Business, Energy and Industrial Strategy Committee 

Oral evidence: Corporate Governance, HC 702

Tuesday 24 January 2017

Ordered by the House of Commons to be published on 24 January 2017.

Watch the meeting 

Members present: Mr Iain Wright (Chair); Richard Fuller; Peter Kyle; Amanda Milling; Michelle Thomson.

Questions 372 – 442

Witnesses

I: Baroness Sarah Hogg, Lead Independent Director, HM Treasury, Chairman of the Audit Committee, John Lewis plc, and non-executive director, Financial Conduct Authority; Tom Gosling, Partner, PwC; and Simon Fraser, Chair, Investor Forum.

II: Ken Olisa, Deputy Chairman, Institute of Directors, Chairman of Independent Audit, Chairman of the Shaw Trust, President of Thames Reach, and non-executive director, Thomson Reuter; Andrew Ninian, Director, Corporate Governance and Engagement, Investment Association; and Sir Philip Hampton, Chair, Hampton-Alexander Review.

Written evidence is on the committee’s website.

Examination of witnesses

Witnesses: Baroness Hogg, Tom Gosling and Simon Fraser.

Q372       Chair: Good morning.  Thank you for coming to the Select Committee.  I am afraid that we are slightly depleted this morning, because there is a debate in Westminster Hall led by Chris White, one of our colleagues, on the midlands engine, and several of our colleagues are participating in that.  Apologies.  Can we begin?  For the purposes of the record, do you mind telling us who you are and which organisation you are representing?

Tom Gosling: I am Tom Gosling.  I lead PwC’s remuneration advisory practice, working with FTSE 100 and large European remuneration committees.  I am also on a steering group of the Purposeful Company task force, which is a cross-industry body looking at long-termism in the UK.

Baroness Hogg: I am Sarah Hogg.  I see my label says HM Treasury, and that is because I am the lead independent director on the Treasury board.  I hasten to say that I am not speaking on behalf of the Treasury.  This is a long list of denials of the other organisations I am currently associated with.  I am an independent director of the FCA and also, perhaps of interest to this Committee, of John Lewis Partnership, which has a very interesting governance model.  I am also on the Takeover Panel, and I have promised all of them I will say I am not speaking on their behalf.

Simon Fraser: I am Simon Fraser, chairman of the Investor Forum, which is what I am here today to represent.  We can perhaps go into it in more detail later, but the Investor Forum was set up two years ago to help facilitate a better dialogue between boards and their shareholders.

Q373       Chair: Baroness Hogg, do shareholders care about corporate governance?

Baroness Hogg: It is a curate’s egg: some do and some do not.  One of the difficulties is getting the debate out to the ultimate shareholders: the people who give the mandates.  Of course, the people who give the mandates are already intermediaries to the investment management houses, because if the chain of care does not go the whole way back then it will be at best a slightly hypocritical commitment to caring.

Q374       Chair: Simon, what is your view on this?  You have talked about the formation of the Investor Forum as a means of trying to have better shareholder engagement.  Is there a problem here?

Simon Fraser: We think investors do take their stewardship responsibilities seriously.  There are issues, and we can perhaps go into them later, depending on the types of investors.  We think the seriousness of their involvement is evidenced by their support of the forum.  33 institutional members holding 35% of the UK market, which is about £700 billion worth of assets, have signed up in the last six to eight months to join the Investor Forum.  This represents a new activity, of course, on top of many years of investment in institutional shareholder engagement.  The mere fact that we exist is an indication that they take their responsibilities seriously.

Q375       Chair: You say that, but one of the reasons we are looking at corporate governance at the moment is that we have been dealing with a couple of scandals in corporate life.  They can be linked with weaknesses in corporate governance.  One of those companies was Sports Direct.  By all accounts, some of the corporate governance failings in Sports Direct were known for an awfully long time, but investors and shareholders turned a blind eye to that because of high profits.  I put back the question.  If there are profits being made and things are happening that are seen as positive in terms of returns, shareholders really do not care about corporate governance and things contained within it, such as board diversity, executive pay and performance of non-exec directors.  Is that fair?

Simon Fraser: I do not think that is the full story.  The reason we were set up was to try to put governance firmly back into the investment decision-making process.  Good governance of a company, along with good fundamentals and good business practice, ultimately leads to the creation of value or the avoidance of loss of value.  Our job is to make sure that those two things are absolutely joined up.

Without wanting to spend the whole debate on Sports Direct, shareholders were very heavily involved in the governance issues at Sports Direct from the very earliest case.  We have been involved only in the last couple of years.  It is an exceptional case, because, ultimately, shareholders do not have the power to change things at Sports Direct, given that the independent shareholders have less than 50% of the overall vote.  That is probably an exceptional case within the premium listed companies in the UK.

Q376       Chair: Baroness Hogg, we have had the concept of shareholder primacy for many years in this country.  To what extent is that still applicable?  To what extent should good, effective corporate governance be taking into account other stakeholders: employees, customers, suppliers and the wider company?  What is your view on this?

Baroness Hogg: I do not see them as being in conflict.  The critical point to which Simon was I think alluding is that corporate governance is not a nice-to-have add-on that society might like; it is critical to the sustainability and effective performance of a company.  When I was chairman of the Financial Reporting Council, I used to like going to see investment managers—and in particular stock selectors, who are the key to this; they are the ones who take the buy and sell decisions—and saying, “What protections do you think you have against being told a great story by a smooth‑talking CEO?” 

Fundamentally, I believe that the protections are a strong board and clear reporting at the end of the year, signed off, one hopes, by good professionals.  Those are the two guardians of the system, and one underrates those at one’s peril.  Therefore, it is not just a nice-to-have; it is essential to the performance of the company over the medium-term.

Q377       Chair: Do you think shareholders are exercising their responsibilities as well as they could be, and to the extent that they could be, on things like executive pay and performance of directors?  We have been told that re‑elections of directors are on something like North Korean levels.  Not all directors are performing well, so why are we not seeing a little more challenge and scrutiny there?

Baroness Hogg: It varies.  They are showing much more interest in the performance of directors and the selection of directors, which is a key moment.  When I was chairman of the Financial Reporting Council, we introduced into the corporate governance code a presumption that all directors of FTSE 100 companies at least, and probably further down, should be put up for election every year.  That was because a number of investment management houses said to us that directors were not listening if they were not up for election that year.

Although at first there was a good deal of resistance to this thought, annual election did go through, and most companies apply it.  You may say it looks a little North Korean, but, for the director concerned, that election is an important moment. I always think that AGMs and those votes are rather like a vote in this august room.  I am going to use the parallel: they are rather like Prime Minister’s questions; the event may look a bit of a farce, but the preparation that people have to do for it is really, really good for them.

Q378       Chair: My final question before I open it up is about reporting.  I am very interested in your view, Baroness Hogg, and your view, Simon, in terms of whether we have to amend the reporting requirement and the role of the annual report to improve corporate governance.  I was particularly interested that the Investor Forum annual review says, “Reporting is struggling to keep pace with the changing shape of business and seems unable to cater for the rise in the importance of a wider stakeholder group”.  What needs to change?

Baroness Hogg: There was one important change, which was when the words were introduced to the code that the report as a whole should be fair, balanced and understandable.  You may think those are three rather basic words, but it was amazing, in my view, how many reports were not very fair, were not very balanced and were deeply un-understandable.

I would like to see an extension of the Financial Reporting Council, and in particular the Financial Reporting Review Panel’s work, in terms of reviewing annual reports from just the numbers at the back of book compared to the report as a whole.  There would then be more detailed scrutiny of individual reports to illuminate best practice and worst practice.  That would be an extension of the role that would be valuable.

Simon Fraser: There is plenty of evidence of companies reporting well.  The specific quote you referred to was to do with the intangibles in companies, and more modern companies not having as much in fixed assets versus intangible assets.  On the subject of the reporting of governance, the best companies out there do work for all their stakeholders, because that is ultimately how they succeed: for their customers, their employees and their shareholders.

Many of them report that in their report and accounts, but joining it all up could be done more effectively so that everybody can see why one is dependent on the other and that it is not just a nice-to-have.  A fuller explanation of how the board is fulfilling its responsibilities in all these areas, in order to drive the strategy of the business, is something that we continue to encourage boards to look at.

Q379       Richard Fuller: I would like to welcome you all as well.  I will open with a broader question about shareholders.  What is the accountability of shareholders when things go wrong in the companies in which they invest?

Baroness Hogg: Do you mean the intermediate shareholders, the investment management houses, the people who have the mandates rather than the ultimate shareholders?  Do you go right down the chain to the pension fund—the beneficial owner—or to the people who are exercising the decision to buy and sell?

Q380       Richard Fuller: I would be interested in your thoughts on both of those.  There are three staging posts with various individuals.  We have the board of directors; we have the intermediary; and then we have ourselves.  Perhaps you could answer: what is the accountability of each of those when things go wrong in the companies in which investment has been made?

Tom Gosling: It is not fully my area of expertise, so I am sure that Baroness Hogg and Simon will have more to say on it.  When something goes wrong in a company, ultimately it is the board’s responsibility, having been appointed by the shareholders.  It is important that we retain the concept that shareholders appoint boards to run companies on their behalf.  There is a danger in us looking to cross the line of shareholders intervening in the day-to-day running of companies, because that runs the danger of infantilising boards, which have to be held independently accountable.  For me, the primary accountability should sit with boards.

Simon Fraser: I would agree with that.  Corporate governance in the UK, in our view, is not broken, but it could work more effectively.  It is a very complex system comprising law, code and best practice.  When it goes wrong, as you have indicated, it is very difficult to know exactly which lever you have to pull.  The problem the shareholders have is that there are limits to how far they can go.

As Tom has explained, they are not insiders; they are not, obviously, responsible for managing the business; they are not privy to any of the management information; they may not have a full picture.  Their only engagement is through the senior management and the board of directors, so boards cannot discharge their responsibilities to shareholders.  When that happens, it is not a pretty sight.  We have seen that in one or two examples we have worked with as well.

Q381       Richard Fuller: Is it fair to say, Simon, given your response, that the accountability of shareholders is limited to two main levers?  First, they can reduce or completely divest their investment; or, secondly, they can exercise their power of authority over the election of directors.

