Guidelines to halt big bucks for failure

Does he deserve it? Should he be paid more? Are other people making him look good and should he really be rewarded so well when the share price is tanking?

Big rewards are commonplace. There are businessmen around earning unprecedented salaries, bonuses and share options. But what is making everybody nervous are the huge severence packages ladled out to executives when they are forced out following poor performance.

The issue has been around for awhile, but it now appears to be reaching some kind of a climax. Small investors have always been jumpy about it, but now the big institutional players have made it plain that the big payments have offended them, too. The government thinks the whole thing is such an embarrassment that a Whitehall consultation is under way.

Such attention from central government has put an uncomfortable public glare on high-profile figures, such as Sir Christopher Gent at Vodafone, who received a £6.5m bonus for taking over Mannesman even though the deal reduced shareholder value. And GlaxoSmithKline’s Jean-Pierre Garnier caused consternation among shareholders when the company arranged a ‘reward for failure’ package that would turn him into a multi-millionaire should he cock things up.

However, last week came the first formal signs that business believes the problem has to be addressed with measures that go further than claiming that the ‘market’ is the best determinant of pay levels.

Indeed, the Confederation of British Industry put its head above the parapet and revealed six key guidelines developed with the express intention of allowing businesses to sidestep the furore that often follows the departure of a chief executive with the aid of a golden parachute.

Whether we like it or not, it now appears that ‘guidelines’ will be the strongest measure UK plc sees to deal with failed executives walking away with extravagant severence deals. Signs are that government will hardly want to legislate.

Business, in the form of the CBI, has been keen to show that it can keep its own house in order. Director general Digby Jones launched the six guidelines last week by emphatically stating that the CBI is ‘unequivocally against rewards for failure’.

‘There have been a small number of well-publicised cases where severance arrangements have given the wrong signals. It is vital that the business community works hard in every way at polishing its reputation with the wider community,’ he said.

The six guidelines

Firstly, the CBI wants contractual terms between executives and a company made available to shareholders as soon as they are agreed – not left until the next annual report. He wants severance arrangements made available just as early.

Secondly, the CBI wants the language of employment contracts cleaned up so everyone, including the shareholders, understands what it means.

Next the CBI advises that payments made under share or equity-based incentive plans should not be offered as part of an executive’s departure arrangements.

This could be quite a blow given that share-based offerings are a cheap way for companies to offer executives big bucks. The CBI also advises that attempts to enhance pension payments, outside the contractually agreed arrangements, should only be given the go ahead with shareholder approval.

Power to the little man!

Then it gets a little vague. The CBI says directors should have contracts that only last a year, in normal circumstances, but that longer deals can be struck if the circumstances dictate. Critics will argue that this is neither one thing nor the other, and will open the way for boards to make whatever arrangements they please.

Criticism is bound to intensify with the fifth guideline, which advises that – though exceptional terms may be offered for a couple of years – they must be brought in line with other board members.

Lastly, the CBI advises that a proportion of remuneration be offered in shares to be held for three years.

The CBI openly concedes that its advice will be viewed as too soft by some and going too far by others. You can’t win, it seems, but the CBI did garner an important ally this week – the Association of British Insurers.

Representing some of the country’s biggest institutional investors, the ABI says the CBI’s guidelines are a sign of ‘growing consensus’. It must be relieved because, together with the National Association of Pension Funds, the ABI first published guidelines in December of last year.

More importantly, it will be happy to see the CBI moving to address the problem because a business sector moving to engage with the issue is less likely to provoke legislation from government – an outcome the ABI is dead against.

The need to avoid legislation is also probably behind the ABI imploring companies to adopt the CBI’s guidelines, because they would ‘make a considerable contribution to addressing the problem’.

The ABI believes that some businesses have moved to deal with the issue.

It notes that BP has been working on ‘phased’ severance packages, while Lloyds TSB has said it will consider what changes could be made.

Scottish Power has reduced the notice period for its chief executive from two years to one. His lump sum payment part of his severance package will only cover six months, while the rest will come in installments only if he fails to find a new post within nine months of leaving. Admirable stuff, but will moves like this see off further government regulation?

Patricia Hewitt, the trade secretary, is keen to see pay linked to performance while encouraging big rewards for those who succeed. As the consultation closed on Tuesday, she would have already seen that business might just be allowed to sort itself out.