The government has called on pension funds and other shareholders to keep 'fat cat' executive salaries in check in its recently announced remuneration voting reform plans.

That thrusts pension trustees into the unlikely role of referees of one of the most controversial issues of 21st century capitalism; the spiralling pay packages of business leaders in comparison to the average worker. 

Whether pension funds are ready to perform that role is however, highly debatable.

Crux of the matter

Introducing binding shareholder votes on bosses' pay are one of the key proposals that will hand much more power to pension funds.

The idea goes that pension funds and other shareholders would force companies to abandon excessive pay awards as the extra cash would give more of a boost to the value of their investments if the money stayed within the company.

That's all well in theory, but many argue that pension fund trustees are a hesitant bunch on these issues and not suited to becoming critical authority figures on such a vital point of the economic system.

Christine Berry of campaign group FairPensions has warned that giving new powers to investors is not a solution in itself, "when we know shareholders often do not use the powers they already have."

Dr. Roger Barker, head of corporate governance at the Institute of Directors told Pension Funds Insider that pension funds require a "change of mindset" to make the remuneration voting plans a success.

In particular, he was critical of pension funds which came out against making votes on executive pay reports binding, before the government proposed this.

Barker said: "That is an unhelpful attitude. It would be nice to be arm's length shareholders in the companies that you are involved in but without effective engagement a big governance vacuum exists in the system."

The National Association of Pension Funds welcomed the proposals, and encourages its members to engage actively as shareholders through initiatives such as the Stewardship Code.

Nonetheless, the body's most recent survey on the subject found that just 12% of pension funds engage directly with the companies they invest in, 7% say their engagement is neither direct nor indirect, while 3% of pension funds simply answered 'don't know'.

These results reinforce a picture of a few, typically large public sector pension funds, being in the vanguard of shareholder engagement and the vast majority taking a back seat. This majority of funds allow their asset managers to carry out their shareholder refereeing duties on their behalf.

Stacking the odds

Some asset managers are very dedicated to effective engagement. The Co-Operative Asset Management, for instance, voted against remuneration reports or abstained 57% of the time they acted in the companies they were investing in throughout 2009 - the last year for which they have reported.

The firm, which recently was appointed as leader of new government-backed scheme NEST's shareholder engagement, follows established practice by choosing to abstain rather than issue a vote against management "in the first interest, and when an issue is not considered fundamental".

The difference between abstention and actually voting against a company makes little difference under the current advisory status of executive pay votes.

However, should the proposal make votes binding, with 75% of shareholders needing to pass a remuneration report for it to be adopted, the difference between abstentions and votes against could become a crucial one.

Counting abstentions in the group of shareholders needing to approve a report by 75% would have seen 67 FTSE 100 firms lose executive pay votes since 2003, according to proxy voting experts Manifest. Disregarding abstentions altogether would, on the other hand, have seen just three FTSE 100 companies have their executive pay plans overturned over the same period.

Barker told Pension Funds Insider that focusing too much on the small print misses the point though in his view. He said: "It would be easier to keep the usual threshold for company decisions of 50 plus one percent but encourage institutional investors to engage more actively and in an informed way." 

This again raises the question of why pension funds are seemingly so hesitant to influence the companies they invest in.

To be continued

A worrying absence on these shores is the kind of highly active funds that North America is home to. Some of these publish detailed voting intentions on their web pages and fly across oceans to make that voice heard

Forcing pension funds and their asset managers to reveal their AGM voting records was not included in the government's executive pay proposals. This fact has disappointed those  who saw it as a way to politely cajole pension funds into better engagement.

The Co-Operative's Niall O'Shea, head of responsible investing, said that "we were somewhat surprised that mandatory disclosure of voting records for asset owners was not one of the recommendations that the government made."

"We think the government has ceded to the voice of the city on this", O'Shea added.

Roger Barker is critical too of pension funds which hide their voting records, saying that "it is ironic that institutional shareholders should push very hard at times for companies to be transparent as possible yet vigorously oppose plans to reveal their own voting actions."

Phineas Glover, corporate governance analyst at the Co-Operative describes efforts to reach out to pension funds on corporate engagement as "a long process of winning hearts and minds".

Glover told Pension Funds Insider that some items of the government's executive pay plans should make it easier for pension funds to become active shareholders.

"Remuneration reports have been very complex and difficult to digest for a long time," he said. "These plans should give a much clearer picture on the links between pay and performance, which should help pension funds to distinguish good and bad practice."

However, in a further nod to pension funds' meekness, Glover's colleague Ian Jones (head of responsible investing) said granting a binding vote on executive pay could paradoxically make trustees even more wary of opposing a company's board.

Jones said: "The more consequences that a shareholder vote carries, the more cautious shareholders will be in opposing a company."

The Co-Operative team are hoping that the Kay review on short-termism in the UK equity market, whose preliminary results are due in March, might give pension funds further prompting to engage.

Saving face

Those who work in the corporate governance sector reckon that pension funds could find themselves in the firing line if they don't begin to ask more of companies on matters such as executive pay.

Barker warned that regulation could follow should trustees disappoint in their new role as corporate referees.

He told Pension Funds Insider: "Pension fund trustees and other institutional shareholders are the appropriate people to hold boards and executives to account and if they don't do that because of a lack of resources or willingness then the inevitable outcome is going to be direct government regulation. This is a very undesirable outcome but we have seen it happen in the US when shareholders fail to hold companies to account."

Jones agrees, saying: "If shareholders run scared of opposing outrageous pay packages then they themselves will have to face the consequences and the reputation of stewards will sink even further."

Of course, it is worth pointing out that the existing voting rules have been used effectively on several occasions by pension funds to force a company to keep executive pay in check.

At the end of January, Cairn Energy scrapped a plan to award chairman Sir Bill Gammell a £2.5m bonus after it became clear that institutional shareholders and asset managers were going to oppose it.

And who could forget the 2003 rebellion against GlaxoSmithKline when pension funds forced the pharma giant to cancel a planned £22m 'golden farewell' to its chief executive?

At a time when many pension funds struggle with record deficit figures and the gap between executive and ordinary pay has widened substantially, it seems wider public opinion will firmly hope that pension funds can score more of these successes in the years to come.

As Barker says: "It will be an uphill struggle but there will be no choice but to make this happen."

dbillingham@wilmington.co.uk