UK companies are using the power of the pen to bamboozle shareholders into voting for big pay rises for their executives, research from the Melbourne Centre for Corporate Governance and Regulation reveals. We talk to researcher, Associate Professor Bo Qin, about the ‘say on pay’ debate.
Associate Professor Bo Qin has a slide he likes to show at his ‘say on pay’ presentations.
It reads like this:
“TSR means, in relation to a share in the Company or an ordinary share in a company in the comparator group in a performance period, the aggregate of the increase above or decrease below the average market value of such a share at the beginning of the relevant performance period and the aggregate value of dividends paid in that performance period (excluding any tax credit), where each such dividend is deemed to have been reinvested in the shares of each relevant company from the date of payment of the dividend to the last day of the performance period.”
Got it? No? Don’t worry, neither does anyone else.
“I show this passage and give my audience a minute to read it and then I test them on how much they understand,” says A/Prof Qin.
“Most people, even the professors, fail.”
The passage is taken from the executive remuneration report of a major British sporting goods retailer, and is a textbook example of the way in which language is being used by executives from publicly listed companies across the UK to obscure meaning and baffle the average shareholder.
A/Prof Qin, his colleague Associate Professor Flora Kuang and the University of Groningen’s Associate Professor Reggy Hooghiemstra, are investigating the impact ‘unreadable’ reports are having on shareholder voting practices.
Their research has found most remuneration reports produced by UK companies require more than 17 years of education - or a post graduate qualification - to understand.
The ‘readability’ of the reports was assessed using the Fog Index, a linguistic tool that estimates the years of formal education a person needs to understand text on first reading.
The researchers also found that when faced with a report too complex to understand, ‘mum and dad investors’ are less likely to vote against the recommendations it contains.
As a result, they are unwittingly green-lighting hefty pay rises and bonus schemes for company executives.
UK companies were first required to start producing executive remuneration reports in 2002 as part of a bid to better explain and justify the skyrocketing pay rises and bonuses being awarded to their executives.
On average, according to 2016 figures, UK executives are paid about 180 times more than the median employee wage. In Australia, by way of comparison, that rate is between 15 and 100 times the median. In the US, it is 300 times.
The UK’s ‘say on pay’ policy was introduced in response to rising shareholder discontent. It was intended to make listed companies more accountable on the wages they pay their executives, and give shareholders the chance to influence corporate practices.
But, in fact, it is having quite the opposite effect.
A/Prof Qin says ensuring a low percentage of voter dissent is not only good for executive bank balances, it is also good for the reputation of the company and its board members, and protects against negative media coverage.
But are directors deliberately using the power of the pen to deceive? A/Prof Qin says the answer is not that simple.
“Directors are expected to explain everything in these reports, including why they deserve a pay rise, so it can increase the complexity of the information being provided,” he says.
There may also be some issues relating to competitive intelligence so they can’t be too open and honest in what they are saying in their reports, and this can lead to things being made to be unclear.
A/Prof Qin says the research also shows that if indeed it is deliberate, the strategy of clouding meaning is not without risks.
Companies with more than 50 per cent of shares owned by institutional investors, including banks, insurance companies, pensions, hedge funds and investment advisors, are more likely to have a dissenting vote where reports have a low readability rating.
“If you have more institutional investors, confusing your message would not work and may even backfire,” he says.
“This is because they may be better able to understand the report than a retail investor.
“Or might consider a less readable report as a warning sign.”
Overall, he says the research clearly shows “something has to change” and that UK regulators need to do more to ensure clearer pay-related disclosures to investors.
It also points to a growing need for the UK to follow the lead of the United States, where there has been a requirement to present the reports in ‘plain English’ since 1998.
There are warning signs too for Australia, where there is no ‘plain English’ requirement.
In Australia, corporate boards are subjected to a two-strikes legislation when shareholders voted on remuneration reports at annual general meetings. If a company receives 25 per cent or more of ‘no’ votes from eligible shareholders at two consecutive meetings, the entire board needs to stand for re-election.
So, A/Prof Qin says, the risk is that Australian companies follow the lead of their UK counterparts – and complicate information around executive wages - to avoid facing a spill.