We Really Need to Talk About Executive Pay
In the latest report of the Business, Energy and Industrial Strategy Committee, MPs called for businesses to simplify the structure of executive pay and put an end to long-term incentive plans which, they say, “have become too complex and are liable to create perverse structures and short term decisions”. They recommend a more simple pay structure, comprising salary, bonus relating to stretching targets, including those relating to wider performance criteria and payment by means of equity over the long term.
There is an awful lot of discussion at the moment around executive pay, who should opine on it and whether the levels are commensurate with the responsibilities.
One thing which should be self-evident is that there needs to be a change in what is perceived to be payment for failure. Unless you are a football manager, where payment of failure seems to be the norm, action needs to be taken to make the payments for “failure” less egregious. While it is important that contractual terms are adhered to, there is, quite understandably, a sense of outrage that often Chief Executives receive significant sums of money for apparent failure or, worse, where there has been evidence of apparent malpractice. The situation which transpired when Phil Clarke left Tesco is but one example. There can be no justification for bonuses or other sums to be paid to Chief Executives who are departing the business, either voluntarily or involuntarily. They must be paid their contractual entitlement as to salary but no more. A bonus scheme which “has not yet paid out” is exactly that and should be treated as such. It is, however, important to remember that, quite often, Chief Executives who have “failed” in a business will find it extremely difficult to find a commensurate role in the future. While it is not the responsibility of the company from which they are departing to compensate them for this, nevertheless it is important to recognise this in looking at their severance payment.
Turning to the question of pay in general, I cannot accept the argument that the pay for the Chief Executive which be a specific percentage of that which the “average” worker within a business receives. As others have said, this very much depends on the business in question as “average pay” in a business with a higher percentage of higher paid, skilled businesses would, therefore, mean that Chief Executives were paid more even though the business might be smaller and their responsibilities lower. Furthermore, how does one take into account the pay in other parts of the world which can completely distort a global business’ pay scales? We have to remember that, whether Donald Trump likes it or not, we are living in a global market. If the UK falls behind other countries by overly legislating around pay, UK plc will potentially not be able to attract the best talent, especially at the moment given the uncertainties around Brexit.
It is, of course, important that the interest of executives should be aligned with the interests of shareholders. It is their responsibility, as directors, to act in the best interest of shareholders and therefore their remuneration should reflect this. There should always be a place for a short term, annual bonus in any remuneration package. However, targets need to be clear, unambiguous and allied to the best interest of shareholders and the amount paid out in respect of annual bonuses should, in my opinion, not exceed 100% of base salary and should be targeted at paying out some 50% of base salary. Companies have tried, together with remuneration consultants, to become cleverer and cleverer about designing schemes so that they have become virtually incomprehensible. Boards need to decide on the two or three key parameters for the success of the business (excluding share price which is a resultant of success) and align the annual bonus with these.
Turning to long term incentives, although it is an imperfect measure, the best and most obvious measure of the performance of a company lies in its share price. Long-term incentives should, therefore, be allied to the share price performance and, in order to encourage executives to act in the long-term interest of the company, it should be made mandatory to hold the shares for a specific period of time. However, one must be careful not to encourage Chief Executives to overstay their welcome. It is accepted that Chief Executives should move on after a period of time which is probably no less than four and no more than seven years after first taking office. It would therefore make sense for shares to be held for that period of time. While it would often be considered to be unfair for Chief Executives to have to buy significant amounts of shares at the outset of their tenure as it could be a disincentive for the right candidate to join the company, similarly shares should not be gifted to them. Surely, therefore, the best way of tying remuneration to performance is to return to the darling of the 1980s – the share option. Share options have the beauty of being easy, clean and, if allied to a lock in period before which they cannot be sold, ensure that long-term performance is at the forefront of executive’s mind. The added advantage of a clean and easy remuneration structure such as a bonus plus share options means that significant proportions of the annual report could now be culled, directors could spend time worrying about important things such as the strategy and direction of the business and the role of the “remuneration advisor” would be significantly reduced, thereby reducing the costs to the company. This looks like a win-win situation to me.