Reforming company pension law
British workers hoping to boost their retirement income through work-related pensions are in for a shock. Employers are not obliged to honour their commitment to keep pension schemes solvent even though employees have made all agreed contributions. Company law permits directors and shareholders to extract high returns and then dump companies without making good liabilities to pension schemes.
BHS, one of the UK’s biggest retailers, entered liquidation on 2 June 2016. Its 2014 accounts show a deficit of £139m on its defined benefit (DB) pension scheme. This is based on the 2012 valuation of the scheme and 2016 valuation would produce an even bigger deficit. BHS pension scheme had been in deficit from 2003 to 2014, with the exception of 2008, but did not face any questions from the Pension Regulator. During the period 2000 to 2014, BHS shareholders extracted around £930m from the company.
An insurance company buy-out of the BHS pension scheme seems the most likely form of rescue. This option would require an injection of more than £550m. With BHS in liquidation, the DB pension scheme ranks as an unsecured creditor i.e. it will receive something once the secured creditors are paid. The chances of that are nil. So over 20,000 past and present BHS employees are facing major cuts to their pension rights.
BHS is not alone in neglecting pension scheme obligations. In June 2016, a report published by investment advisors, AJ Bell, showed that 54 of the FTSE100 companies with a pension scheme deficit paid £48bn in dividends in 2014 and in 2015. In 2014, the same companies had £52bn deficit on their pension schemes. The dividends paid by 35 of the FTSE100 companies were bigger than their pension scheme deficits. Here are some examples:
In 2014, Royal Dutch Shell had a pension scheme deficit of £6.7bn, but paid out dividends of £7.5bn and £8bn in 2014 and 2015. AstraZeneca had a deficit of £1.87bn in 2014, but paid dividend of £2.2bn and £2.4bn in 2014 and 2015. British American Tobacco had a deficit of £628m, but paid £2.8bn and £2.9bn as dividends in 2014 and 2015. Vodafone had a deficit of £549m but paid dividends of £3bn and £3.04bn for 2014 and 2015. Directors personally benefit from neglect of pension obligations because they hold shares and share options. Higher dividends increase the value of share options. So what’s to be done?
First, a key requirement is to ensure that directors cannot extract cash and then dump companies by walking away from pension liabilities. The composition of the boards of companies with more than 500 employees needs to be changed. My preference would be for a system of two tier-boards. One tier consisting of the Executive Board, elected by shareholders, manages the business. The second-tier consisting entirely of stakeholders, including employees, should supervise the Executive Board. This Supervisory Board would appoint executive directors, design their remuneration package and approve strategic decisions, including those related to investment, financing and dividends. Its key duty would be to ensure that all wealth is equitably shared. Such boards would not have easily enabled BHS and others to dishonour obligations to employees.
Second, BHS and other companies have made full use of financial engineering to boost profits and shareholder returns. However, what is good for shareholders is not necessarily good for employees. The pension scheme trustees should have a right to demand an alternative audit of company accounts to satisfy themselves of the risks associated with the financing of pension schemes.
Third, companies should not be permitted to pay dividends without making good deficits on pension schemes.
Fourth, companies with a deficit on their pension schemes should file a report with the Pension Regulator, explaining how it will eliminate the deficit and whether past promises have been kept. The Regulator must provide a public response to that report.
Fifth, pensions and insolvency legislation should be changed so that the pension scheme is treated as a preferential creditor i.e. the deficit on it will need to be eradicated before any creditor is paid.
The above proposals are not a panacea because tensions between corporate capitalism and social responsibility cannot easily be dissolved. However, the reforms have a capacity to dilute the power of directors and shareholders to abuse employees.
Prem Sikka is professor of accounting at the University of Essex and the leading left commentator on financial accounting matters