City big guns seek to limit rewards for failure

Dec 12 2002 by Brian Amble Print This Article

A new initiative designed to limit payments to failed executives was launched today by the Association of British Insurers (ABI) and National Association of Pension Funds (NAPF), whose members collectively own approximately half the shares traded on the London Stock Exchange.

Although work on the initiative has been going on for the past year, the timing of the announcement is thought to be aimed at preventing ailing Telco Cable & Wireless giving its embattled chief executive a potential pay-off of more than 2 million.

Peter Montagnon, head of investment affairs at the ABI, said his members had reacted with "consternation and dismay" to the latest news coming out of C&W.

The new statement of best practice on executive contracts and severance sets out the view of institutional shareholders on how boards can take steps to avoid unmerited payments.

The statement calls on companies to ensure that they do not write contracts that commit them to pay for failure. It recommends that severance payments should be made on a phased basis rather than in one lump sum and calls on boards to disclose and justify pension enhancement.

The two bodies said their members will use the statement as a reference point when voting on remuneration reports at annual meetings. It is expected that shareholders will use the guidelines as a benchmark for voting decisions under new requirements on executive pay disclosure, which will come into force in January 2003.

"Extravagant pay offs are highly damaging to the reputation of companies which sanction them, as well as being costly to shareholders," said Peter Montagnon.

Christine Farnish, Chief Executive of the NAPF, said: " We believe this statement will establish a useful basis for preventing payment for failure. The key for boards is to get the contract terms right at the outset; they must be held accountable for this."

The paper includes the following key points:

  • Shareholders will hold boards accountable for the design and implementation of appropriate contracts.
  • The primary responsibility resides, however, with Remuneration Committees, who should have the leeway to design a policy appropriate to the needs and objectives of the company. They should also have a clear understanding of their responsibility to negotiate suitable contracts and be able to justify severance payments to shareholders.
  • When drafting contracts, boards should calculate and take account of all the material commitments which the company would face in the event of severance for failure or underperformance. This should cover all elements of the severance package, including any property liabilities on behalf of the departing executive.
  • Boards must also consider and avoid the serious reputational risk of being obliged to make and disclose large payments to executives who have failed to perform.
  • Performance objectives set for executives by the Board should be clear, so there is no need to pay compensation when these are not met.
  • Boards should ensure that there is an appropriate balance between contractual protection and total remuneration and be able to justify their policies to shareholders.
  • Phased payments are preferable to one-off lump sums.
  • Boards should not grant pension enhancements which cannot be justified to shareholders.
  • Contracts should be readily available for shareholders to inspect, together with any side letters relating to severance terms and pension arrangements.
  • Shareholders will take account of contracts and the way they are implemented in considering their vote on the remuneration report.