UK: The rolling contract.

UK: The rolling contract. - As a practice, the rolling contract, with its guaranteed pay-off, makes failure highly profitable and shows little sign of abating.

by Matthew Lynn.
Last Updated: 31 Aug 2010

As a practice, the rolling contract, with its guaranteed pay-off, makes failure highly profitable and shows little sign of abating.

When Liam Strong finally departed as chief executive of the ailing retail conglomerate, Sears, in April, the immediate and instinctive question from the press and shareholders was 'What's the pay-off?' In Strong's case, around half a million, a sum that raised few eyebrows. The lavish pay-off has become deeply ingrained in British corporate life, as much a part of the executive package as private healthcare, a pension and a chauffeured Jag.

So, if Strong's valedictory cheque was so unremarkable, why the public outcry, and why the roasting in the serious and tabloid press alike? After all, Strong had been running Sears for five years, for which he had been well paid - around £400,000 a year. It wasn't as if he'd been suddenly turfed out. As the company stumbled from one disaster to another, its share price underperforming the market by 55%, there were plenty of warnings that his job was on the line. And yet, when the shareholders finally demanded his head, the company had no alternative but to write him a fat cheque, a clear-cut case of reward for failure.

Strong, you see, was on a two-year rolling contract - and the sum he collected was, in relative terms, actually pretty modest. Last October John Clark picked up £3 million in compensation after being sacked as chief executive of BET following its takeover by Rentokil. Clark had a three-year rolling contract and couldn't be sacked without being given three years' money to see him on his way - despite strong opposition from Rentokil.

Little could better illustrate the gulf between the employment conditions of the average British employee and the goodies enjoyed by the people who run large companies. Most people, if given the boot, would be lucky to receive three months' pay, let alone three years'. And, were some egalitarian Eurocrat in Brussels to propose them as part of the social chapter, the cries of protest from industry would be deafening. Boards would point out that industry would be reluctant to hire new staff unless it was easy and cheap to get rid of them: do as we say, not as we do.

It wasn't meant to be this way. As long as four years ago, a group of institutional shareholders launched a campaign against long rolling contracts, recognising that they were both fundamentally unfair and often deeply damaging to shareholders, whose money was, after all, being used to finance the pay-offs. And yet, after much huffing and puffing and the publication of several codes of conduct (Cadbury, Greenbury and now Hampel), little appears to have changed.

The prime mover in the campaign against rolling contracts was Alistair Ross Goobey, the single-minded head of Hermes, the pension fund manager with more than £30 billion under its control. In June 1993, he wrote to the chairman of each of the FTSE-100 companies, warning them that as a matter of policy Hermes (then known as Postel) planned to vote against the re-election of any director with a rolling service contract of more than 12 months.

The fund managers had been spurred into action by a series of pay-offs which, even by the City's generous standards, seemed extravagant. For, example, after the takeover of Ranks-Hovis McDougall by Tomkins, the company had to stump up £2.2 million to four departing directors. Earlier, when Bob Horton, now Railtrack's chairman, was ousted from BP, the board softened his landing with a pay-out of £1.5 million. The departure of Peter Scott as chairman of the media-buying group Aegis had cost the shareholders £2.2 million. And all those payments were generously capped by the £3-million cost to Glaxo's shareholders for seeing the back of its chief executive, Ernie Mario.

The rise of long rolling contracts had taken place gradually, almost without anyone noticing. Originally put in place to make sure executives couldn't hop from company to company (and thus, arguably, in the interests of shareholders), they gradually became part of the normal package awarded to senior executives. By the late 1980s it was quite normal for executives to be appointed with rolling contracts lasting five years.

Of course, the main problem was not really the length of these contracts but the fact that they were rolling: rather than naturally reaching the end of a contract, an executive would always have a notice period of several years and thus could always expect a number of years' pay upon dismissal.

That meant that every time one was sacked for failing in their job, a pay-out of millions was unavoidable. The 1992 Cadbury Code, the first of the recent reports on corporate governance, recommended a two-year maximum for rolling contracts and many businesses did shift down from five years to two.

Ross Goobey succeeded in putting the issue at the top of the agenda: his attack on rolling contracts won plenty of publicity and political support, but it didn't immediately solve the problem. As concern over executive pay mounted, boardroom pay became a hot political issue. The Government's response was to set up the Greenbury Committee, headed by the eponymous M&S chairman, to examine both pay and pay-offs.

Greenbury found it difficult to steer its way through the minefield of executive pay, but condemning pay-offs for failure was one of the relatively easy moves it could make. When the code was published in 1995 it recommended that companies should move towards contracts of no more than one year in duration and sometimes even less, unless there were particular circumstances that made a longer contract necessary. Thus far, there has been little movement towards these goals. 'There has been progress in the right direction,' says Ross Goobey, the man who initiated the campaign in the first place, 'but it hasn't been as fast as it should have been.'

Part of the problem has been the fact that the Greenbury code was, after all, voluntary. Pensions and Investment Research Consultants (PIRC), a corporate governance consultancy that monitors companies on behalf of pension funds, has found countless examples of businesses flouting the code. In a survey last year it found that in the first half of 1996 the rewards for failure paid out to directors of the top 250 quoted companies rose to £22.8 million, almost matching the £23.2 million paid out in 1995, the year the Greenbury Report was published.

It found that although three-year rolling contracts, which covered 44% of directors before Greenbury, had fallen to just 5% of companies, the number of two-year contracts had risen from 24% to 54%. A subsequent PIRC report, published earlier this year, found some, but not much, improvement: 76% of companies had some or all of their directors on contracts of over a year.