Simon Fraser: There are the other resolutions at the AGM as well.  They can also put a special resolution to the board of directors.  This happens increasingly in the United States, where shareholders will actually put a resolution to the board.

Q382       Richard Fuller: Could you give the Committee some examples of that?  That might be helpful.

Simon Fraser: Shell in particular has had shareholders bring forward resolutions to their AGM, which have then been voted on by all shareholders.  You are broadly correct in how you describe it: they are not able to get involved in doing the job of running the business, hiring and firing the management and paying the management. These are all things that the board is ultimately responsible for.

Baroness Hogg: Sorry, there is more of an engagement than that.  In any major FTSE 100 company, the chairman and the chief executive, preferably separately, will be consulting shareholders throughout the year, and the influence exerted at those points is extremely important.  The interest taken in succession planning, for example, before an actual vote, is an extremely important area of influence.

Of course, it is not always true that shareholders can simply vote and walk away.  If it is an index fund, they have in a sense to take more interest in using the other levers, precisely because their decision on whether to buy or sell has been abdicated by being part of an index fund.  Paradoxically, index funds, I always argue, should take more interest in corporate governance, because they have put aside one of the levers and have now to focus more on the other.

Q383       Richard Fuller: You have talked about a type of investor, and one of the interesting things in the UK is that there has been, since the big bang, quite a significant change in the base of shareholders, a growth of index funds, a very significant reduction in pension funds as a proportion of public listed shareholdings and a very significant increase in international shareholdings.  Tom, do you have any recommendations to the Committee about whether we should be considering that change in the type of investor in terms of how it has affected the work of our corporate boards and how far forward they look?

Tom Gosling: I am not sure it has had an impact on time horizons, because there are long and short-term investors wherever you look in the world.  It has had an impact on where the sources of influence are around investor behaviour.  When the ABI, as was, and the NAPF accounted for half the stock market, it was a lot easier to get a UK perspective on what collective engagement should mean, and to influence that throughout the investor base.  That is much, much more difficult to do now.

The other implication is that, particularly in the area of corporate governance, the role of proxy voting agencies has become more important, with the prevalence of non-UK investors in the UK market.  Systemic changes to how governance is done in the UK from a shareholder engagement perspective need to look at both things like the stewardship code and the good work of the Investor Forum, and the role of proxy voting agencies and how they influence the voting patterns of non-UK investors.  It has become a more complex environment for policymakers in the UK to influence.

Q384       Richard Fuller: Is there any evidence that international investors are any more or less engaged than domestic shareholders?

Baroness Hogg: It depends so much on your shareholder.  The Norwegian sovereign wealth fund, for example, has a set of principles that would be subscribed to by many people in this country in terms of its approach to its investments. It may not engage directly very often with companies, because it has shareholdings in so many companies right across Europe, but its principles are very much in line with long-term UK investors’.

Richard Fuller: So there is no real difference.

Tom Gosling: Most of my interactions are around consulting on pay matters, but my anecdotal experience has been that there is not a systematic difference between how overseas and UK investors think about engagement. However, they certainly care about different things.  Using pay as an example, traditionally, US investors have had very different views from UK investors.

Richard Fuller: Would you bear that out, Simon?

Simon Fraser: Yes.  This is the very reason that the Investor Forum was created: in order to represent all investors, wherever they come from, and create a more professional platform for all investors to engage collectively with UK companies.  We are already working with international investors; about a third of our assets have come from international investors, and we hope to grow that significantly as we create more of a track record.  I would agree that, while there are differences in types of investors, you cannot assign them to particular geographies.  There are long-term and short-term investors in every jurisdiction.  The most major flow of money is coming from the United States.  The big difference there is the fact that they use proxy agencies in a more formulaic way to vote their shares.

Q385       Richard Fuller: Is that a company like ISS?

Simon Fraser: Yes.  Even though they may be very long-term underlying shareholders, often their proxy work is being outsourced to ISS, which may send a different message.  That is one of the challenges that we hear from companies and chairmen as to how to engage with international investors.

Q386       Richard Fuller: Is that outsourcing a model that you would recommend that UK investors should look at more assertively?  In the past, we used to have brokers who would produce nice company reports and tell us all the ins and outs by doing diligent research.  That had flaws as a model.  Is an ISS or a proxy an equivalent to that, or is it completely different?

Simon Fraser: No.  As I mentioned earlier, we want to see governance being put more firmly into the investment decision-making process.  You can use ISS, because there is a huge volume of work in crawling through all of the annual reports, but it should be used as an advisory model, not as something that is making decisions for you.

Therefore, the good practice we want to see is that the decisions to buy and sell the shares are aligned with the people who are making the votes.  If they are voting against pay, they should not be telling the chairman that they really want that chief executive to stay there because they think he or she is great.  Putting stewardship back into the heart of the investment decision-making process is exactly what we are trying to drive.

Q387       Richard Fuller: With the Chair’s indulgence, I am going to try another area, if I may.  Sorry to carry on.  One of the issues is about the disparity between large public companies and large private companies in terms of their reporting requirements and transparency.  We have seen over the last few years quite a significant transfer of assets from the public sector to the private sector. 

For society as a whole and for employees, if not necessarily for investors, there are potentially issues there.  What are your observations about that transfer?  Why are investors deciding that private may be better than public?  What is the issue for governance, and do you think we ought to be looking at improved reporting and transparency for those larger companies, regardless of whether they are public or private?

Baroness Hogg: I agree with your last point, and a number of steps have been taken in that direction.  To begin with, the code that was developed under Sir David Walker’s guidance for companies owned by private equity investors concerning the degree of public reporting that should be developed by such companies was an important step forward.  That is now nearly a decade ago.  An extension of that to other private companies would be valuable. 

I would argue—and this may simply reflect my history with the FRC—that the model of the corporate governance code, which is not a set of regulations but a comply-or-explain code requiring companies concerned to do things in a certain way or else explain publicly why they are not doing so, is a good model, because the diversity of private companies is even greater than the diversity of public companies.

Q388       Richard Fuller: How would they effect that?  Private companies would not necessarily have public accounts that they would file, other than the short-form accounts at Companies House.

Baroness Hogg: Often they are plcs, still.

Richard Fuller: Yes, that is true.

Baroness Hogg: Their other reporting requirements may be more limited.  Take John Lewis, which is not a quoted company but is a plc; it has bondholders, so it has some public reporting requirements as well.  On the whole, its reporting requirements and its whole aim in reporting are to its shareholders, who are its own employees.  The shares are held in a trust, but it is an employee-ownership model, which is a particularly important challenge when it comes to producing an annual report.  There, “fair, balanced and understandable” is really important to ensure that all your employees can understand this gobbledygook that tends to get put in annual reports.

Q389       Richard Fuller: Before I move on, would you have a—albeit arbitrary—sensible but clear limit below which the company could be exempted from such reporting?

Baroness Hogg: It is always important to have lower limits for any burden of regulation that you introduce over and above company law.  Again, the diversity of smaller companies is even greater, and the last thing you want to do is put barriers in the way of start-ups.  It is bad enough that they have to go and hire accountants and things like that.  They have to do a lot more.

Q390       Richard Fuller: Tom, what are your thoughts on this private/public issue?

Tom Gosling: One of the reasons for the transfer from public to private markets is of course that, over the last couple of decades, there has been the growth of much larger pools of private capital that can be deployed to sustain larger enterprises in the private sphere.  Equally, one hears that people are concerned about some of the restrictions that listed company status implies.  Throughout this, we have to be careful that we are not creating an un-level playing field across different sources of capital in the economy.

Given the increased role that large private companies are playing, there is a case for extension of some of the reporting requirements.  It needs to be looked at quite carefully, because, of course, a lot of the existing reporting requirements have been set up because of the particular issues around separation of ownership and control that you have in publicly listed companies.  I do not think it is a case of lifting it over.

Having said that, I think that responsible private companies see value in reporting that goes beyond the legal minimums.  Baroness Hogg referenced John Lewis, and at PwC we do a lot of reporting that goes beyond what we are legally required to do, because we see value in providing that transparency to stakeholders.  I am sure that some form of broader comply-or-explain requirements could be brought in that would be beneficial.  We have to be realistic about sanctions, because there is not the same sort of sanction as when you have a listed company’s shareholders.

Q391       Richard Fuller: Would you extend that to compensation?

Tom Gosling: You could.  Again, you have to ask why you are doing it.  There is a lesser case for extending it to compensation in private companies, because the main reason for having compensation disclosure in publicly listed companies is that shareholders rightly want to know the incentives that are being put in place and what that means for the agency issues that arise between the shareholders and the executives.  There is a much lesser case for it in private companies.

Q392       Richard Fuller: From a shareholder perspective you may be correct, but from the public’s point of view, they may want to know.

Tom Gosling: They may want to know, but then we have to ask the question: is it beneficial to the business environment for them to know?  Again, there are private companies that voluntarily disclose remuneration information, and they feel that is helpful in creating a climate of trust.  We have to be quite careful that we do not create an environment where the remuneration disclosure issues discourage private investment in the UK.  I am not sure I would make it a mandatory requirement beyond what is there at the moment.

Q393       Richard Fuller: Mr Fraser, would your members welcome an extension in reporting equivalence between publicly listed and private companies?  It might stop the seepage of listed companies into private hands.

Simon Fraser: I am not really an expert on the private sector, but your general point that capital has choices is a very important one, for private versus public, but also for the UK versus other markets.  As I mentioned earlier, one of the reasons that we were set up was to try to demystify how you can collectively engage as a foreign investor.  There are lots of standards and rules, but the US rules also impose some restrictions on how US investors engage with our companies, which we have tried to incorporate in our collective engagement framework, to make it clear and understandable how they engage.

Whatever we do, both for our public and private markets, we are seen as an attractive place to invest.  We need to continue developing and strengthening our governance structures in order to attract capital, not to discourage people from investing here.  Therefore, when we are making these decisions as to how to adjust, alter or legalise some of our governance frameworks, we need to make sure we do not encourage the 55% of the UK market that is owned by foreigners to go and invest in other parts of the world, because they have a choice.

Q394       Chair: I will pass on to Michelle in a moment, but I am going to use my Chair’s prerogative to ask a question.  We are looking at corporate governance, and we are also looking at industrial strategy.   One of the themes that spans those two inquiries, and is seen as a structural weakness in the British economy, is the lack of long-termism; our approach is too short-term, and that could be in terms of the perspectives of shareholders.

