the earnings of the average worker.

The media was already preparing for a year of large pay ratios, tumultuous AGMs, and protracted negotiations between corporate executives and shareholders. However, it was not until Covid-19 arrived on our shores and began causing unprecedented economic disruption that the climate around executive pay really changed.

Pandemic

At its peak in May, almost nine million employees were furloughed from their jobs, taking a twenty per cent pay cut in the process. Organisations have been forced to rescind job offers, reduce working hours, and implement redundancy measures. Even though many companies have made protecting jobs a key goal, often the need to sure up the business’s financial position has required significant sacrifices.

Amidst these volatile conditions, the announcement of executive remuneration is fraught with difficulty. In our blog on the furlough scheme (CJRS) in April, we found that unless a company also took proportionate steps to cut executive pay, any furlough announcement was likely to receive significant stakeholder backlash.

Since then we have had AGM season. The scale of the disputes which have arisen between companies and shareholders demonstrates the reputational risk which companies face should they fail to amend their executive pay scheme to reflect the difficult decisions they have made regarding their workforce.

Media coverage of these disputes reveals three core insights:

1. Avoid double-standards: a c-suite may be exhibiting double standards if they do not forfeit part of their remuneration at a time when they are asking the workforce to make similar or greater sacrifices. They may also be depicted as out of touch with their employees and isolated from their own decision-making.
2. Justification by performance: unless the company has succeeded in navigating the pandemic without any loss of value, revenue, or employees, large executive pay packets may seem like an unjustifiable expense, or one which does not reflect the company’s performance. Read, for example, the concerns raised by shareholders in response to Ashmore’s proposed executive pay plan, in light of its recent decline in AUM.
3. Taxpayer as shareholder: if the company is known to have accepted Government funding through any of the various Covid support schemes, a large executive pay package may be viewed as a misuse of public money. Take for example the media’s coverage of the shareholder revolt over the proposed pay packet of Ryanair CEO Michael O’Leary, which highlighted the company’s use of state money through the CJRS and the Bank of England’s Covid Corporate Financing Facility.

These narratives contain echoes of the fallout from the global financial crisis and the Government’s £50bn bailout of the banking sector, when public and media opinion concluded that much of the bailout money from taxpayers was ultimately used to finance lavish banker bonuses.

Share the pain

In this new normal, the question of what is and is not acceptable in terms of executive pay is more unclear than ever. By and large the message from shareholders is that executives must ‘share the pain’, but this decree has been interpreted in a variety of ways with varying success.

As of August, 36 FTSE 100 CEOs had reduced their executive pay by an average of 20 per cent in the wake of Covid-19, broadly in line with that forfeited by furloughed workers. While this may have placed a financial burden onto corporate executives, the move was widely depicted in the media (for example see articles by the BBC and Financial Times) as a largely superficial gesture, given the generally low proportion of executive pay packets made up by the base salary (approximately one-fifth of CEO earnings according to figures reported by The Guardian).

Scrutiny of executive pay schemes has increasingly focused on the use of Long-term Incentive Plans (LTIPs), as well as annual bonuses and pension perks. In part, this is because they have the potential to effectively compensate any reduction in base salary. But mainly it’s because ‘sharing the pain’ is not so much about ensuring that executive pay reflects company performance, but rather ensuring that company performance is correctly defined.

An LTIP is a company share plan arrangement in which shares will be delivered to an employee at the end of a performance period, provided that they have met certain performance criteria. Traditionally these criteria are based on the company’s share-price or dividend. However, even prior to Covid-19 arriving on our shores and disrupting the status quo, the debate in the media and political spheres had begun to conclude that standard LTIPs based on specific goals that result in increased shareholder value were defining performance in terms of narrow and outdated metrics.

Thus, in recent years we have seen companies look to revise and modernize traditional LTIPS, tying them to more brand-conscious performance indicators; everything from sustainability, to customer and employee experience. Take for example the decision Shell made in 2018 to link executive pay with the company’s carbon emissions targets, following pressure from the company’s shareholders, or the recent move by Starbucks to link executive pay to diversity goals as of 2021.

Covid-19 and the ‘share the pain’ mentality has brought employee experience to the top of the agenda as a company performance metric. According to the Investment Association’s guidance on executive remuneration during Covid-19: ‘Remuneration Committees and management teams should be even more mindful of the wider employee context through this period and the impact that it should have on pay outcomes for the executive directors’.

Communications

Amending pay policies themselves is only solving part of the problem. As with any kind of reputational risk, the severity of the threat posed by an executive pay announcement can hinge upon the communication strategy. What is becoming clear is that the traditional messaging that businesses have previously used to justify their remuneration schemes no longer holds water in the Covid era.

In the past, those seeking to defend generous CEO pay packets argued that businesses looking to compete in the turbulent global marketplace need the kind of dynamic and experienced leadership that can only be provided by a select few candidates. Competition to recruit these individuals is therefore fierce, and consequently the pay packages used to entice them into leadership positions can be staggering. Furthermore, the financial costs involved in offering a CEO a highly-competitive remuneration package have often been rationalised as a mere drop in the ocean compared to the substantial boost which a well-chosen and highly-sought-after appointee can give to a company’s share price.

However, what business leaders need to recognize is that in the economic and political climate created in the wake of Covid-19, the potential reputational costs of excessive executive pay can far outweigh the direct financial costs. Simply reiterating the business case for a large CEO salary does not placate the burgeoning desire of stakeholders to see companies demonstrate a moral responsibility towards their employees and the country more generally.

In our joint research report with the Non-Executive Directors Association, we found that boards are increasingly mindful of these reputational risks, and what’s more they are turning to NEDs to help them guide decision-making. Indeed 66% of NEDs told us that they had been consulted more on reputational issues during the coronavirus crisis. With NEDs making up the majority of corporate remuneration committees these reputational issues will increasingly include executive pay among them, and the independent voice of the Non-Executive will be key in helping organisations assess the risk vs reward of their pay strategy.

We are well and truly in a new normal in terms of corporate responsibility – one in which communication will be key.