UKSA education - Directors

Governance
Directors run corporations. They are elected by the shareholders. The terms of their election (majority vote required, eligibility for re-election, period before re-election, circumstances for removal) are set by each corporation's Articles. These are the rules that govern the way a company does business. Articles are approved by shareholders within a framework laid down by Law.

....but directors' remuneration is different
'Remuneration' is the word that covers the wide range of avenues through which directors can become better off: pay, deferred pay, bonuses, share options, share grants, pension rights, benefits. For a public company these items (and the other terms of a director's contract such as his severance terms) are set by a Remuneration Committee of independent directors of the company. 'Independent' means 'non-executive' and without other potentials for bias.

The Remuneration Committee publishes a Report giving full details of directors' remuneration. Shareholders may vote on this report but the results of the vote are non-binding. So in effect directors' remuneration is set by other directors.

Consequences
Company directors are as conscientious, honest and public-spirited as any other group bound together by a common occupation. But the consequences of this arrangement are both obvious and predictable: remuneration-creep. Increase in directors' remuneration has outstripped the increase in average earnings by many percentage points annually for at least 25 years. So long as these remuneration setting arrangments continue, so will the directors' pay explosion.

It's not the high profile cases that matter so much: it's the many cases of 'average' that are paid 'well-above-average'. A second-rate finance director of a second-rate company would consider himself poorly rewarded if he did not get more than the Prime Minister as basic, with bonuses and options on top. That cannot be healthy, can it?

The pay explosion trickles down
Senior managers are paid by directors. The expectations of senior managers are coloured by the remuneration levels on the next rung of the ladder. And the remuneration of directors is validated by the pay of those on the rung below them. So senior managers benefit from remuneration-creep.

Middle managers are paid by senior managers . The expectations of middle managers are coloured by the remuneration levels on the next rung of the ladder. And the remuneration of senior managers is validated by the pay of those on the rung below them. So middle managers benefit from remuneration-creep.

Junior managers are paid by………..Well, you get the picture.

....and a special cheer for share options
Share options are a smoke-and-mirrors way of delivering the large amounts of cash that directors pay themselves. Options appear to reward achievement by being tied to a rising share price. In fact they reward share price volatility. To understand this, look at the many companies where the share price now is at much the same level it was 10 or 15 years ago but the managers have made large amounts of money from the excitements in between. Or look at performance fees where the same mechanism works in a different context.

If you don't believe us, believe Warren Buffet, the legendary American investor: "Stock options are a fraud on the investor"

.........and the lesson for investors is....
Left to itself this mechanism will undermine the market for company shares. That is too serious to be allowed to happen, so it won't. But it's not at all clear how this drama will play out, whether by legislated constraint or the invention of new investment vehicles that protect against these excesses.

For now, just be aware that directors and employees have a claim on the wealth of their corporations in priority to those of the shareholders. not legally, but practically - over the long term. So do not put your life savings where you think this claim might be abused.