What would you think about the idea of different classifications of shares, whether it is in terms of tax treatment or in terms of voting rights? That seems to happen in US tech companies. That might be for different reasons, in terms of maintaining control by the founder.  In terms of trying to help address the long-termism problem, would different classifications of shares help?

Baroness Hogg: I am instinctively wary of creating different classes of shares, because one of the great principles that we have followed in the UK is the equal treatment of shareholders.  This is very important in the takeover process, of course.  The minute you start introducing different classes, you get a number of problems: different treatment of shareholders, arbitrage, distortions.  I absolutely share your concern about the need to encourage and stimulate pools of patient capital, but I do not think dual classes of shares are the way to do it.

Q395       Chair: What would you suggest?  What would help those pools of patient capital?

Baroness Hogg: There has to be a change in the zeitgeist.  I would go back to the ultimate shareholders and say, “It is over the long term that markets work best and that the benefits of equity investment are going to yield the best returns.  Think about allocating your pools of capital in a way that helps you to discover this fact through the use of your own shareholder funds”.  If you try to create close-to-the-end incentives, you will just stimulate arbitration further up the chain.

I would also start with the fundamental principle that our deep equity markets are a huge advantage to us in this country, which is why we have strong private and public markets.  I see the two as complementary.  A lot of private equity investment is made on the presumption that, somewhere down the line, you will be able to float the company and realise the benefit on a deep public market.  Likewise, companies can be taken out of public markets at a particular moment in their development.  It is important when there is a huge restructuring going on not to be subject to the day-to-day massive fluctuation in the share price, but you may ultimately wish to bring it back to the public market. 

Seeing the two as complementary and symbiotic is important.  Ultimately, so far as patient capital is concerned, I would love to see more work done.  It is all about understanding the ultimate shareholder end of its value in terms of return.

Tom Gosling: We need to be very careful to distinguish between shareholders who have a long-term perspective and shareholders who hold shares for a long period of time.  They are not necessarily the same.  One of the features of the UK market is that it is relatively low on what you call blockholders, which would be shareholders who hold large amounts of the company and therefore can really engage with and influence management.

There is evidence showing that blockholders can be beneficial to long‑term value creation.  It is worth us looking at whether we have things in our regulatory structure around, for example, announcement rules when you increase holdings; rules on structured access between shareholders and companies; and whether we have things that have actually disincentivised the building of large blocks.  There might be some work to do there.  Special classes of shares are a way of in effect getting blockholding, and we should be open to looking at that, but recognising that we moved away from special classes of shares for a very good reason: because they can lead to abuses.

Q396       Chair: Tom, I am very interested in the distinction between shareholding—thinking about a company, wanting to own that company and contribute to its strategic direction—and share trading, where, frankly, you may not care about the corporate governance and the long term. Is there anything within corporate governance rules, the code or legislation that could address that?  It is inhibiting the long-term performance of the British economy, is it not?

Tom Gosling: It is very, very difficult to access the motivations of shareholders.  Any sort of regulatory attempt through tax rules or what have you would almost certainly lead to unintended consequences.  The focus needs to be at the company level itself, to help companies be and think more long-term.  I am sure that we will come on to some of that.  On the regulatory side, I go back to making sure that we try to sweep away any inhibitions that currently exist to people who might want to build up 7%, 8% or 10% holdings in companies.

Simon Fraser: Your question is exactly the right one.  I am not convinced that different shareholder structures work effectively, having experienced them all around the world.  As Baroness Hogg explained, people just tend to arbitrage those.  You see it in France and India.  The key here to me is the full investment chain, from the ultimate beneficiary right through to the board of directors, which is the fiduciary overseeing the company’s results.  That is what John Kay’s report was around; I know that you have talked to him a lot.

The Investor Forum was one of 17 recommendations that John Kay made.  Maybe we should focus on some of the other recommendations that look at the relationship between the pension fund, consultant and fund manager, and the incentives that are set up there, which are often very short-term. We are also trying to rebuild trust between the institutional investor and the board of directors, where it has broken down, to try to encourage a longer-term approach there.

Q397       Michelle Thomson: Good morning.  Thank you for coming in.  I wanted to ask you questions about culture within organisations.  My opening question is: to what extent does good corporate governance influence and shape the culture of an organisation?  Almost conversely, what of the opposite to that, where a lack of enthusiasm for corporate governance allows a culture to prevail?  I am interested in your thoughts on that.

Tom Gosling: It is symbiotic: you can get into positive reinforcement and negative reinforcement between the two.  Boards certainly can have a strong influence on culture throughout the organisation.  I have done a lot of work over the years in the banking sector, and it is interesting how, since the financial crisis, the expectation from regulators that boards will be much more heavily involved in questions of culture across the organisation has had a positive influence on the level of management attention on the issue.  It can work that way.  However, we clearly have to remember that it is the executive that drives business, and the cultural tone is set by what the executive does much more than by what the board does.

Baroness Hogg: I believe strongly in tone from the top, but you are absolutely right.  You can be getting a lot of good noises at the board level, but if the board is not taking the trouble to deep dive and discover if the words expressed in the boardroom are being performed against further down the organisation, then you can easily get a disconnect.  It is an important part of the board’s responsibility to be thinking and engaging on the culture of the business.

There is no quick fix.  We all sit there saying, “Well, the thing we need to sort out here is the culture”, as if you could turn a switch.  It is extraordinarily difficult.  Culture remains in pockets in big organisations, even when tone is being demonstrated at the top and driven through at the senior executive level.  It is a continuing challenge, and you can never let up on it for a minute.  When you have a strong culture, of course then you have to cherish it, but just watch it does not become complacent.  That is the other danger.

Simon Fraser: Good culture ultimately drives good business practice and therefore good results.  Maybe I am showing my age, but when I started investing, there were not a lot of numbers to analyse on Swiss companies and even on US companies.  What you did was actually go to visit the company and understand their culture.  If it had a good culture and a good business strategy, you tended to invest with it, and you put perhaps more emphasis on that than even the numbers.

We have tended more recently to become very fixated on the numbers, and particularly quarterly numbers.  If we can drive investors to seek out good culture, then we can drive capital towards those companies that are running a successful business that incorporates all their stakeholders and has a good culture.  Ultimately, that will drive good business.

Q398       Michelle Thomson: All three of you touch on a couple of further areas, in terms of really taking corporate social responsibility seriously, and cognitive diversity in boards and how that shapes culture.  I appreciate what you are saying, Tom, about business leaders driving this.  What role, if any, do you think that politicians might have in the overarching business environment framing out both of these important areas?

Tom Gosling: Policymakers cannot directly intervene and try to micromanage this, but they can set a tone.  There are things that are extremely helpful in this regard.  Some of the approach to setting targets around diversity has been very helpful, which has been non-regulatory intervention.  If you look at the gender pay disclosure, it has been framed in a way almost to force a pay gap disclosure on most organisations, because it reflects the underlying representation issue.  Some of these things can really help encourage board focus on fixing the underlying issue.  Those mechanisms are more effective than trying to dive straight into framing the solution from a regulatory perspective.  Policymakers can set a framework and can indicate priorities.

Baroness Hogg: Cognitive diversity at the board level has been hugely important.  Across my period on boards, I have seen such an enormous amount of change, all positive in terms of the degree of challenge at the board that you get when there is much greater diversity around a board table.  There is always the danger of thinking “We have fixed that.  We have a lovely, diverse board.  It has a certain amount of women; it has ethnic minorities.  The board looks great”.  The much harder task of ensuring that the executive pipeline is equally rich and diverse can get overlooked, simply because it is harder.  Not thinking that you have ticked a box and moved on from that set of issues, but understanding what is happening in the business as a whole is a really important part of that responsibility.

Simon Fraser: The critical thing here is that culture is driven by the executive and board of the companies.  Therefore, the key really is making sure, as an outsider—politician, investor, or whatever—you can distinguish between good culture and poor culture more quickly.  Culture can change very quickly as well.  It comes back to transparency and the description of how you display that you are managing all aspects of your business and have a good culture within your business.  That is critical.

Q399       Michelle Thomson: Slightly off the beaten track in terms of this, one of the things that came up at an earlier session was around the number of so-called nominee accounts, through SIPPs or whatever, and how people who fit into that category cannot express any voting rights.  The people who are managing the accounts often do not bother, so that particular group may feel that they are disenfranchised.  It intrigues me that they might also provide input to the corporate governance and culture of organisations if they were able to vote.  There is no guarantee that they would if they were, and I appreciate that. 

I suppose my question is around groupthink and group behaviour.  We have a bit of a revolving door, with large institutions influencing regulators.  To what extent do you think, if those nominee accounts had the capacity and did vote, that could also provide a positive influence around culture and potentially a deepening of corporate governance?

Simon Fraser: It is a very important area, and probably requires further investigation.  Ultimately, rightly or wrongly, the individual investor, even through nominee accounts, is a relatively small investor.  There is a serious problem in their being able to express their views or even to receive the annual general report.  We were discussing this yesterday.  Unfortunately, a lot of it comes down to cost.  There are platforms you can hold your shares in, where you can get the annual report and you can vote, but you have to pay for it, and therefore shareholders do not do so.  There are other platforms where you cannot do it and they do not even offer that service. 

There is an issue here that probably requires a different type of investigation.  Ultimately, I forget the number, but around 8% to 12% of the UK market is owned by individuals, so there is a limit to how much influence they could have in the current structure, even if they were voting.

Baroness Hogg: I do find it frustrating that technology cannot solve this problem at lower cost.  You do not need nowadays to get a huge, physical report to have access to the information in it.  It always seems to me that we ought to be able to solve that.  It will, as you rightly say, still be a relatively small proportion, and, indeed, only a proportion of that proportion will want to bother.  Nonetheless, a small number of people can have quite a big influence.  The individual shareholders who turn up to AGMs and embarrass the chairman can be a very useful tool in terms of getting issues surfaced in that public forum.

Tom Gosling: I think that technology will solve the access issue at some point and allow it to be done at reasonable cost.  I am slightly sceptical about whether that is going to cause a revolution in stewardship and engagement.  If I own six international tracker funds, I am invested in probably 2,000 or 3,000 companies.  The whole way that individuals invest today makes it unrealistic to expect that they are going to be the route to better stewardship.

