Second Reading

Part of Companies' Remuneration Reports Bill [HL] – in the House of Lords at 11:47 am on 24th April 2009.

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Photo of Lord Joffe Lord Joffe Labour 11:47 am, 24th April 2009

My Lords, I join other Peers in congratulating my noble friend Lord Gavron on introducing this topical debate and on his excellent speech in support of his Bill.

It is clear from what has already been said that the remuneration packages of executive directors in the corporate world are astonishingly high. Deloitte's 2008 directors' remuneration report on the FTSE 250 companies shows that fixed annual salaries, plus pensions, of executive directors other than chief executives ranged from £293,000 to £935,000. Most people would think that those salaries were more than sufficient to generate maximum commitment by directors to produce outstanding results, but they would be far off the mark. To these salaries are normally added annual and longer-term bonuses, which for on-target performance typically range from 85 per cent to 270 per cent of basic salary, depending on the size of the company. These bonuses push up the average total remuneration of executive directors to between £561,000 and £3.4 million. For chief executives, the range is £963,000 to £5.3 million and, for superior performance, from £1.5 million to an incredible £10.9 million.

Pity the Prime Minister who receives a modest £194,000 for running the whole country, Cabinet Ministers with their £142,000, the Cabinet Secretary and the head of the Civil Service with £235,000 and university vice-chancellors with an average £194,000, although one was recently awarded £500,000, which caused an outcry. A similar outcry arose in relation to chief executives of NHS hospitals, when one was awarded a remuneration package of £210,000, although the average was only £110,000. Chief executives of local authorities receive on average a little less than that.

What then is the explanation for the vast gap between corporate directors and individuals with equal or even heavier responsibilities in other fields? Are corporate directors cleverer or more accomplished at their jobs? Do they work harder, do they carry more responsibility and are their jobs more difficult? The answer to all these questions is self-evident: it must be no. There is one obvious difference that explains these extravagant rewards, which is that, unlike the Prime Minister and others to whose salaries reference has been made, corporate directors fix their own salaries.

It is argued by those in the corporate sector that their remuneration packages are market driven and that, unless they are paid these extravagant amounts, they will be tempted to go elsewhere. But where would they go? Who would want to employ them? Would most of our companies really be harmed if some of them did depart?

It is a myth that there is a genuine market that drives corporate salaries. In practice, directors have created a false market. The higher they pitch their salaries, the more their counterparts in other companies increase their packages, and so the process goes on and the packages get higher. The policy director of the Work Foundation said:

"It is an incredible closed shop and those are the dynamics operating in top directors pay. The increases are based on the myth of market forces, but this is actually the antithesis of market forces".

The noble Lord, Lord Taverne, referred to the extraordinary increase in salaries of corporate directors. I found a smaller figure, which was only a 50 per cent increase, in the five years ending 2007-08, with the corresponding increase in average earnings of only about 20 per cent.

In the current economic crisis, one might have expected that directors would be volunteering to reduce their salaries in the same way that some of their employees are being urged to agree to reductions in their earnings to save their jobs. Although some, to their credit, have volunteered to waive bonuses, this has been very much the exception. It is surprising how little regret has been expressed by directors at their own mistakes, particularly when due to their poor decisions they lay off staff. Indeed, far from there being a consideration of reductions in their remuneration, the views expressed in some of the remuneration reports are that even higher salaries are needed to compensate directors because of the great skills needed to recover from the setbacks created by the current economic crisis.

Obviously, like everyone else, corporate directors are entitled to be fairly remunerated, but how can their excessive remuneration be controlled? The theory is that the remuneration committees with independent non-executive directors will exercise control over remuneration, but the question is how independent these non-executives are. As a chairman of a remuneration committee, according to Deloitte, one can earn an annual fee of £120,000. That is an attractive role for not a great deal of work. Innovatively, the very directors whose remuneration they have to determine appoint them. I recall being told many years ago by a board member of a major UK company that the chairman of the remuneration committee went to see the chairman of the company to advise him of the bonus that the committee had agreed to recommend for the year. The company chairman glowered at him and said that it was not enough. The remuneration committee chairman scuttled back to his committee to reconsider and had no difficulty in upping the bonus to the level considered reasonable by the company chairman.

I do not suggest that this is what happens regularly, although the manner in which the board of the Royal Bank of Scotland whistled through the inflated pension arrangements for Sir Fred Goodwin does little to create confidence in the effectiveness of remuneration committees. Further, as has been pointed out, it is difficult to overlook the fact that most of the independent directors are directors of other companies and part of the same director market.

Apart from remuneration committees, the other forms of control of executive directors' remuneration are said to be shareholders' rights to vote down recommendations on remuneration at AGMs. However, the main shareholders are the pension funds and other investment funds whose investment managers, being normally extremely well paid, do not have an impressive record in opposing recommendations on remuneration. The small shareholders can protest loudly but can seldom succeed in opposing extravagant pay awards.

Accordingly, it really is necessary for government to take steps to curtail excessive remuneration. But that is easier said than done. While the Government have every right to lay down conditions curtailing excessive remuneration in companies that they are helping, in the same way as President Obama has done in the USA, it would be extremely difficult and probably harmful to seek to impose arbitrary maximum salaries on earnings.

Against that background, the Bill introduced by my noble friend Lord Gavron is an important step in the right direction. A great deal more has to be done by government, but transparency on director rewards, which will emerge from the Bill, will act as some brake on corporate greed, put pressure on remuneration committees and provide the information for further action by government and pressure by shareholders. I enthusiastically support the Bill.

In conclusion, I draw attention to the danger of using public pressure to reduce directors' bonuses, which could lead to the wrong position. Care needs to be taken that existing bonuses are not consolidated with basic salaries, as the result of that would be the worst of all worlds.