The proposed strengthening of UK shareholders’ say in executive compensation arrangements would increase their influence over company policies, but considering the tools shareholders already possess to impose their will on boards are unlikely to materially shift the balance of power between shareholders and debtholders, Fitch Ratings says.
In the boom leading up to 2007 numerous companies chose to relax their financial policies to take advantage of cheap debt to boost share buybacks and engage in M&A. This contributed to the average downward rating drift of half a notch in the average corporate rating in the four years to 2007 – the same downward movement as in the 2008/9 recession. Shareholder pressure played a significant role in this, most notably with activist investors regularly forcing changes in corporate strategy.
Importantly, this all happened without binding executive pay votes, and there is no legislative reason why it could not happen again. Indeed, in the US we have already seen a partial resurgence: increased share buybacks have led to eleven downgrades since the start of 2011. The greater macroeconomic uncertainty in Europe means boards, shareholders and bondholders remain generally risk-averse, and we expect this, along with the current crisis, to take some time to change.
The UK government is proposing a number of measures designed to limit excessive executive pay. These include introducing annual binding votes on remuneration policy and exit payments.
Corporate compensation feeds into our credit analysis indirectly through our assessment of a company’s corporate governance regime and the quality of its management. In general, bondholders’ desires around executive compensation should be aligned with those of long term shareholders – both groups have an interest in paying enough to attract capable leaders, but not too much, and ensuring broader remuneration is linked to increased cash generation in the medium term leading to improved interest and dividend cover.
There are frequent points of practical divergence, though. These include sum-of-the-parts valuations, where shareholders apply a valuation discount to conglomerates, but bondholders usually value diversification; financial policy, where there is rarely any upside for bondholders in gearing up; and more general attitudes to risk in financial strategy.
