How to harness CEO self-interest to protect pensions
12 February 2019
- More defined-benefit pension schemes survived if CEO was a member
- Staff pensions more likely to close if bosses have their own executive plan
- Study suggests pensions could harness CEO 'self-interest' like shareholders
- Government-backed prison terms for 'reckless' bosses hard to enforce
Forcing bosses to join the same pension plan as their staff could protect ‘salary-related’ pension schemes that offer workers a guaranteed income when they retire, a study shows.
Researchers believe it could also prevent huge firms like Carillion collapsing with black holes in their pension funds, as directors would stand to lose most.
Carillion workers were members of a defined-benefit pension scheme, which promised a guaranteed income once they tired.
However, the pension scheme was nearly £1 billion in deficit when the firm collapsed in January this year. It means 28,000 workers will lose at least 10 per cent of their annual pension, with the rest paid by the Pension Protection Fund, which acts as a ‘lifeboat’ for failed pension schemes.
The directors did not lose out, as they were members of another executive pension scheme, which appeared to be well-funded prior to Carillion going into liquidation.
The collapse of Carillion and BHS became a key focus for a Government white paper, Protecting Defined-benefit Pensions, and a cross-party Parliamentary Inquiry last summer.
This week Amber Rudd, secretary of state for work and pensions, promised tougher jail sentences of up to seven years for bosses who mismanage company pension schemes.
But Joanne Horton, Professor of Accounting at Warwick Business School, who has researched defined benefit pension schemes and provided written evidence to the inquiry, believes that forcing bosses to join the same company pension scheme as their staff could better protect those pension plans.
She said: “If Carillion CEO Richard Howson and his executives had been members of the company’s main pension plan the outcome might have been different.
“If they had paid more into the main pension plan alongside their employees, instead of having their own executive pension scheme, they would have stood to lose the most when the company collapsed.
“Government plans to protect defined benefit pension schemes are a welcome development, but the focus is still on punishing ‘reckless’ trustees, rather than encouraging CEOs to fund pension schemes properly.
“It is incredibly difficult to define what constitutes ‘reckless’. The decisions the trustees took may have been completely rational at the time, they just turned out to be the wrong ones.
“Trustees can also recommend contributing more to the pension scheme, but the CEO can say no.
“As CEOs have the final say, it seems far more logical to incentivise them to fund the main pension scheme properly by requiring them to be members, rather than threatening the trustees with a punishment that could be near impossible to enforce.”
A study by Joanne Horton, of Warwick Business School, Paraskevi Vicky Kiosse from University of Exeter Business School, and Evisa Mitrou from Queen Mary University of London examined all 322 publicly listed UK firms that offered a defined-benefit pension scheme between 1999 and 2013.
They found 74 per cent were in deficit, to a total of £560 billion.
As a result 74 firms fully closed their defined-benefit plan during this period. A further 156 firms partially closed their pension plan, denying access to new members of staff.
Instead workers paid into defined-contribution pension plans, where the money was invested on their behalf with no guarantee how much they would have to support them in retirement.
If employers offered a defined-benefit pension scheme, the share-holders bore the risk if its investments underperformed as the company had to make up the shortfall. That would affect its profits, share prices, and dividends.
Defined-contribution pension schemes transferred all that risk to the employees, as their individual pot and their annual pension would be smaller if the investments underperformed.
Firms with underfunded pension plans also found it harder to borrow money. Therefore shareholders often put pressure on CEOs to close their company’s defined-benefit pension scheme.
The researchers found CEOs were 77 per cent less likely to close the firm’s main defined-benefit pension scheme if they were a member and a trustee of the plan, even if the scheme was in deficit.
However, if the CEO was a member of a separate executive pension scheme and the main pension plan was underfunded, it was 62 per cent more likely to close.
CEO membership of the main defined-benefit scheme also reduced the negative impact it had on the company’s credit rating, even if the plan was in debt.
This suggests credit rating agencies recognise that those CEOs have a stake in making sure the firm’s pension plan is sustainable and preventing conflict between the executives and debtholders.
Professor Horton said: “If the Government wants to tackle ‘reckless’ executives who undermine company pension schemes, they could harness CEO self-interest.
“Shareholders do it all the time. They offer CEOs stock options to ensure they share their interests, including closing the firm’s defined-benefit pension scheme.
“Regulators can harness CEO self-interest in the same way by requiring them to become members of the firm’s main pension plan on the same terms as their employees.
“That could potentially prevent further scandals like Carillion and protect the remaining defined-benefit pension plans from closure.”
This research was the subject of an article in FT Adviser.
Joanne Horton is Professor of Accounting and teaches Advanced Corporate Reporting on the MSc Accounting and Finance, Accounting and Financial Management on the Executie MBA (London) and Critical Perspectives of Accounting on the Undergradute programme.
For a copy of the research, the submission to the Parliamentar Inquiry on the white paper Protecting Defined-Benefit Pensions, or to request interviews with Joanne Horton, contact Warren Manger on 024 7657 2512 or email email@example.com or call Ashley Potter on 024 765 73967 or email firstname.lastname@example.org.