Amy Wilson (EOS): 'Simplify Pay Structures'
‘We provide a platform for like-minded investors to pool their resources, so we can create a more powerful force for change,’ Amy Wilson says. EOS’ stewardship is focused on improving long-term financial returns on investment as well as fostering better, more sustainable outcomes for society and the environment – an approach EOS refers to as holistic returns. It acts on behalf of a collective of long-term global investors, which entrusts it with approximately €1.4 trillion, invested in over 10,000 listed equity and corporate debt holdings around the world.
Wilson is in conversation with Frederic Barge, founder of the non-profit research initiative Reward Value. His organization campaigns for a change in remuneration practices in executive pay, arguing that current compensation practices no longer fit the societal context in which companies operate and aiming to achieve a shift in favor of sustainable, long-term results over short-term profits. Recent research by Reward Value has shown that a company’s remuneration model strongly determines the extent to which it invests in sustainable production and R&D and aims for long-term results. Additionally, investor sentiment has a strong role to play in influencing executive behavior. ‘We found that the impact of shareholder positioning is even more significant than the remuneration policy itself,’ says Barge, ‘and obviously, the two combined give you the best outcome.’ Wilson is part of Reward Value’s advisory council.
How do you try to achieve change on behalf of your investors?
‘A crucial part is active stewardship of the businesses held by our clients. We engage with investee companies all year round on ESG issues as well as financial and strategic issues. And we also advise our clients how to vote at shareholder meetings, which we see very much as part of those ongoing engagements. As well as dealing directly with corporates, we advocate for changes in the public policy space, and we look to influence the investment landscape, to promote more long-termism and encourage everyone to take more account of the concept of holistic returns.’
If you see investors as gatekeepers of sound corporate governance, what is your opinion on voting policies?
‘Voting is a very important responsibility and right for shareholders to express their views on how companies are being governed. We do recognize, however, that voting can be limited in focus. It can be quite binary on some very nuanced issues. So it is not perfect. That is why we put so much emphasis on wider engagement and stewardship year-round.
Our vote policies address all the major governance issues that you would expect: board composition, executive incentivization, and audits – all those fundamental topics. We have also started to introduce some proactive vote policies that look at two areas so far: climate change and human rights.
We see voting as a means of ensuring minimum standards; it is not necessarily where we push for best practice. We think that ongoing engagement is better suited to that. When we look at climate change, for instance, we do a detailed analysis and identify companies that are materially misaligned with the goals of the Paris Agreement, such as a company scoring zero out of 100 on the Forest 500 assessment. We may well advocate with companies to go far beyond that in our engagement, but when it comes to voting, we set those minimums.
Comparing the US and Europe, and even within Europe, there are, of course, differences on particular topics. We try to maintain a healthy tension between pushing for global good practice, but also recognizing the context. An issue like executive pay is inevitably extremely localized, because executives live and work in a particular country, with particular tax conditions and particular social norms around pay. So we are trying to strike a balance. We also recognize that there are differing opinions on how best to do these things. And that applies to many issues: there is no perfect model. There are lots of different opinions.’
According to Federated Hermes’ principles, remuneration practices are seen as key to aligning the activities of management with the company’s purpose, strategy and performance. The experiment we did at Reward Value also showed that a company’s remuneration model and the positioning of shareholders can have a strong influence. How relevant is research such as this for you as an investor?
‘Very relevant. Firstly, relating to the impact of investor sentiment, it confirms what we would hope: that investors have a very important role to play in encouraging boards and executive teams to take a long-term view. Secondly, the research confirms the fundamentally important role that incentives play.
The way that you set people up to perform and then reward what they have done will have an influence on how they behave. We have concerns about pay design where a very large portion of pay is put into incentive schemes. If someone is heavily incentivized to hit a set of numbers, it introduces a huge amount of risk and unintended consequences. The bigger the emphasis is on incentives, the more they will be driven to hit those numbers, regardless of whether it is the right thing for long-term, sustainable success of the business. We would rather move away from a heavy emphasis on incentive schemes, and towards much simpler pay schemes that are focused on long-term share ownership, plus a very robust strategy with KPIs that directly link back to the firm’s purpose.
Of course, we have to take a company-by-company view, and pay structures are very often not perfect. Sometimes we have to take a pragmatic view – is something better, is it on a positive trajectory, is it reasonable, if not ideal?’
Remuneration is still creating a lot of controversy, certainly in the times we are in now. I am keen to understand how you believe those issues can be tackled. There is an element of excessive unfairness, where bonuses are sometimes extremely high. We have seen cases where bonuses reached hundreds of millions. The amounts sometimes stagger and surprise us all.
‘The issue of quantum is, as you say, the lightning-rod issue in terms of public opinion, and rightly so. It becomes a surprisingly difficult debate to have. Because there is the question of, well, how much is too much? How much is the right amount to pay an executive? We also have market forces at work, and we have the unintended consequences of transparency pay reporting, which is intended to enable investors to have a say on pay. In Europe and especially in the UK, we have exceptional transparency on what executives are paid and how. But of course, that, unfortunately, contributes to ratcheting of pay everywhere, because then everyone compares their pay to everybody else’s, and gradually, everything moves up and up and up.
It is somewhat easier for us to take a step back and say, at system level, this pay is all too high, but an individual board trying to recruit a new chief executive, or retain talented executives, can’t necessarily afford the luxury of having that philosophical argument. They are in a situation where they are having to attract and retain people.