Q400       Peter Kyle: Thank you to all three of you, because it has been a fascinating session, and in fact a fascinating inquiry, too.  Tom, if I could turn to you, I know you have studied the link between executive pay and company performance.  What do you think the evidence tells us about the link between company performance and executive pay?

Tom Gosling: There are different perspectives through which you could look at that.  I know that you have also received evidence to date in this inquiry looking at the question about whether high pay and high differentials drive performance.  That may be what you are referring to here.

Peter Kyle: Indeed.

Tom Gosling: My reading of this is that, if you look at most of the large‑scale academic studies published in high-quality peer-reviewed journals—and those are very important provisos here, because there are lots of studies on executive pay that push all sorts of things—the predominant number of those would claim that there is a link between higher pay differentials and higher performance.  That is consistent with the idea that, if you pay more to get better managers, you get better performance.

There are studies that also point in the other direction.  There is anecdotal survey evidence, for example from the CIPD, which talks about employee views on high pay, although of course that does not take you through to what the actual outcome is; it just tells you what people think. 

My view across all of this is that, regardless of where the tendency may or may not lie, this is actually situational.  You will have situations where fairness, defined as equality, will be a core part of a company’s culture, will align with its purpose and will be a very important part of promoting strong performance in that company.  You could look at employee-owned business, partnerships, co-operatives, mutuals and benefit organisations as examples of organisations that fit that model.  At the same time, you can have organisations that are very, very focused on fast-moving excellence and innovation, where a market and contribution-driven approach to pay can be aligned with their purpose and culture, and can be very successful.  Technology companies might fit in that sector.

Q401       Peter Kyle:  Does the evidence differentiate between short-term and long-term performance of the company in terms of executive pay?

Tom Gosling: It tries to, and the conclusions that I have stated would not change based on that.  However, we have to accept that it is very, very difficult to access all that stuff, which is why I strongly put the emphasis on studies that have been published in high-quality, peer‑reviewed journals.  This data can be quite sensitive, and you can get opposite conclusions depending on whether you analyse it correctly or not.

In a way, the practical answer I come out with from this is that there will not be a one-size-fits-all answer that says high or low pay differentials are good.  What is corrosive to the corporate social fabric is pay differentials that are unjustified.  Therefore, as we go through this, I believe that we need to be encouraging boards to look at the question of pay fairness in the organisation in a more meaningful way than has happened to date.  Work could be done through a combination of the remuneration committee’s remit, reporting requirements, expectations and engagement to bring about real change.  We should not assume that the answer to that will be lower differentials.

Q402       Peter Kyle: It would take a brave person to say that short-termism has not crept in to our corporate culture at various levels. Do you believe that senior executive pay and high levels of remuneration have or have not contributed to that?

Tom Gosling: Pay structures have contributed to that more than pay levels.  We have developed an approach over the last 20 years that is very, very driven by target-driven performance pay plans, with targets operating over one to three years.  There is a lot of good academic evidence that these are problematic, and that they can encourage short‑term behaviour or worse.

Again, it is not one-size-fits-all, because there are circumstances where target-driven pay systems work exceptionally well—for example, turnarounds and so on—and they would probably always play a role.  However, the role has got too big, and having 75% of a typical senior executive’s package based on these schemes has set up a situation in which it has become very difficult for remuneration committees to manage.

If I could wave my magic wand in this area, I would like to see the centre of gravity in the market have less emphasis on target-driven pay schemes and more on significant and long-term levels of shareholding, which evidence does show is positively related to strong long-term performance.

Q403       Peter Kyle: You mentioned fairness.  One of the other questions I had, and the final question I would like to ask directly of you before bringing the other two witnesses in, is: do you believe that remuneration committees should be taking into account public perception of pay and fairness; or should they be sticking quite rigidly to where the evidence tells them delivers the highest amount of performance within their own organisation?

Tom Gosling: It is a very, very interesting question.  Boards increasingly recognise that you cannot create that binary distinction.  We are in a situation where, clearly, there is a problem around public trust in executive pay, which is acting as a lightning rod for a broader issue around trust in business.  Left unresolved, that can lead to situations where the business environment becomes less favourable.  We have to have a political context where people accept the operation of business.

Remuneration committees should be taking greater account of it.  The process of thinking that through—as long as we do not prejudge what we mean by fairness, because there are different perspectives on it—will help a board ensure that pay throughout the organisation is better linked to that organisation’s culture and purpose.  That, I think, will be beneficial for them as well.  I do not think we can set it up in quite that binary way.  I hope that answered your question.

Peter Kyle: You have explained yourself incredibly well.  The fact that your hand is in a bandage makes me wonder just how you incentivise pay in your team.

Tom Gosling: It was a CEO.

Q404       Peter Kyle: You are a victim, then, not the opposite.  Baroness Hogg, I am sure there is a lot that you would like to say about the role of annual reports and annual reporting in incentivising corporate transparency, but also performance.  If we take this issue of pay, from your John Lewis experience, I am pretty sure that you would say your organisation is not interested in people who are purely motivated by pay and therefore incentivised by pay.  You look for other factors that motivate them.  We have had evidence to that effect in this inquiry.  How replicable is that in other parts of the corporate sector, based on your experience?

Baroness Hogg: I can take two extremes of my experience.  One of those you mentioned, John Lewis, has a fixed maximum multiple of what the highest paid person may earn to what the average non-management partner earns on an hourly basis.  That is a multiple of 75 and was set in the constitution a long time ago, because the philosopher king of John Lewis, John Spedan Lewis, advocated the principle that there should be a maximum that management was entitled to charge workers for the privilege of managing them.

It is a very, very strong principle embedded there.  I see the strengths and weaknesses of that.  Actually, those calculations are quite hard to make.  How do you value pensions?  There is no easy way of doing this, nor for a moment would I say that that is the sort of multiple you could put into any other company and it would work in exactly the same way.

At the other extreme, I have sat on the board of one our biggest companies, competing for its top talent in a small pool of extremely experienced senior executives, whose remuneration was generally American, if I can put it that way.  It is operating in a completely different place.

What is the theme I would draw out of both?  It is slightly different from the conclusion you were reaching on short-term and long-term pay.  Simplification of pay is a cause I would absolutely love this Committee to advocate.  One of the problems with these target-based schemes is not that they are not long-term enough; it is sometimes even that they are too long-term.  They are immensely complicated.  They may end up costing the company a huge amount of money.  At the same time, when the scheme is advanced to the executive, that executive may not value it very highly, because it is so uncertain out there in the future, and they will start to play the elements to meet targets.  There can be distortion. 

It is about simplifying pay and taking away some of the complexity of long-term arrangements that have to be valued for the annual accounts.  Their complexities are well-illustrated by the name—a Black-Scholes model.  It tells you an awful lot about how we have got into a far too complicated field in remuneration.  Simplify and clarify, and then you will be able to use the weapon of transparency quite a lot.

Q405       Peter Kyle: You, and all people in the senior parts of John Lewis, must be very frustrated with the way that the John Lewis model is bandied around as a solution to every ill that we find in parts of society at the moment.

Baroness Hogg: Absolutely.  Our chairman, Charlie Mayfield, is constantly saying that this does not create a model you can just take and put somewhere else.

Q406       Peter Kyle: The problem with that is that it does not explain the poor performance of John Lewis in other parts of its history.  There is clearly a role within John Lewis where the model and great leadership are a combination you need to get right.

Baroness Hogg: I have talked about John Spedan Lewis.  The bit I like about the history of John Lewis—and then I will shut up about this model—is that his father, who was the man who got it all going, was a real trader.  He had all the entrepreneurial trading instinct, and then he had the philosopher son, and it was the two together who made the model.  You can never do without both halves.  Sorry, that was too much.

Q407       Peter Kyle: No, not at all.  John Lewis, with its robust model, would not survive and thrive without great leadership, and pay does play a role in that.  My final question to you is about annual reporting, because you are an advocate for annual reports having specific types of information in them that will incentivise long-term thinking.  Am I right that annual reports could play a stronger role in incentivising long-termism in the corporate sector?  As my final question, I would very much like to hear you say a few more words about that.

Baroness Hogg: I am not going to have another long list of things that have to go in the annual report.  There is a grave danger of making a Christmas tree.  When I was at the FRC, not a week passed without somebody saying, “Here is another thing you ought to insist that people put in their annual report”.  They are all quite long enough, and there is a great danger in thinking that making it longer is making it better; actually, making it shorter is making it better.  I do not believe that there are some specific elements that should go in that are not there.  I believe they should be fair, balanced, and understandable, and the FRC should have a role in reporting on how well companies are fulfilling those requirements.

Q408       Peter Kyle: Thank you.  The Chairman has given me half a question.  You are a non-exec of the FCA.  Is that correct?

Baroness Hogg: Yes.

Q409       Peter Kyle: The FCA is one of the few regulators that have the power to go in and examine governance.  As somebody who sits on the board of the FCA, do you feel that power is a beneficial one?  Do you feel that it is used in a meaningful way?  I have been an FCA-regulated non-exec director and felt the heat.  Do you feel that power has value?

Baroness Hogg: I believe it has value, but I also believe that the FCA should be extremely cautious about its own level of understanding, and not presume that it knows too much.  It has learned quite a lot over the last few years about how to think about governance.  It started from a position where it did not really have a great understanding of how the dynamics of governance worked, and it has improved a great deal.  I think it has a lot of value.  When I was not on the board but was an adviser to them, I used to sit in on a number of those interviews to which you have referred.  Again, the preparation that people did for those interviews was actually jolly important, even if we who were doing the interviewing were not much use.  I am sure we were.

Q410       Amanda Milling: You were talking about John Lewis.

Baroness Hogg: No more.

Amanda Milling: John Lewis is bounced about as a kind of shining light and a great example, and we are not taking evidence, I do not think, from John Lewis, so you are our evidence.  We have talked about culture and business models.  One of the things I am really keen to understand is this: if there was one thing you could take from the John Lewis model, which we could learn from in terms of the inquiry for corporate governance, what would it be?

