In particular, it wants to see a “fundamental shift” in the structure of their remuneration packages towards ones that are “much simpler, more transparent, more performance than share price driven and less leveraged”.
It also wants to see the board and its remuneration committee being held much more accountable for remuneration policies than they are now.
In its paper, Remuneration Principles: Clarifying Expectations, it says that the prevailing executive pay model is deeply flawed.
For instance, there have been huge rises in CEO compensation over recent years – the High Pay Centre, which runs a clock on its website showing how much the average FTSE 100 director is earning by the second, has worked out that the ratio of CEO pay to the average worker has doubled in just over a decade, from 70 times in 2002 to 140 times in 2015.
This has caused growing public resentment as evidenced by recent PwC research which found that two thirds of the population thought executive pay was too high, enraging 72% of them. It has not gone unnoticed by politicians, including prime minister Theresa May.
Hermes points to other issues it has with the existing pay structures. They are often misaligned to long-term value: they are highly leveraged and yet they too predictably pay out at a consistently high level, with average FTSE 100 bonus payments of 75% of the maximum and 80% of companies paying out target levels of bonus every year.
“This suggests that target calibration is difficult and ‘variable’ or ‘performance-linked’ pay are misnomers,” it says.
Incentive schemes are often so complicated that their ability to motivate is reduced. As a result, Hermes complains, the participants consider them as “little more than lottery tickets” although with some elements almost guaranteed to pay out.
Finally, the asset manager says that trust between remuneration committees and investors is “at a low ebb and among the public is lower still”. This is not all the companies’ fault. Investors often fail to engage with them meaningfully or hold boards to account sufficiently.
Hermes, which manages £28.6bn in assets, believes that both companies and investors need to resolve their tensions through engaging constructively and being open to constructive change.
It says it follows five remuneration principles that were drafted in 2012 with the purpose of encouraging companies to make proposals for their pay structures that reflected their strategies and business models.
“Our proposition was that pay should direct management to behave more as engaged owners rather than short-term custodians of a business.
“The resulting success will ultimately be reflected in the long-term share price to the benefit of investors, management and the company.”
The Hermes principles are:
• Shareholding: management should make a material long-term investment in the company’s shares
• Alignment: pay should be aligned to long-term success and the desired corporate culture
• Simplicity: pay schemes must be clear and understandable for both executives and investors
• Accountability: remuneration committees should use discretion to ensure that awards properly reflect business performance
• Stewardship: companies and investors should meet regularly to discuss strategy, long-term performance and the link to executive remuneration.
Hermes also recommends that the chair of the board should write annually to the employees of the company to explain the basis of the chief executive’s pay award for the current year. The company should also discuss the ratio of CEO to median worker pay, using both internal and external comparisons.
Hermes Investment Management chief executive Saker Nusseibeh said it was time for companies and investors to rethink their approach to executive pay. “The investment management industry must recognise its responsibility to engage with companies effectively as interested owners and, where necessary, use shareholder rights collectively and consistently.”
He said Hermes stood ready to work with companies to help them make the changes necessary in the interests of the company and their long-term shareholders.