Nonetheless, quite a lot of executive pay is higher than it should be. And because we have designed such complex approaches to pay, labelled as pay for performance and incentive schemes, certain levels of pay have become hard to challenge. Some of it is also driven by local norms. We have huge problems with executive pay in the US – in our view, it is systemically broken. But a lot of that is rooted in the social and political context of the US. And we don’t control those levers.
To try to decide how much is too much, we look at various structural angles, like the differential between executive pay and workforce pay, the ratio between the CEO and other executives, and how pay is looking across peer groups.’
In engagement, do you see whether companies could actually simplify those structures?
‘In our engagement discussions, we often find that boards and even executives agree with a lot of the principles that we have. There is support for moving to simpler schemes, more focus on the long term and more fixed salary, higher shareholdings. But we find that in practice, it is difficult. Companies often say that other investors would not agree, and there is some truth in that – there are differing views on the investor base. Of course, we would rather boards act with conviction, and decide what is best in the long-term interests of all their stakeholders – which, in our view, is simplifying pay. But it is a debate that is open.’
Where do you see improvements?
‘There are some very large multinationals, mature players, that have got a lot of experience integrating what is now thought of as ESG metrics into their incentive schemes in a way that we think is authentic. We have mixed views on the whole ESG-and-pay debate, because if ESG metrics have been included in pay but there is nothing that sits below that in terms of a company’s strategy and how its resources are structured, it just becomes a bit of greenwashing, or another way of justifying the level of pay in a slightly more socially acceptable way. It is actually the worst thing for the whole ESG agenda, because it devalues and undermines what we are trying to achieve. So we are very pleased when we see a company that already has all of these things baked very clearly into its strategy.’
One way to look at commitment is to consider where a company’s capex or R&D is going. Is that part of your overall engagement?
‘Yes, absolutely. If you are looking at an oil and gas company, for example, we would not just look at executive pay schemes, we would also look at capex, how the organization is structured, who reports to whom and what is the governance around all of this, to assess the credibility of what we are being told. We have seen some really interesting developments from the oil and gas majors in terms of declaring Net Zero Alliance strategies. We have then looked much more deeply at capex plans and things like accounting assumptions and oil prices to try and assess if all this adds up. Does it look like the company is actually on track to deliver against this?
There is a challenge in the climate space in particular, in that companies are currently very much focused – possibly too late in some cases – on setting up the right targets and angling businesses in the right direction. But we have yet to see whether they deliver on that. This is not specific to executive incentives, you could say the same about capex: you can invest all the capex in the right places, but does it actually deliver the change that we need to see? When it comes to incentives, if the metrics focus too much on processes and not enough on outcomes, executives could still make a lot of money over the next 10 years from the climate elements of their incentive plans, without actually delivering the real-world outcomes that we need to see in terms of emissions reduction et cetera. This is particularly acute and critical, because the next decade is so crucial to addressing the climate crisis. It has never been more important how those incentive schemes are designed. And clarity is absolutely key. It does involve difficult decisions – we are expecting boards to have to make trade-offs at times. We understand you can’t do everything all at once and we need a sense of prioritization.’
What about say-on-pay and the advisory vote construct? For example, France and Switzerland have replaced advisory votes with more binding votes, and there are comparable developments in the UK and Australia. To what extent does the current setup give investors the influence they need? We have seen quite significant votes against remuneration reports. If there is such a massive vote against, should this not be binding?
‘I would say that the current situation is imperfect, but I can already see unintended consequences of trying to address the issues through these mechanisms rather than through stewardship and boards’ accountability to shareholders. It comes back to the point I made earlier of voting being binary. It is why we believe in our model of ongoing deep engagement with companies year-round. Because the reality is that it comes down to the particular company. For well governed companies with boards that are focused on the long term, clear on their duties, responsive to shareholders, it would not matter whether the vote was advisory or binding. The board would act in the way that we would hope they would act. In the case of companies that are what we would think of as not very well governed, again, it would not really matter whether the vote was advisory or binding, they would find a way of doing what it is they want to do. We have a binding vote on remuneration policies and yet plenty of policies that we disagree with get through, and some boards are not terribly responsive even when a reasonable amount of dissent has been received. So I don’t think the voting mechanism is a silver bullet.
The other factor is local practices. Investors as a whole have a considerable amount of influence on pay in a country like the UK, but much of that is rooted in the wider context of stewardship in the UK and the responsiveness of boards to shareholders. In a country like the US, we have less influence and say-on-pay votes are more readily disregarded by boards. So it depends on the context. I think the mechanism of the vote being advisory or binding is not the only or perhaps even the most important factor.’
How do you approach your role of representing the ultimate beneficiaries at Federated Hermes?
‘We are very clear that we are acting ultimately on behalf of the end beneficiary, which, in our case, is primarily a pension beneficiary. It comes back to the concept of holistic returns: there is no point in us making a financial return for this person if there is no stable society for them to live in and the natural environment can’t support a healthy, stable life for them and their loved ones. So we keep the beneficiary very much in mind when we are thinking about the right thing to do.’
That’s music to my ears.
‘Speaking personally, it is a great privilege to work for a firm that takes this so seriously. It is not easy, I will say. It is rare that there is an obvious right answer. We have to weigh things up very carefully. We try to strike the right balance, always coming back to these guiding principles about beneficiaries and holistic returns. But yes, it is certainly a complex world, boards have a very complicated job to do, as do executives. And ultimately, we try to be thoughtful and responsive, and careful in our considerations.’
This article was published in Management Scope 07 2022.
This article was last changed on 31-08-2022