Are directors too cowardly about executive pay?

The executive pay model may need fixing - but more standardisation is not the answer, a report warns.

Last Updated: 31 Aug 2010

This year we’ve seen a lot of attention focused on executive pay – or more specifically, on what’s wrong with it. How were City types allowed to rack up huge bonuses when their decisions ended up destroying billions of pounds of shareholder value? How could corporate leaders be collecting target-based incentives at a time when workers were being laid off? Well, according to a new report from search firm Hanson Green, the key is for directors to think much harder about what kind of reward packages their company specifically needs, rather than just copying the industry best practice…

There’s clearly a prevailing view that Something Must Be Done about executive reward; that’s obvious from the big shareholder rebellions that the likes of BP, Shell and Next have faced lately when trying to get their remuneration reports passed. Hanson Green argues that the issue is not bonuses per se, but the targets used - and it reckons that this highlights a fundamental failing of most companies’ approach to reward. Rather than taking a long hard look at the business, working out its key performance indicators (along with a suitable timeframe) and devising a bonus scheme around them, directors have been far too keen to adopt standard schemes with suitably benchmarked numbers – on the grounds that it’s easier to get them past the governance lobby.

‘The problem is that most remuneration committees are just not very brave,’ says Legal & General chairman Sir Rob Margetts, who’s quoted in the report. ‘Standardisation makes no sense given the huge diversity of businesses. Companies have entirely different ‘heartbeats’ when it comes to assessing performance, depending on the sector, cyclicality, size and maturity. Remuneration structures should reflect this diversity.’ But instead, when someone takes a radical approach – as Richard Lapthorne did at Cable & Wireless, with the introduction of private equity-style incentives – they just attract controversy.

We can see the argument that it's daft to throw the performance-related pay baby out with the bonus bathwater; after all, if sensible bonuses structures can help inspire out-performance, they’re clearly worth having. The problem is that identifying the correct KPIs is an awful lot easier with the benefit of hindsight (presumably the banks didn’t think at the time that they were incentivising the wrong things). For bonuses to be effective motivation, they have to be simple enough for individuals to understand - but the simpler they are, the less likely it is that they'll incentivise the right behaviours across the board, particularly over an extended period of time. If the remuneration committee can square that circle, they really will have earned their crust.

In today's bulletin:

Government's bank reforms are a waste of space, say MPs
BA plunges to £148m loss - can Walsh stop the rot?
We need a longer-term lending solution, says FPB
Are directors too cowardly about executive pay?
Learning from the voice of experience, with YouTube

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