Baroness Hogg: It would be that it made its own model.  Nobody came along and said, “John Lewis, this is how you have to do it”.  It was the leaders of John Lewis who developed the model.  Nobody in that period was conducting this kind of inquiry, or even doing the job the FRC does, let alone the FCA.  It was John Lewis itself that developed its own model, and that is critical.

Q411       Amanda Milling: It is a model that has been successful for a long time as well.

Peter Kyle: Not consistently.

Amanda Milling: Not consistently, but look at the retail market now and its direction of travel.

Simon Fraser: This is where the role of the board is so critical in figuring out what the long-term business objective of the company is, setting it out on a very, very long-term basis and then hopefully committing the future management and future generations of management to keep by that model, and not to rewrite the model and strategy every time a new set of executives comes in and says, “The old executives were terrible”.  A really strong board can frame the philosophy behind the company and stick with it for a very, very long time, maybe adjusting it at the margin.

The strategic direction that is set by the board is absolutely critical.  Good boards do that.  John Lewis has obviously had it embedded for very many years, but there are lots of companies that do not.  They say it is the executive’s job to figure out what the strategy is for the next three to five years, not the board’s job to figure out why we are here for the next 30 years.

Chair: Thank you very much.  That has been very helpful to the Committee.  We are really grateful for your evidence. 

Examination of witnesses

Witnesses: Ken Olisa, Andrew Ninian and Sir Philip Hampton.

Q412       Chair: Gentlemen, many thanks for attending.  It is good to see you.  We will be discussing diversity on boards, so it is good to see three men.  For the purposes of the record, do you mind telling us who you are and which organisation, if any, you are representing? 

Andrew Ninian: I am Andrew Ninian.  I am director of corporate governance and engagement at the Investment Association.  We represent UK-based asset managers, and help them facilitate some of their stewardship responsibilities.

Ken Olisa: Good morning.  I am Ken Olisa.  I am deputy chairman of the Institute of Directors.  I have various other hats to do with corporate governance, and I expect that we will return to those in the questions.

Sir Philip Hampton: I am Philip Hampton.  I am the chairman of the Hampton-Alexander review.  I am also chairman of GSK, a large pharmaceutical company.

Q413       Chair: Sir Philip, may I start with you?  You know your way around a boardroom.  We have looked at this in respect of corporate governance scandals, and there are themes about perhaps a dominant individual—maybe an egotistical bully—who is pushing through an agenda, with a weak board that does not challenge or scrutinise.  I am interested in your time at RBS.  Are they not the same themes?  What did you have to pick up in terms of the pieces?  You had a domineering, egotistical, bullying chief executive who was thinking about expansion and the fountains at the new headquarters, and you had a board that was not curious, was not aware of some of the complex financial issues and had a “scratch my back” culture. 

What can we learn from that?  You obviously want to have that ambition and dynamism in a capitalist system, but it has to be curbed by good corporate governance.  What lessons can we learn from your experience at RBS?

Sir Philip Hampton: I do not want to confirm or deny every word you used.

Chair: Oh, go on.

Sir Philip Hampton: Some of it is still the subject of litigation, I am afraid. Obviously, what you have said has been widely said in the media, and indeed in other circles.  A lot of this was covered in David Walker’s review of the collapse of RBS, where he drew some important conclusions.  You are right, of course, in your assertion.  One of the biggest challenges that can arise in a board is the excessive influence of an individual.  It can be the chairman or it can be the chief executive.  It is rarely anybody other than those people.  The whole structure of governance is to make sure that that does not arise. 

It is a key principle of the structure of governance that there be a separation of the powers of the independent director to control or manage the board, and to make sure that an individual, particularly a chief executive, does not exert excessive influence.  That structure works really well.  It is now almost universal in UK board structures.  Like all these structures, it does not guarantee anything.  You can get individual industries, and individual interpersonal dynamics, that that structure does not deal with.

Q414       Chair: What else needs to improve, then?  We had the financial crisis, and we had RBS.  You have mentioned David Walker’s review.  Governance seems to have improved, but in the wider corporate life what is your assessment?  What further steps need to be taken?

Sir Philip Hampton: About the whole of governance?

Chair: Yes.  Corporate governance is working relatively well, but when it goes wrong it can go spectacularly wrong.

Sir Philip Hampton: In overall terms, the UK’s structure of corporate governance is pretty good.  It is not universally good.  We will always have the Sports Directs, the Philip Greens and so on.  There are no structures that eliminate that.  Our overall framework of governance in this country is admired pretty much globally.  Lots of countries follow, or try to follow, big aspects of our model. 

You started with RBS and the financial crisis, and that is a really big issue.  It was not entirely due to governance structures within the boards.  Boards ultimately take full responsibility for things that happen in their business, but particularly in the case of the banking system it works within the Basel international regulatory framework, and, frankly, the Basel framework around capital adequacy in the banking system was deeply flawed.  You could adhere to your regulatory principles of adequate capitalisation and be absolutely dangerously placed as a bank, and that is what happened.  I am not saying the board is not hugely responsible; it clearly is.  There were lots of other things in the financial crisis.

Q415       Chair: Ken, you have been a non-exec director, and Sir Philip has talked about the role of the independent directors to challenge and scrutinise.  Is that your experience?  I apologise that this is a very general question.  Do non-executive directors do the job that they have to do, or is it often that if they ask awkward questions they will be kicked off the board?

Ken Olisa: You ask that question.  I was, of course, kicked off the board.  I am the first ever FTSE 100 director to be fired at an AGM.  Sir Richard Sykes is the second, although I point out that that is only because S follows O in the alphabet.  It was not personal other than that.  The fight we were having was precisely over corporate governance.  It was us against a group of directors who disagreed with us.  More importantly, there were shareholders who disagreed with us.  They exercised their democratic right at an AGM to get rid of us.

Q416       Chair: Are you an example of the system working well?  Shareholders did not like what you were doing, and therefore, as we do not often see, you were not reappointed to the board.  Is that a sign of success?

Ken Olisa: It was even better than that.  We were then able to talk about what had happened, and the fights that had happened in private inside the board then became extremely public—that is a matter of record—which allowed people to learn lessons from it.  To go back to your earlier question, part of the problem is that it is hard, at the date, to know quite what is happening in the laboratory and where the pressures lie.  It is not really explained outside the boardroom, for all kinds of reasons.  The pressures that one would like to see on the company to moderate its behaviour do not occur, because no one is engaging in those kinds of discussions.  We had very little conversation with the non‑shareholders who voted us off, for example.  The institutions in the UK did not engage in any kind of dialogue with the board at the time.  It was a private argument—irrespective of the merits of it—that only became public, and therefore allowed us to engage, when we were fired.

Q417       Chair: I am not putting words in your mouth, but from what you say it follows that shareholder engagement with corporate strategy, the role of corporate governance in terms of the performance and decision‑making of a company, does not work well.  Is that fair?

Ken Olisa: In my experience, shareholder engagement is extremely poor.  You are not putting words in my mouth.  Yes.

Q418       Chair: Andrew, would you agree with that?  Is shareholder engagement a problem?  Shareholders, in the main, just do not care about this.

Andrew Ninian: They do care.  They spend a lot of effort and time engaging with companies.  You have to clarify the different types of engagement.  There are a number of different types of engagement: day-to-day meetings between fund managers and management teams to get an understanding of strategy and performance; meetings between fund managers and governance teams on governance issues with the chairman and the senior independent director; and, finally, meetings between governance and fund manager teams with remuneration committee chairs to get an understanding of where the remuneration strategy is going.  There is a debate about quantity and quality from both sides.  How do you improve the quality of the dialogue, so the two sides get into a room and discuss material issues rather than getting into the minutiae of executive pay?

Q419       Chair: Would you consider specific recommendations to help improve that dialogue and engagement?

Andrew Ninian: We have had a lot of debate about how that engagement can be focused.  If you go straight into executive pay, there is a lot of debate about whether companies are actually engaging with or informing their investors on executive pay.  Is there really a consultation process going on there?  Are they really interested in the views of their shareholders, or are they just affirming the view that the board has come up with?  We need to go back to the question of how we can improve quality rather than doing it for the sake of doing it.

Q420       Michelle Thomson: Good morning.  I wanted to talk a little more about diversity, and I do not necessarily mean gender diversity or ethnic diversity.  It is more about genuine diversity in terms of background, life experience and sector.  I am interested in the qualities or characteristics that you think influence and shape those matters.  I am looking for some general principles before we go into detailed questions.  Perhaps you, Sir Philip, would like to lead off.

Sir Philip Hampton: Boards and, indeed, top management teams are responsible for a whole, wide variety of complex issues.  If they do not have the appropriate level of diversity, they will not be able to deal with the breadth of issues that arise in a large public company.  This is one of the key findings from the financial crisis.  A lot of bank boards in particular were pretty narrow.  They were male and stale, frankly, and were from largely similar backgrounds.  They probably had lost touch with lots of things that are important for banks and companies generally to do.  They almost certainly did not have a great enough degree of internal tension and challenge.  If they had had it, we would not have had at least the extent of the crisis that subsequently arose.

The whole idea of a board, really, is to make sure that all the points are put.  They may be accepted or rejected, but they all have to be there.   That does require the appropriate level of diversity.  The Hampton-Alexander review was focused on gender diversity, which is the most fundamental diversity of the human species.  Until very recently, boards were pretty much exclusively male.  It still is a challenge, although not so much in boards, as Baroness Hogg was explaining; the boards have made quite a lot of progress.  Boards are overwhelmingly non-executive now, in our corporate governance framework, and having more women on boards is not the same as women having proper, effective business careers.  The Hampton-Alexander review will maintain a focus on boards, because they remain extremely important, but we are also looking at executives. 

To your overall question on governance, Chairman, the bit we are missing is the focus on the executive committees.  Because of the structure of boards, they are non-executive.  Companies are actually run by their executive committees.  They are the full-time people, with the best paid jobs, who really decide most things.  A typical board member has two or three days a month.  It is just not the same thing.  We are putting much more focus now on the executive committees, and the people who report to the executive committees, where there is still a noticeable female under-representation.  Other forms of diversity, I totally accept, are very important, including background, race and so on.

Michelle Thomson: I am interested in hearing from both you, but I have to say that so far there is nothing that you have said that I disagree with.  I do have a challenge of how on earth we get to that nirvana.  I would like to hear from Ken and Andrew first, before we go back to that.

