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The COVID-19 pandemic is resulting in an economic crisis mired in uncertainty. Industry and governments have been forced to react to previously unseen and almost unimaginable threats to the global economy.
After all, how many companies had ‘global pandemic’ listed as a principal risk in 2019? The severe impact of the pandemic on jobs has further heightened investor and public scrutiny of executive pay levels.
We’ve tracked the actions of the UK’s top 350 companies, and analysed how these compare with the reaction to the global financial crisis.
Key takeaway: Boards are more willing to accept that cutting executive pay may sometimes be necessary – something rarely seen as acceptable in the past. We hope this signals a move towards fairer and more performance-driven pay levels.
COVID-19 and the 2008 global financial crisis
In the UK and many other countries, governments have stepped in to pay employees, reducing the short-term need for redundancies. Such job support schemes have been widely embraced by industry and represent an unparalleled intervention by government into the labour market.
Thinking back a decade to May 2010, as the global financial crisis (GFC) continued to bite, we saw the reduction of the UK debt rating and the bailout of Greece. Comparing this crisis with the COVID-19 pandemic, significant similarities and differences exist. One of the starkest similarities is the pain felt through the economy – albeit the shutdown of whole industries this year is unprecedented and has resulted in furloughed staff, pay freezes or reductions, and redundancies, with more on the way.
From a corporate governance perspective, a significant difference with the GFC is how remuneration committees and executives have reacted by adjusting their pay arrangements. The GFC saw a large number of companies around the world freeze pay and limit incentive payouts. Very few companies outside the banking sector, however, actually reduced pay at executive or senior management levels. There were exceptions: Ireland did see significant reductions to executive pay, but in the UK payouts largely remained flat. During the current crisis, we have seen a significant number of companies cut executive and senior management pay levels. Whilst these cuts are of a temporary nature aligning with the rest of the workforce that have been furloughed or let go, the change of approach in comparison to the GFC is notable.
Opening the door to opportunities
The level of executive pay over the past 30 years has grown exponentially. What has also increased significantly is the focus on executive pay levels in the context of the wider workforce. CEO pay ratios are now widely published (for example in the UK and US) and the level of stakeholder scrutiny of these figures has increased. Negative publicity is not only widely viewed and acted upon by customers, but also employees and others related to the business.
Since the GFC, the role and responsibilities of a remuneration committee in the UK have become deeper. Committees are now required to demonstrate that executive pay outcomes are fair and that they have taken serious account of wider workforce pay and conditions when setting directors’pay. Moreover, society as a whole expects directors to understand the wider workforce and be clear on how pay links to corporate culture.
The focus on pay, along with other topics such as corporate tax and the treatment of employees during this crisis, will continue through the subsequent economic fallout.
Within days of lockdown beginning, as the potential labour force impacts became apparent, industry bodies and investors began releasing guidance proposing that companies should be ‘sharing the pain’ at executive level. This did not fall on deaf ears. Soon after lockdown, many companies began to announce pay cuts to senior management as part of the drive to preserve cash. Many of the cuts were management-led, which shows particularly strong empathy for the wider workforce.
UK companies respond to the pressure
Following the GFC, shareholders in the UK were given a forward-looking remuneration policy vote that takes place for each company at least every three years. The first of these votes generally took place in 2014. Given the triennial nature of the policy, 2020 was set to be an important year, with the majority of UK companies needing to renew shareholder approval.
As a result of the pressures on executive pay as the pandemic hit, we witnessed companies deferring any proposed increase to pay for at least a year. A common practice seen was to defer implementation of any pay rises until more certainty returns to the economy. This approach is justified given the potential reputational impact of executive pay increasing whilst employees may be furloughed.
Additionally, companies have also been under significant pressure in recent years to reduce the levels of pension contribution received by senior management, in order to bring them in line with those received by the rest of the workforce.
Important changes we have seen this year:
- A majority of companies reducing pension contributions for new executives formally in the remuneration policy – changes that on the whole were planned well before the pandemic struck
- Many have also implemented actual decreases in pension contributions to serving directors, while a decade ago a cut to an individual director’s pay package was almost unimaginable
This has been a great example of investors and industry bodies all giving a clear message on a topic and companies responding.
- A majority of companies reducing pension contributions for new executives formally in the remuneration policy – changes that on the whole were planned well before the pandemic struck
- Many have also implemented actual decreases in pension contributions to serving directors, while a decade ago a cut to an individual director’s pay package was almost unimaginable
This has been a great example of investors and industry bodies all giving a clear message on a topic and companies responding.
Banks cut pay as dividends take a hit
Given the impact of COVID-19 on the real economy, regulators acted to preserve healthy balance sheets in key industries. The government also asked UK banks to suspend dividend payments for 2019. Elsewhere in Europe:
- The European Central Bank issued guidance for banks not to pay dividends for financial years 2019 and 2020 until at least 1 January 2021.
- The Swiss Financial Market Authority FINMA urged Swiss-domiciled companies to drop dividend proposals. These moves were intended to boost banks’ capacity to absorb losses and to support lending.
In this context, it was encouraging – and unprecedented – to see a large number of major banks announcing various actions to reduce executive pay, including salary cuts, cuts or waiving of bonuses, or agreements to postpone planned compensation increases. Announced pay reductions by some major banks are set out below, although so far many of the commitments have been in form of charitable contributors volunteered by top management. Given dividend cuts, we expect the remuneration committees of banks to clearly communicate with investors their approach for reflecting the impact of COVID-19 in executive pay for 2020. Boards will need to take into account not only the impact on investors but also on staff in the new economic environment, including where layoffs may have been planned pre-coronavirus.
Final thoughts
Executive pay levels continue to receive media and public attention year after year. The huge increases in pay seen over the past 30 years have not reflected corresponding improvements in market or economic performance, and have become increasingly hard to justify.
However, comparing and contrasting two economic crisis – the global financial crisis in 2008-2010 and the more recent COVID-19 pandemic and subsequent lockdown – we are able to see a notable change of tack between how Boards responded in terms of executive pay.
With payouts running into several million pounds per year for many CEOs, there is clearly a long way to go before a level of pay is reached that society considers fair. However, the fact that a third of companies reduced pay in the lockdown shows significant shift and an improvement when compared to the GFC. The reasonably widespread response to the lockdown, coupled with the reductions in pension contribution also seen in recent years may not be the end of the journey for investors who wish to see executive incentives structured to drive sustainable long-term value creation. It may, however, be the start of an era where remuneration committees feel more comfortable with reducing salary levels if performance is hit. We may also be seeing the first benefits of the remuneration committee being formally required to account of wider workforce pay and conditions.
Certainly, the role of investors has never been as important in delivering a clear message to Boards on pay as it is today. We will continue to engage companies to ensure pay is fair and appropriate in the circumstances. Whilst the current circumstances are, we hope, time-limited, we can try and use this year and the temporary reductions seen as a catalyst for longer-term change.
Disclosures
Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.
