Second Reading

Part of Companies' Remuneration Reports Bill [HL] – in the House of Lords at 11:15 am on 24th April 2009.

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Photo of Lord Gavron Lord Gavron Labour 11:15 am, 24th April 2009

My Lords, I beg to move that this Bill be now read a second time. Although the idea of the Bill was originally suggested by me to the office at No. 10 in 1997, the current timing is entirely due to the noble Lord, Lord Taverne, whose name would be on it if more than one name were permitted. The noble Lord, Lord Tugendhat, was also willing to have his name on it. The Bill was therefore initiated by a representative from each of the three main parties. In addition, the most reverend Primate the Archbishop of Canterbury has written expressing his delight that we are introducing it; he is supportive of it and is sympathetic to its aims.

The Bill was conceived well before the present crisis. It is not aimed only at the excessive earnings of the financial services in the City, although many of the most extreme abuses were there. It is intended to cover all public companies and will continue to be relevant when the present crisis is ancient history, which I am sure we are all looking forward to. It is a short and simple Bill, occupying barely a page and a half in its official form. It has a single purpose: to draw attention to the growing gap between the highest and lowest paid in our public companies.

Many in this house may know that it was reported in the US investment magazine Alpha that in 2007 three American hedge-fund directors paid themselves around $3 billion each for one year's work. These were exceptionally clever people, and it was an exceptional opportunity for them. Still, though, $3,000 million each; enough to keep them and their descendants in extreme luxury for many generations. You might think that for these astonishing rewards these three must have made some great contribution to the good of the world—but no. They were simply betting on the collapse of the sub-prime market, making a fortune out of something that led ultimately to the misfortune of millions of others.

You may also think that the excesses of the United States are remote from our lives, but that is not the case. Finance and financial services are now global. In the Financial Times on the 7th of this month it was reported in a survey by Napier Scott Search, a headhunter, that this year UK bankers' average pay had for the first time in three years dropped below the levels of Wall Street. In 2007 there were British institutions, banks, asset managers, insurance companies and pension funds queuing up to invest in the best American hedge funds. So it is far from impossible that Mrs Jones of Worthing finds that her pension has been diminished by the huge rewards of those three Americans—only slightly, but still diminished.

To put these huge figures into context, I should point out that in April 2008 the average annual pay of the lowest 10 per cent of full-time workers in Britain was £13,624. Those on the current minimum wage of £5.73 an hour earn less than £12,000 for their year's work.

The Bill is also inclusive of the managers and directors of our publicly quoted companies not involved in financial services. When, 12 years ago, I first conceived the idea of publicising the ratio between the highest and lowest remuneration in our public companies, a typical ratio in many companies would have been around 30; for example, if the lowest paid averaged £10,000 per annum, the highest paid were getting around £300,000. Perhaps naively, I thought 12 years ago that that gap was rather large. Today, we find instances where the ratio is 300. The lowest paid might get £20,000 per annum and the highest paid may be getting around £6 million. What is the relationship, you may ask, between the $3,000 million I mentioned earlier and the more modest £6 million to which I have just referred? It is precisely that. The $3,000 million makes the £6 million look modest. It would make £12 million, even £20 million, look modest. Partly because of this, the growth in the ratio over the past 12 years from around 30 to around 300 is likely to continue. In another 12 years, it might be 1,000, or even more.

In the British Army, the ratio between a full general and a newly recruited soldier is 10:3. In the Royal Air Force, the ratio between an air chief marshal and an aircraftsman is 10:1. In the Royal Navy, the ratio of earnings between an admiral and an ordinary seaman is 10:2.

It so happened that I spent the Easter weekend in France, where I was told by a French historian that French pirates in the 18th century had developed their own system of remuneration. The captain, who was usually also the owner of the ship, took a quarter of the booty. The rest was divided equally among the crew; the ratio was usually around 10:15. I hope that most noble Lords will agree that our generals, admirals and air chief marshals are in no way lesser men than our chief executives. As for the French pirate captains, they appear to have been moderate in their demands. Perhaps they had principles absent in some of those we are discussing today.

At least one very distinguished politician has said that as long as the lowest paid are getting enough, why does it matter what the top people get? I would submit that it does matter. I think it is a disincentive for those at the bottom and in the middle. Why should they strive to improve productivity and to control costs when they see these excesses at the top? Why should they be content with inflation-linked pay increases when there are soaring increases above them? Can they really believe that their chief executive is worth 300 times what they are worth?

I should point out that these highly paid directors are not entrepreneurs. A distinction must be made between entrepreneurs and professional managers. Entrepreneurs create wealth. They create companies and build them up, sometimes into great corporations and, in doing so, many gain huge fortunes. When they set out, they normally risk their house, their reputation, the security of their family—indeed, everything—to get started. In my book, they deserve a large share of the wealth they create. They get it only if their venture succeeds.