Ken Olisa: There is always a danger, when we talk about diversity, of conflating what I call two sides of a coin, because they are the same issue.  One of them is social justice and the other is competitive advantage.  They both need to be tackled.  When I sit at senior meetings and people talk about diversity, they very often think they are the same topic.  Very often, people become bored, close their eyes and go away because they think it is about social justice, when actually they are there to talk about how to make the business stronger or better.  I am on the Parker review looking at ethnic diversity on boards.  To separate the two, the social justice piece is quite important, but it is for you, the policymakers, to set that framework.  I will focus on the competitive advantage bit.

A lot has been said about cognitive difference, background and so on.  I will not repeat all that.  There is another very important message, which unfortunately connects back with the other side of my coin. If the people running organisations do not look like the people whom they are trying to employ, trying to sell to, trying to buy goods from and being regulated by, then those people in the supply chain, etc, are less likely to be empathetic to the needs and requirements of the company.  I would argue, with evidence, that that therefore damages the competitive advantage. 

To Philip’s point about the supply chain of executives, there is a lot of data on ethnic minorities to show that enlightened companies tend to recruit broadly along the demographic of the UK, but by the time it gets to the middle ranks it is down to white people, and by the time it gets to the top rank it is down to white men.  Something happens in that process, and it does not seem to matter that those at the top say all the right things and those at the bottom have joined according to the demographics.  It gets stuck in the middle. 

The reason it gets stuck in the middle, in my observation, is that it is really difficult to hire somebody as a middle manager who is not like you.  I give lots of stories, but I will not do it this morning.  I have a friend who is transgender; I have lots of Asian friends; I have African friends, etc.  You are saying to a middle manager, “You have to understand what has gone through the heads of that range of people before you take away all your own experiences and choose somebody”.  That is an enormous risk to take as a middle manager who is under pressure to deliver KPIs month in, month out. 

To me, it is not surprising that you hire across a demographic and it then gets stuck at the middle, because the hirers do not have the experience, knowledge and confidence to take that scale of a risk to hire somebody who is wildly not like them.  At the top, we can bring them in by saying to the headhunter, “Find me a transgender person, an ethnic person”, or whatever, and they can look in the pool.  Middle management struggles to make that happen.

Michelle Thomson: Again, there is hardly anything that you have said that I disagree with, so we will go on to Andrew.  I think there is meat in all of these.

Chair: That is a challenge to Andrew.

Andrew Ninian: From an investor perspective, we are looking for a diversity of perspective, so having the right people around the boardroom table who can make the right long-term decisions to create value over the long term for shareholders and constructively challenge and support the executive team.  They have to have the diversity of perspective, as Ken said, to represent the employee base, the consumer base, the geographical base and the product expertise for the strategy they are trying to deliver.  It is about having the right people to both constructively challenge but also support and lend expertise to the management team.

Q421       Michelle Thomson: Good.  You have won the star prize as well.  I am not going to disagree with any of that.  The challenge in all of this—which I guess nobody in the Committee would disagree with—is how on earth do we get to that in terms of framing policy decisions?  There is obviously the influence of senior business leaders such as you.  Given my background, as possibly a troublesome female in business who has encountered, consistently, resistance at every level for asking what I consider to be entirely reasonable questions, how on earth do we get to the level of change and the pace of change we need?  It is a very important point you make, Ken, about competitive advantage, which is my driver.  Are we doing enough?

Sir Philip Hampton: Are you talking about the boards or careers for diverse people generally?

Michelle Thomson: I accept what Ken is saying about how you grow it through the organisation.  You are right, and there is a whole load of other stuff in there, but, specifically, it is boards that frame out the leadership and, above that, policymaking as well, at government level.  What are your thoughts on those two levels?

Sir Philip Hampton: There are two critical things for, certainly, gender diversity, but they will apply to other types of diversity.  The first is leadership.  It is like anything else in a business.  If the board and the top management team are saying, “This is really important”, then the message goes down through the organisation very quickly, and the organisation will respond.  We have seen plenty of examples of that.  The second universal thing is targeting.  Businesses respond to targets.  If you say, “We have to get to 20% or 30%”, or whatever the number is, then normally the machine comes together to deliver that.  It may exceed it, or it may fall short, but it knows where it has to go.  Targets and deadlines are hugely important. 

Aside from those two really big principles, you have to look at each individual and the individual dynamics.  What products, markets, background and history do they have?  There is a whole suite of things that you can do.  If you are in the services industry, for instance if you are in the big four accounting firms or the big investment banks, they put a lot of staff on returnships, to get women back.  They train and invest in them hugely in their 20s; then they lose them in their 30s.  It is ridiculous, both for the women and the organisations, that they are lost forever.  They put a lot of effort into this: “Okay, five years out, two children and come back”, if I can simplify things grotesquely.  Other organisations say, “It does not really matter whether our training is at the right level, but from now on it is a woman on every slate.  There must be at least one female, or one out of three”, or whatever it is.  Then the organisation eventually makes sure it has training, development and recruitment programmes to get there.  There is not a single model that is right for every business at every time, but those principles of leadership and targeting are the most important.

Q422       Michelle Thomson: Are we doing enough, Ken, and fast enough?

Ken Olisa: There is a group of people inside, certainly, every large company.  I think the focus of the discussion today is FTSE 100; this is maybe FTSE 350.  They are not particularly well empowered at the moment.  If you wanted to probe into the way business is run today, and find a pool of talent or energy you could do something with, there are the affinity groups.  I have a range of different stories that I will not bore you with this morning, about how affinity groups behave.  I was asked to give a speech to a bank on black people and business, or something along those lines, by the black affinity group of the bank.  I said, “I will come and do it for you, but I will do so for a fee of £5,000, which I will then give to charity”.  They said, “We do not have a budget anywhere near enough to cover that kind of money”.  I said, “How much do you have?”  They said, “We might be able to give you a fee of £500, but that really would be quite a big thing”.  I said, “Just think what you are saying.  Your bosses are telling you this is a really important group of talent, in a really important organisation, and you have no money to do anything with”.  This is tokenism and not reality. 

I happen to know the man at the top of the bank, and he is not a tokenistic person at all.  Somehow it has been lost through the HR bit—I should not say that—or whatever bit it was lost through.  The fact is that they are not empowered. Fiona Woolf ran an event in the City a few years ago when she was the Lord Mayor, and invited the leaders of affinity groups from across the City to come and find common cause.  There is a really potent energy among that group of people.  It is not a union argument; it is just people in a business caring about the competitive advantage of that business.  There may well be a disclosure or a reporting dimension to sharing what those affinity groups do within organisations, which would then start to feed Philip’s supply chain, as we were talking about, internally.

Andrew Ninian: Behaviours are changing.  We have talked to company chairmen a lot about diversity.  The odd candid one will say, “We brought women on to the board because we had to, because of public pressure and investor pressure and to meet those targets.  Actually, on bringing the women on to the board, we realised that it does create a different dynamic.  It does create a different conversation.  Actually, the board has worked better as a result of having that diversity of perspective, with someone coming to a problem from a different perspective, asking a different question, putting it in a different way and challenging the management in a different way.  It has led to the board operating in a more effective way”.  It is self-fulfilling that the benefits are seen by those individuals who were once sceptical, and they then help to motivate and encourage the development, and the improvement comes.

Q423       Michelle Thomson: In terms of the roles of the non-execs, do you think that we should be separating out, in terms of directors’ duties, non‑execs and execs?  The argument has been made, and certainly my personal view is, that you would really like non-execs to be quite challenging.  There is always a danger they can be very passive, or do not get as much information, and yet they have to stand by the same duties.  Do you think we should be separating them out?  Again, that is a potential plug for cognitive diversity within the board.  What are your thoughts on that, Andrew?

Andrew Ninian: We support the directors’ duties as they are in law. They could be better implemented and how that stakeholder voice is heard by the board could be reinvigorated.  In terms of differentiating the roles in law, we would be nervous about that.  I am struggling to see what creating a specific position in law would solve.  It is within the code.  The issue of independent non-executives and constructive challenge is debated there.  I am not sure how translating that into law would create a massively different impact.

Ken Olisa: I agree.  Collective responsibility is critical.  The UK board structure makes lots of sense.  I would not want to differentiate.

Sir Philip Hampton: We have a unitary board structure, and in law and governance terms it has been unchanged for quite a long time.  What has actually happened, though, is really quite different.  It is often unrecognised or underrated, and that is because 20 years ago we said that boards have to be dominated by and principally non-executive.  30 or 20 years ago, boards used to be primarily the executive directors around the business with a couple of non-executive directors to help, guide, advise them or whatever.  The whole thing has switched around, and now a typical board may have two executive directors and 10 non‑executives. 

We have gone, without ever really saying it out loud to ourselves, to a much more supervisory board structure.  That is the reality.  You have a supervisory board, an overwhelmingly non-executive board and businesses are really run by the executive committee, at least on a day-to-day, month-by-month basis.  We are much more like the Germans than we ever really recognise.  They have a supervisory board, and they have a Vorstand or management board.  We are massively more like that. 

I am not saying it is a problem, but I am saying it is unrecognised and the implication of that is not much attention is paid to the structure and nature of the executive committee, because that is not the bit that is reported.  There is an overwhelming focus on what is, in common language, a supervisory-type board.

Q424       Michelle Thomson: I have a last question for you, Sir Philip, before I finish up.  Would you put a highly talented and nationally recognised creative on the board of a bank?  That is our script, by the way.

Sir Philip Hampton: As Andrew said, boards, in the end, need to be effective.  They have a representational style in order to achieve the diversity benefits and so on, to make sure all the arguments and issues are properly surfaced, but they are not designed for political correctness, or certainly showmanship, if I can put it like that.  If the person can make an effective contribution to the discussion on a bank board then, yes, of course.  Of course, now all directors need to be approved by the regulator, and I suspect that regulatory hurdle might be difficult to jump over in that case.

Q425       Chair: Following on from that point, I was very interested in some of the comments.  Ken, you said company boards should look like the people that they employ.  Andrew talked in terms of diversity of experience and representing the employees.  I do not believe in tokenism, but on that basis, would you agree with workers on boards, Sir Philip?