In some ways Greenbury had backfired. What was put in place as a recommended maximum under Cadbury had rapidly come to be regarded as the norm: now everyone wanted a two-year rolling contract.

Another survey, this time by Arthur Andersen, found that an astounding 85% of British companies were ignoring the Greenbury Code by offering service contracts that ran for more than one year. It found that three-year contracts were restricted to just 9% of companies, suggesting that the campaign had had some effect in curbing the worst boardroom behaviour, but that two-year contracts were the norm in most of the companies it looked at. 'It shows that Greenbury has not really had any effect at all,' says Anne Simpson, managing director of consultants PIRC. And now we have the Hampel report. Part of Hampel's remit was to address the 'box-ticking' attitude that its predecessors had engendered; this it did by advocating broader 'principles' of corporate governance. But 'principles' are damnably vague and open to interpretation.

On the issue of executive pay-offs, Hampel is unlikely to make much difference; indeed, it is viewed by some City observers as a step backwards, not forwards.

And utterly excessive five-year contracts continue to be offered and signed. For instance, both Sir Tom Farmer, chairman of Kwik-Fit, and Sir Richard Storey, chairman of Portsmouth & Sunderland Newspapers, have five-year rolling contracts. While such cases exist, without any form of action being taken against them, there is little incentive for the average two-year contract to be reduced.

Shareholders may be irritated by some of the excesses of the companies they own, but so far they have proved only partially effective in curbing what they often see as unnecessary and unwarranted greed. In the end, the one effective sanction they possess is the one originally threatened by Ross Goobey four years ago; voting against the re-election of directors who have service contracts running for more than a year. 'The trouble is that we would be throwing the executive out with the bath water just to prove a point,' says one fund manager.

There is some evidence that fund managers are prepared to go that far. Unofficial figures suggest that at some AGMs in the past year votes as high as 30% have been recorded against executives with long service contracts; not enough to kick them out, but enough to give some pause for thought. Likewise, PIRC research into proxy voting (used in the rare instances where a show of hands at the AGM is not felt to be enough) threw up some interesting results: of the 50 directors who attracted the greatest opposition, 72% were executives and, of these, 94% had contracts longer than one year. There has yet, however, to be an example of an executive being voted off the board simply because the shareholders did not like his or her service contract. Until that happens executives may feel confident their rolling contracts can survive.

Not only is there a reluctance among shareholders to vote down executives.

There is also a reluctance to force the courts to take the circumstances of dismissal into account. Some shareholders now argue that where chief executives have failed, companies should refuse to give them a pay-out, even if they have a long contract, on the grounds that they have not done a good job. 'We would like boards to take a stronger attitude to mitigation in those cases where executives have been terminated for underperformance,' says Ross Goobey. It is a worthy aim, though PIRC found that only 16 of 78 companies even provided a statement on mitigation in their annual reports.

Given this limited progress in the campaign against long contracts, and Hampel's half-heartedness, it would be unwise for anyone to hold their breath.

Name: John Carter

Position: Chief executive Company: Hepworth

Rolling contract: Two years

Pay-off: Quit the industrial group after five years in the wake of falling pofits and warnings that more of the same were to be expected: his pay-off was undisclosed.

Name: John Clark

Position: Chief executive

Company: BET

Rolling contract: Three years

Pay-off: £3 million. He took Rentokil to court for sacking him after its takeover of BET: the award was for loss of salary, loss of pension, bonuses and other benefits.

Name: Richard Clothier

Position: Chief executive

Company: Dalgety

Rolling contract: Two years

Pay-off: Pocketed £620,000 plus pension entitlements on resigning after 20 years with the troubled foods group when it reported a £72-million loss.

Name: Gerald Corbett

Position: Finance director

Company: Grand Met

Rolling contract: Two years Pay-off: Left with £600,000 before the food and drink group's £23-billion merger with Guinness, after his Guinness counterpart was designated finance director of the combined entity.

Name: George Greener

Position: Chairman

Company: BAT Industries financial services arm

Rolling contract: Two years

Pay-off: Left in the face of an overhaul of the Eagle Star and Allied Dunbar operations he had run for four years: £706,000 plus £585,000 pension top-up.

Name: Roger Leverton

Position: Chief executive

Company: Pilkington

Rolling contract: Two years

Pay-off: Lost the top job at the ailing St Helens glassmaker for failing to cut costs fast enough in view of tumbling European glass prices and the strong pound: £900,000.

Name: Stuart Lyons

Position: Chief executive

Company: Royal Doulton

Rolling contract: Two years

Pay-off: He stepped down by mutual agreement after a failed acquisition. Because the decision was mutual, he waived the £500,000 he could have claimed under his contract.

Name: Brian Staples

Position: Chief executive

Company: United Utilities

Rolling contract: Two years

Pay-off: £600,000. His forced resignation brought critical reaction from institutional shareholders who, it seems, would have preferred to see the chairman go instead.

Name: Liam Strong

Position: Chief executive

Company: Sears

Rolling contract: Two years

Pay-off: His £500,000 pay-off as part of a planned break-up of the stores group sparked a furore among shareholders distressed at a steady decline in the share price and a plunge in profits.

Name: John Willis

Position: Director of programmes

Company: Channel 4

Rolling contract: Three years

Pay-off: Left following a decision not to choose him to replace Michael Grade as the channel's chief executive: £500,000.

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