Executive Pay: Building A Better Understanding

Research from Schroders released in July 2024 suggests UK-based chief executives were paid around one-fifth of their American counterparts in the fiscal years 2021-2023. It showed a New York-based chief executive, for example, can expect an average of $7.2 million in annual pay, compared with $1.4 million for the equivalent London chief executive.

The problem is less acute for larger companies, but American chief executives still earn almost double their UK equivalents. However, in smaller companies – and particularly in high growth sectors such as technology and healthcare – the difference is significant and may contribute to a ‘brain drain’ of British talent.

UK boards recognise the problem. The latest FTSE 350 Boardroom Bellwether , a yearly survey by The Chartered Governance Institute UK & Ireland that gauges sentiment inside British boardrooms, showed 53% of boards view rules and scrutiny over executive pay to be detrimental to hiring the right candidates. The problem is highest among FTSE 100 companies, where 65% think rules and scrutiny on pay are disadvantageous.

The report also revealed problems of communication between institutional investors and boards. While 47% rate the quality of engagement by their institutional investors as excellent or good, 50% rate it poor or merely satisfactory.

The stakes are high. Companies are operating in international markets and pay needs to be internationally competitive to recruit and retain executive talent. If they feel pay awards aren’t fair, executives may vote with their feet and move to jurisdictions such as the US, where pay is more flexible. It may also influence where companies choose to list their shares. The UK stock market has been shrinking at its fastest pace in a decade, with the number of listed companies declining from 3,250 in 2007 to fewer than 1,800 today.

There is not just a drain to different jurisdictions, but also to private markets. Private markets have a significant advantage because disclose requirements are less onerous. The rewards can be much higher, and top executives may gravitate there. 

Building support

Against this backdrop, how can boards rally shareholder support for executive remuneration? Involving key shareholders from an early stage can help ease the passage of remuneration awards, enabling investors to understand why executive remuneration is structured in a specific way and allowing problems to be aired and debated before it comes to a vote.

Creating strong comparators can help investors understand the competitive landscape, including the US. It is important to be flexible and look at experimental structures. In the US, for example, there tends to be a higher focus on ‘at risk’ pay, with small base salaries – typically 10% of overall pay. International shareholders often express concern that UK remuneration structures don’t encourage entrepreneurialism, but instead are all about risk aversion.

The ‘at risk’ pay is a mix of a short-term bonus and long-term incentive plans. These incentives can be structured in a variety of different ways: restricted stock units, long-term plans, or hybrid plans, for example. Not all will have a performance component. In the US, investors see a robust compensation structure as one that incorporates multiple equity award types.

It is important to communicate effectively on how remuneration links to targets. This will help investors judge executive pay awards against performance over the longer-term and hold boards to account. These targets need to be appropriate for the industry and a company’s growth ambitions. It is not one-size fits all: three-year targets may not work in fast-growing industries, for example. There are also questions over the appropriate remuneration structure for NEDs, who are often paid in cash and not necessarily aligned with the board and shareholders.

UK companies have undoubtedly got better at drawing in multiple stakeholders, but it is still a work in progress. There needs to be a stronger understanding between boards and investors over executive pay to avoid a bleeding of talent from UK listed companies to the US and private equity. This could be a factor in reversing the tide of the UK’s shrinking stock market.