Sir Philip Hampton: Again, it depends on whether they could be effective.  I would not go for the tokenism argument either, but workers or talented people generally should not be excluded.  I have certainly taken some unusual board decisions in terms of appointments.  You have to be very careful when people are narrowly representative.  I was on a board of a Swedish company many years ago where there were two trade union representatives, basically worker representatives; that was the law in Sweden at the time.  It was a large public company.  Everybody accepted it on the Swedish board. 

Before every board meeting there was a board dinner, which did not include the worker representatives.  Most of the meat of the meeting was discussed then.  Of course, the trade union representatives were perfectly aware of this, and had no objection to it.  In law, you cannot object to a separate directors’ meeting if they choose to have one.  You cannot ban them.  You have to be very careful that you do not produce the dynamics of, “Actually, we have to fix those guys or fix that guy because he has a single angle”.  It comes back to the principle that the board has to be unified as well.

Andrew Ninian: From our perspective, we are not in favour of mandatory employees on boards.  As I said, we like directors’ duties.  As soon as any individual comes onto the board they need to represent all stakeholders in the company as a whole and the long-term vision of the company.  You have taken evidence from FirstGroup, and they show where they have an employee on the board and it works for them.

Q426       Chair: Why does it not work for others, Andrew? FirstGroup seems to operate very well as a FTSE 100 company.  Why do others not employ this?

Andrew Ninian: We have the code, which sets out the governance expectations of UK listed companies.  That is the cornerstone.  Recently, there has been a greater debate that companies need to choose the governance structure that is most appropriate for them.  If they need to diverge from that code, then they explain why it is the appropriate structure for them.  Why are more companies not doing it?  I am not entirely sure.  It may be that they do not necessarily see the benefit.  There has been a greater debate over the last few months about the stakeholder voice, and maybe a lot of boards are thinking about it now, but it has to be right for their company, in their individual circumstances, within the context of the company law and the unitary board system that we operate under.

Q427       Chair: Do you think it is feasible to have additional reporting requirements whereby companies say, “As part of our board structure and composition, this is how we have considered how we improve employee engagement, employee representation and not just the voice of the worker but that wider stakeholder”?  Do we do enough at present, and what more can be done?

Andrew Ninian: We need a better understanding of how directors are fulfilling their directors’ duty and getting that stakeholder voice into the board so they can make the best long-term, rounded decisions for the company as a whole.  You probably need to do two things.  One is a slight amendment to the code, to make sure that boards are thinking about the stakeholder voice, and that they are required to outline how they do it.  Then you underpin that with a reporting requirement of how they have heard the views of stakeholders or taken them into account in making their decisions over the last year.  Usually, if you create a reporting requirement, then boards think very carefully about how they implement that process and hear that voice.  That stakeholder voice will be heard more fully if you have a reporting requirement to say how you have done it.

Chair: Would that work, Sir Philip?

Sir Philip Hampton: A lot of this is done in businesses informally.  The question is: to what extend should it be formalised?  Andrew Witty, the CEO of GSK, after every set of results and presentations, has a big webcast to employees talking about the results and the things that are going well.  He has a sense of accountability to employees.  I was on the board of a large public company a good while ago, and after presentation to the City we had a group like this where we made exactly the same presentation to the trade union representatives.  “This is how the business is performing.  This is what we are worried about.  This is what we are pleased about”.  We never publicised that, but it was a very important part of the engagement with the employee base.

Ken Olisa: There is an irony that, in professional development, it is very often a good idea to get a high-flying employee to go and sit on somebody else’s board so they can get board development experience.  It is not a great leap to say that, “If they can sit on somebody else’s board they can perhaps sit on our own board”.  The point Andrew has made that is supremely important, certainly from an IoD perspective, is about that collective responsibility.  You cannot be on the board, though a worker, representing the workers’ interests.  You are a worker and you are going to represent whatever you need to in the context.  If we Balkanise the board or divide it into exec/non-exec, worker/non-worker, that would set the clock back a long way from what we have been able to achieve since Cadbury.

Q428       Peter Kyle: I am going to look through the telescope from the other way now and turn to chief executives.  We have had conflicting evidence from witnesses in the past about the value and the role of chief executives in creating long-term stability for a company.  What is your view?  Sir Philip, I will start with you, because one witness in particular mentioned the fact that pharmaceuticals is a good example where they are such complex organisations that value is not created by one person at the top.  Due to the complexity of organisations such as pharmaceuticals, the middle managers are the people who create the real value, because they have a lot of authority over specific and diverse parts of the complex organisation.  What is your view on that?

Sir Philip Hampton: It is true of pharmaceuticals, for sure, as you have described.  It is true of plenty of other industries.  Probably the more complex your technology, the more diverse your inputs need to be to get things right.  There are a lot of businesses, basically, where the essence of success is about the team.  In pharmaceuticals, you have to have great scientists.  You also have to have great marketeers to distribute products effectively, globally in our case.  You have to have very smart regulatory and compliance people to make sure that you get all your drugs approved in all the various jurisdictions, which is a legal/scientific combination.  You have to have great manufacturing, because you have zero failure when you are putting stuff into human bodies.  It has to work, and work effectively. 

You have to do a whole range of different things.  You are absolutely right that the skill of the CEO is unlikely to cover all those bases.  It is all deep expertise. The key people in pharmaceutical businesses, and plenty of other businesses, are the people who bring all that together.  They can be a scientist; they can be a commercial guy; they may be a financial guy; they may be a lawyer.  The different disciplines can all produce the leader, but it is about actually making the team work together.

Q429       Peter Kyle: In terms of remuneration, is it correct that the very senior person is perceived to be the chief value creator in many organisations out there, and therefore remuneration follows that perception, where in actual fact, if you want the reward to follow where the value is created, other parts of the organisation should be rewarded?

Sir Philip Hampton: I speak for GSK and the same will be true in some other organisations.  We have plenty of heavily incentivised people in different levels of the organisation, and there are structures to do that.  If you develop a great drug in GSK, you are going to be pretty well-off.  It is the perfect position, actually.  You may have no public profile, but you will do really quite well financially.  Leadership of an organisation is hugely important.  All the things you have talked about in terms of culture, in terms of style and in terms of ambition are vested much more strongly in the chief executive, in one person, than anybody else.  A change of leadership in an organisation can be—in fact, it often is—very significant for that organisation.  I am not saying that they are all successful or all incredible.  Some of them have greatness thrust upon them and rise to the challenge.  However, to do a top, demanding job really effectively is something that is reasonably described as attracting high pay.

Q430       Peter Kyle: Do you think being a senior subordinate is an undervalued skill?  We focus a lot on the skills of leadership, but the skills of leading at lower levels, and also the skills of understanding the needs of a leader and managing upwards, are undervalued.

Sir Philip Hampton: It depends what you mean by “undervalued”.  If you are at senior levels in a large, complex, hopefully successful business, you are not going to be hard up, most of the time.  We put tremendous focus on the CEO pay, but big organisations have lots of extremely well paid people.

Peter Kyle: You just said it yourself.  You put tremendous focus on CEO pay.  Why is that?  Why the expense of tremendous focus?

Sir Philip Hampton: It is normally the biggest, I assume.  It is easier to deal with in media terms, so that is obviously part of the focus.  From an investor point of view, it can set a bit of a tone.  “Is this an organisation that really pushes pay and maybe pushes it too far?”  It is embodied in the CEO, and therefore investors might reasonably read signals that this is an organisation that is doing more for its employees than its shareholders.

Andrew Ninian: It is also where the regulation is.  The requirements to disclose and the shareholder vote are on the executive directors.  That is why there is so much focus on the chief executive, the finance director and those executives on the board.  That is where the disclosure is, and that is where shareholders have their votes on the remuneration.

Q431       Peter Kyle: To my original question, which is about the creation of value in a company, where do you sit on the scale of where you believe, overall, the greatest value for a company is created?  Is it at the top, through the very senior leadership, the ultimate leadership—the CEO—or is it elsewhere in an organisation?  I am asking you because we have had conflicting evidence, and you have the benefit of being our last panel in this inquiry.  We have had the benefit of hearing a lot of different, conflicting experience.

Andrew Ninian: It probably depends on the organisation.  When we are looking at corporate governance, different companies are operated and run in different ways, so that will impact on that answer.  Certainly, a chief executive has a very big role in terms of leading the company.  Ultimately, the buck lies with them, and if something goes wrong they are the ones held accountable for everything that is going on within the organisation.  We have already talked about the culture of the organisation.  A lot of pressure and responsibility flows through that, which is why they are compensated in that way.  When we are talking to remuneration committee chairs, there is a lot of concern about losing their chief executive, and the impact that will have on the company, its reputation and its share price.  The need to retain the chief executive is often a driver of executive pay.

Peter Kyle: Ken, is there anything you want to add?

Ken Olisa: Actually, I want to amplify Philip’s point about leadership.  The issue is leadership.  If we take it away from business for a moment, look at a good school that turns to a bad school because the headmaster changes.  You have challenged me, because it is such a blindingly obvious thing that I have to worry a little that I have missed something in the logic.  If I think about the chief executives I have worked with as a non-executive director, the board’s expectations of them and employees’ expectations of them concentrate an enormous amount of responsibility on that particular individual.  Their ability to manage up, to use your term, and to manage down and deliver the strategy agreed by the board is what they are rewarded for.  The other part of the regulation we should remember is that the most highly paid directors are also recorded, not necessarily the chief exec.  Your telescope can have another look into the pay structures through normal reporting.

Q432       Peter Kyle: Do you think that there is a morale issue about executive pay?  Chief executive pay is one person, and organisations that you are involved in are thousands of people.  Everybody is going to know the kind of numbers that are talked about at the very top.  I have had the unfortunate experience of sitting around a board table where a vote of thanks was passed for the chief executive for an astonishing set of financial figures, in the full knowledge that that individual did not have anything to do with what delivered the spike in growth, and the team that did was not recognised at all by the board.  That had a terrible impact on morale in that particular team.  Of course, the chief executive was not forthcoming in correcting the board at that moment in time.  Do you think there is a morale issue elsewhere in an organisation when it comes to chief executive pay, Ken?

Ken Olisa: I do not want to sound like a totally broken record on this, but it is back to leadership.  With a good leader, there will not be a morale issue about their pay, because it will be seen to be justified.  Of course, most of the ones I have worked for have been dreadful—and it has all been down to my contribution—but a bad leader will in fact do the opposite thing, and people will rail against them and undermine them.  It is circular and still goes back to leadership.