Professional managers are a different breed. They rarely put their homes or families at risk. They opt for security, not adventure. They are usually intelligent, hardworking, natural leaders, high in integrity and good citizens, but it is often difficult to know if they are doing a good job. Big businesses are like big oil tankers: you apply the brakes and the effect is felt several miles—or years—later. They may be benefiting from the work of their predecessors or the vagaries of the market. What is certain is that they have shown the skills necessary to climb the ladder and be selected for the top job. These are not invariably the skills required to lead the company successfully. We have seen some spectacular failures of selection in the UK and the US in recent months.

Dr Paul Woolley, ex-IMF, who founded GMO Woolley, a successful fund management firm, has created and paid for two research centres, one at the LSE and one at the University of Toulouse, in order to study capital market dysfunctionality. Dr Woolley does not decry the importance of financial services or the importance of top managers in the industry, but during his time in the City he saw the "croupier's take" rise by an alarming degree. The croupier's take is the expression used for the City fees and charges and the directors' earnings which are subtracted from the profits before the ordinary shareholders get paid. He says that the croupier's take now absorbs between 40 per cent and 80 per cent of what used to be the 5 per cent to 6 per cent real annual returns—real, that is, after inflation—made by long-term investments in stock markets. It absorbs between 40 per cent and 80 per cent of what used to be the returns.

Dr Woolley's anxiety about what has been happening in recent years should be shared by all of us, particularly in view of the effect it is having on the savings and pensions of those on middle and lower incomes. They are the losers. The very highly paid directors and executives in the City and in industry are gaining disproportionate rewards at their expense, adding, among other things, to the already worrying deficits in so many company pension funds.

The question is: should Mrs Jones in Worthing bet getting a lower pension so that Lord Jones can get an extra few million? Lord Jones may be very clever, he may be working very hard, but is he worth more than, say, £1 million a year? Are the extra millions he gets an excessive part of the croupier's take?

Not very long ago Jack Dormand sat among us. Lord Dormand, a doughty fighter for justice, is now, sadly, no longer with us. Every year he stood and asked the relevant Minister what the Government were doing about the excessive remuneration of our top directors and executives. Every year, the relevant Minister would reply that it was not up to the Government but was the duty of shareholders to do something about it if, indeed, anything needed to be done. Last year my noble friend Lord Wedderburn, another doughty fighter, assumed Lord Dormand's mantle and asked the Question. He pointed out on 28 January last year that 1,445 directors had received more than £1 million in salary alone, never mind other forms of remuneration, in 2006-07. The noble Lord, Lord Razzall, backed him up.

The Minister at the time—my noble friend who just happens to be called Lord Jones—answered that he did not want to see a sign over UK plc saying that people cannot aspire to the sky. We cannot quarrel with that, but how high is the sky? How high should it be?

There is upward pressure on top earnings from many sources. The remuneration committees which are supposed to control them in fact apply some of this upward pressure. As my noble friend Lord Wedderburn said, those committees are composed mainly of non-executive directors from other companies. They all sit on each other's remuneration committees. They have no incentive to keep rewards down—on the contrary.

Managers of public companies are the temporary caretakers of their investors' money—the shareholders' money. Who are the shareholders? They are actually all of us, represented by the large institutions, banks, pension funds, asset managers, insurance companies, which are all also headed by very highly paid directors. They are not likely to apply downward pressure, and very rarely do.

So we have an imperfect market, a market in which there is upward pressure, from head-hunters, who are rewarded with a percentage of the salary of their appointee— no downward pressure there—and from compensation consultants, who tell all their clients that they should be in the top quartile and do not normally recommend reductions in directors' rewards. The point is that there is almost no downward pressure on directors' rewards, from anywhere.

The Government have had a go at it. Schedule 8 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008, which came into force in April 2008, is headed, "Quoted Companies: Directors' Remuneration Report" and contains a number of very sensible provisions to guide members of the remuneration committee in relating rewards to performance assessment and in wording their report. Surprisingly, it also states that if the director's entitlement is not subject to performance conditions, there must be an explanation of why that is the case. Can anyone imagine why a director should be rewarded for anything other than his performance?

Further on in the regulations is a requirement for the pay and employment conditions of employees of the company to be taken into account in determining directors' remuneration. That is very good, but it amounts to no more than a polite nod in their direction.

The schedule is full of excellent stuff and can do nothing but good in making the deliberations of the remuneration committee more professional and more considered. But sensible though it is, it does not solve the problem of the lack of downward pressure on directors' rewards.

I do not suggest that our Bill will solve this problem. It is the reverse of a sledgehammer to crack a nut; it is barely a nutcracker. But it would, if law, add teeth to Schedule 8—not very sharp teeth, but teeth none the less. It might even show us that the more egalitarian companies are the best performers. Above all, it would provide useful information for shareholders, potential investors, customers, suppliers and potential recruits. It would provide one more element of the transparency that is so evidently desirable in our corporations. I beg to move.