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What’s the Story?

Sir Jon Cuncliffe last week announced on BBC Radio 4 his approach to the fundamental government review of the UK Water Industry. The Independent Water Commission will report in June 2025 and is now open for public consultation and comment.

This follows the July 2024, Labour's manifesto which promised: 

"to put failing water companies under special measures to clean up the UK's water, by providing regulators new powers to block the payment of bonuses to executives who pollute our waterways and bring criminal charges against persistent law breakers" 

True to this promise, on 24 February 2025, The Water (Special Measures) Act 2025 received Royal Assent. This gives the regulator OFWAT new powers to take tough action against water companies damaging the environment and failing to deliver customer service. 

Among the provisions is power to ban bonuses for water bosses if they fail to meet high standards regarding protecting the environment, customer care and protecting the company’s finances. 

OFWAT has welcomed the new powers and said: 

“The Act gives Ofwat new powers to set requirements for companies on remuneration and governance, including prohibiting performance-related executive pay:  .. and that… “We are working at pace to implement the new rules and intend to launch consultations on the final proposals later this year.” 

Why Does it Matter?

The water industry was privatised in 1989 by Margaret Thatcher with much public disagreement and disquiet as to how such a vital public monopoly might operate smoothly within the capitalist system. The UK water industry has since come under successive waves of criticism for poor service, under investment and excessive pollution of seas and rivers. 

Furthermore, shareholder dividends and executive bonuses regularly attract unfavourable public comment. And all that for an industry needing high and ongoing capital expenditure, with growing demand as the UK population expands. 

Executive incentives should be designed to focus attention on the key objectives of the business and provide sharp incentives to deliver those aims. In most commercial companies the main aim is to deliver shareholder value through sustained profitability. However, incentives also recognise and reward other important Environmental, Social and Governance (ESG) factors. CORPGRO commented on ESG Tree some time ago.

In a regulated water company, the primary objectives should focus on service delivery, which includes providing a clean and continuous water supply, as well as safe and reliable wastewater disposal and treatment. These services should be delivered with minimal environmental disruption. While profit and return on capital are important, they must be balanced with these fundamental purposes.

A commercial company failing to deliver customer service will soon go bust. That discipline does not apply to a natural monopoly like water. Instead, the requirement to deliver strongly on both quality and price falls to the regulator. 

In March 2023 OFWAT announced that customer interests will be better protected against the cost of bonus payments where overall performance falls short of the requirements. Bonus cost would be met in full by shareholders in these circumstances, not customers. But OFWAT would not intervene in the bonus setting, evaluation or payment process. This was just a “who pays” thing.

Water companies have very capital-intensive activities and rightly, the capital at work should receive an attractive risk sensitive return under the regulatory regime. But that must be accessed only after delivering the required customer outcomes. Non-financial and financial metrics should interact smoothly. Too often non-financial requirements are siloed into a minor part of the bonus opportunity and so their impact on executive messaging and behaviour is diluted. 

Newspoint view

The 2023 OFWAT move misunderstood the role of bonus incentives for executives. Incentives drive behaviours that drive results. It is not about who meets the bonus cost, executives don’t much care. Rather it is what the bonus is focused upon in the first place that drives attention and performance. 

Bonuses paid when customer or environmental outcomes are poor can now be banned by the regulator. But up front incentive focus and weighting can reshape culture and behaviours dramatically. Getting incentives refocused on the right things is always important. For a core public service, it is vital. 

OFWAT should have a role in approving incentive pay up front. Not in designing bonus proposals, but in approving them before implementation. They should make it clear that customer and environmental factors need to act as an integral part of the overall bonus mechanic, not as a bolt on side addition. 

Shareholders of a listed company have a forward looking and binding vote on Directors’ Remuneration policy. And another, separate, binding vote on all new Directors’ Long Term Incentive Plans (LTIPs). This recognises that closing the stable door while the horse is still inside, is obviously better than after the horse has bolted. The same rules should apply to OFWAT and water companies. 

There will be grim satisfaction in seeing a poorly performing water company boss not receiving their future bonus. But better still by far that they do get paid, but only paid for good performance delivered from a correctly focused incentive design. 

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Executive Compensation and Incentive Design

Please feel free to email or call:

Damian Carnell - [email protected] +44 (0) 7989 337118

VA Bec Bostock - [email protected]

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