Peter Kyle: Sir Philip, you mentioned the role of value creation elsewhere in organisations.  Do you think there is a morale issue about extraordinary compensation?

Sir Philip Hampton: There probably will be if there is egregious unfairness in the way that you have described.  That company probably should have given better incentive structures to the people who created value.  It is reasonable if the chief executive is successful that they are properly remunerated.  As Andrew said, they are responsible for all the stuff that goes wrong; even if they had no association with it, they are accountable.  That is life as a chief executive.

Q433       Peter Kyle: I have just one final question, and it is a cheeky question for you, Sir Philip.  One very senior academic gave evidence to us and said that very senior, very successful, very well paid executives and non-executives in the private sector were obsessed with getting gongs and knighthoods, and that they were driven to an almost illogical degree in order to get civil knighthoods.  This academic believed that anybody who is that well paid and that successful within their own particular sector really has no place in getting gongs; they should be saved for other parts of civic life.  Do you have a view on that?

Sir Philip Hampton: Yes.  Generally speaking, I think that is right actually.  The rewards of being in business should be primarily financial, and other awards and appreciations probably should be more directed at people who are not getting financial rewards.  To get both financial rewards and other marks of recognition is a bit too easy.  The honours system has moved away from having businesspeople getting awards, and that is right.

Q434       Chair: Following on from chief exec pay for a moment, Sir Philip, in terms of GSK, chief exec pay went up by 70% from 2014 to 2015, but the share price more or less flat‑lined; there was a bit of fluctuation.  How can that be justified in the wake of business performance and in terms of returns to shareholders?

Sir Philip Hampton: There is a longer-term trend here.  The FTSE 100 basically is unmoved this century, and yet executive pay has—

Chair: Chief execs do not move the dial, then, on company performance.

Sir Philip Hampton: No, I believe that people should be properly rewarded, but I also believe that the structure of executive pay has not been as well connected to overall performance as it should have been over a long period of time, throughout this century.  We have got ourselves into the wrong place, basically.  There has been far too much focus on incentive pay, and paying people basic pay and giving people good basic pay rises became anathema.  That became the big media, political and, indeed, shareholder event.  We have, to some extent, dressed up what we are really paying people through these incentive structures, as a big generalisation—but it is generally true—because a lot of these incentive schemes, frankly, are designed to pay, or at least end up paying out, even if performance is quite indifferent.  That has been the case in plenty of businesses.  Otherwise, pay would not have gone up when shareholder returns did not. 

My personal view is that we should try to have a move back towards much less incentive pay, and, if necessary to keep the level of rewards competitive, more basic pay.  That balance has gone out of balance, if you like, overall across UK plc.  We still need to make sure that we can recruit and retain internationally competitive and mobile people, and so on, but I think that balance is wrong.

Chair: I would like Richard to follow on this argument.

Q435       Richard Fuller: I am very grateful to the Chairman for raising it, because it is interesting.  We have had many evidence sessions, and when the issue of the comparison of the changes in executive pay with the lack of change in the value of companies—the share price of companies—is presented, you can see the tumbleweed going in front of people.  It seems to be most indefensible, and there are therefore two sets of responsibility.  First of all, those who are in positions of governance need to hear the message that it is not okay to leave it as the status quo; they have to start cutting.  Company boards are very good at cutting—cutting employment and cutting down costs.  Start cutting executive pay. 

Secondly, the Government need to step in.  My question would be on the particular aspect of long‑term incentive plans: you have pay, bonus and then these LTIPs.  Should Government act to phase them out or ban them?

Ken Olisa: Is the question, sir, whether we should phase out long‑term incentive schemes?

Richard Fuller: Yes.

Ken Olisa: No, the Government should not act to do anything to those.  From my perspective, the long‑term incentive scheme is one of the most valuable assets that a board has to direct the strategy of a company.  If you start with the premise that a board’s job is to have a strategy, make sure it is being implemented and make sure it complies with the laws, strategy by definition is relatively very long-term.  The board needs to be able to put in place rewards and incentives to manage that.

Q436       Richard Fuller: Can they not be much simpler than these very complicated schemes?  You could just give people stock.

Ken Olisa: That is a different point.  The medium is a much more interesting discussion.  Paying it in stock is a very good idea.  LTIPs are far too complicated, and that is a matter of fact, so I agree with that.

Q437       Richard Fuller: So keep the incentive for the long term but simplify the system.  Would you say that that should be the only way?

Andrew Ninian: We as the IA instituted the Executive Remuneration Working Group last year to look at what the driver of complexity in executive remuneration was, and it became very clear from the interviews that we had as secretariat on behalf of the working group that companies felt bound into the LTIP model.  That was the FTSE model and they thought that they had to follow it.  However, investors were very clear that there are companies that choose differing approaches, that do not follow the LTIP model, and they have shareholder approval. 

The key recommendation coming out from the working group was that there should be more flexibility for companies to choose the right structure that is most appropriate for their strategy, their business model and what they are trying to do with remuneration.  Are they trying to incentivise the management, are they trying to retain the management, or are they just trying to pay for a good job and reward them for the good job done?  Everything is done through the LTIP model at the moment.  The danger of regulating in a specific way is you are quite quickly creating a one‑size‑fits‑all model, and it could create unintended consequences.

Q438       Richard Fuller: Most people employed are happy when they get basic pay, and a very large number are happy when they get basic pay and they get a bonus at the end of the year, and maybe some of that is performance‑related.  Why does it need to be so complicated for the person who runs the company?  It just beggars belief.  Why should he or she not receive the same type of pay as everybody else?  It is clear; it is clean; the board can understand it; and, most importantly, the public can understand it.

Ken Olisa: I am very sympathetic to your view.  Complicated LTIPs make no sense at all.  I have sat in comp committees where it is quite clear that the chief executive does not understand the LTIP, so they just hope it is going to be okay, so it is clearly not an incentive.  I sat on the board of Thomson Reuters, a Canadian listed company, and the non‑executive directors are partly paid in shares, which we cannot access until we leave the board, so our incentive is absolutely share-based and a long‑term incentive.  Do not confuse the medium with the structure.  Complicated structures are a bad idea a priori. 

Q439       Richard Fuller: I am very conscious of time, Chairman.  I do want to ask one question about shareholder activism, if I may.  Who is the UK equivalent of Carl Icahn, and should we have one?

Sir Philip Hampton: It is Andrew.

Q440       Richard Fuller: Oh, it is you.  Tell us about it.

Sir Philip Hampton: I am only being partly flippant, but Andrew does represent the interests of large numbers of shareholders in relation to other questions.  Andrew, sometimes directly, and those shareholders directly do put very demanding challenges to companies.  It is normally done very privately, which I think is right, but it is not done with any holding back.

Q441       Richard Fuller: So it is a very British way of shareholder activism.  We are very active but we do not like to show it.  We are a bit like a swan on water: there is a lot of action but it is all underneath.  They are big shoes to fit on Mr Ninian.  Carl Icahn tried to stop Michael Dell making Dell go private; he got on to the board of Apple and wanted to return some of the enormous amounts of cash.  He got involved in Herbalife and others, and that is just in the last three years, I think. 

Andrew Ninian: What we do is try to represent our members’ views to the market.  Investee companies understand what we as investors in UK plc expect of them.  For example, we have put out guidance on quarterly reporting, asking companies to move away from quarterly reporting; we have principles of remuneration, setting out our members’ expectations on remuneration in which they invest.  There is engagement, so we help facilitate engagement on an individual basis on remuneration matters or other governance matters.  Sometimes there might be a role for the Investor Forum, which we have already heard from this morning.  There is a lot of dialogue that goes on between companies and investors behind the scenes.

Richard Fuller: You are not demonstrating as much steel in your description.  I am not saying that steel is necessary, but one gets the impression with these proxy fights in America that there are these big egos, in companies and outside, trying to effect change.  You seem to be having a cup of tea and making some suggestions on a piece of paper.

Chair: It makes you proud to be British.

Q442       Richard Fuller: I love tea, but do you have the toolkit to be as active as you could be?  Do you think there is merit for us to be more like the system in America?

Andrew Ninian: The system in America is bound to the legal framework and the rights that shareholders have there.  In the UK, we are premised on a different system in terms of our code, our company law, the way that engagement has worked in previous years and the way that the conversations work, with feedback between companies and investors. 

The way that this goes forward is that we have to recognise the internationalisation of the UK capital market and UK plc, with our members representing a lower amount of the stock market than they did in the past.  We probably account for around a third of the stock market; whereas when it was the ABI and NAPF it was over a half, so there are issues in terms of how much of the market we now represent, but UK‑based institutions do a disproportionate amount of governance and engagement with UK plcs because they see it as their role, and they also see it as part of their investment process, creating long‑term value for their clients by getting the best‑run companies.

Ken Olisa: I feel that the Carl Icahn of the UK, in my experience at ENRC, was The Sunday Times.  I have never had, in my time on the Reuters board in the UK or my time on the ENRC board, a constructive discussion with an investor in Andrew’s group of people.  There are no Carl Icahns.  The press does in this country what they do not do in America and what Carl Icahn does: attack, chivvy away at points and so on.  I do not recognise this description of dialogue between investors and non‑executive directors of major companies.

Sir Philip Hampton: US investors, if they are unhappy, as likely as not will sell, invest somewhere else and not go through the hassle of engagement with the companies.  It is quite expensive to do some of this interaction.  It is not universally true but I think it is generally true.  The situation Andrew describes is absolutely right.  Particularly for big companies with significant issues, the engagement is intense, sometimes aggressive or hostile, very uncomfortable, with not very nice cups of tea.  It is absolutely wrong to think that the big investors in this country do not engage with companies where they have concerns, whether it is about remuneration, strategy or governance; they engage and quite a good bunch of them engage very significantly.

Ken Olisa: Philip, would you agree that they engage with the chairman and the investor relations people of the organisation, not with the whole board?

Sir Philip Hampton: Yes.  It is mainly through the chairman.  When it gets most difficult, there is engagement with the chairman about the management, about the strategy or about the board.  Sometimes it is a senior independent director.

Chair: Gentlemen, that has been a very useful discussion with us.  We are very grateful for your giving evidence.  Thank you for your time.