UK: Heller on Management - Heads they win, tails they win.

UK: Heller on Management - Heads they win, tails they win. - With recent research showing that the more excessive the executive pay, the poorer the results, Robert Heller questions the reliance on short-term financial measures to assess performance at th

Last Updated: 31 Aug 2010

With recent research showing that the more excessive the executive pay, the poorer the results, Robert Heller questions the reliance on short-term financial measures to assess performance at the top.

Want to get the largest possible reward for running a company? Then sack the most workers. That seems to be the message of a recent survey in the US by the Institute for Policy Studies. Last year, it records, 'lay-off leaders' won average rises of 67%, against (a still astonishing) 54% across all 365 top corporations.

Wall Street just loves lay-offs, and the redundancy leaders duly benefited. But boards should look before they leap into fresh orgies of downsizing. Other research, carried out by three Wharton professors, finds (to quote the Financial Times) that 'companies which pay their chief executives too much typically perform badly in terms of profit and share prices'.

The two pieces of research used differing approaches. The Institute looked only at short-term, one-year pay-offs for lay-offs, while the Wharton team investigated one-, three-and five-year returns on assets and to shareholders. Despite these differences, the Wharton measures show an embarrassing correlation: the more 'excessive' the pay, the poorer the results. The corollary is still more disconcerting: the less excessive the chief executive's pay, the better the performance.

But what does 'excessive' actually mean? The definition, even among many top executives, is simply the prevailing level of payment. A Business Week/Harris poll found that 47% of such executives think that US companies pay their top officers 'too much'; only a few more (51%) opt for 'just about the right amount'. However, the picture is markedly different in the context of their own company. A starry-eyed 89% believe their top boss's pay to be either almost perfect - or too little. There's no point in asking what criteria were used for these ill-fitting judgments, for the answer is plainly none. The main determinant of reward is merely what the traffic will bear.

Periodically the public or the authorities (or both in the case of the British) express indignation over excessive pay. This has a mildly moderating effect - very mild. The traffic goes on bearing increasingly stunning sums, with the US leading the way. Average total compensation, after the 54% rise mentioned above, came to $5.8 million last year: and globalisation is speeding the process of catch-up by non-Americans - especially the Brits.

Are these mighty sums buying any worthwhile results for companies and shareholders? Even the beneficiaries themselves don't appear to think so. Only 17% believe that the pay system effectively motivates top managers to produce top results. Over twice as many see still higher pay as the answer, because companies need to pay executives very highly to get the best talent. Since the whole cosy circle is 'very highly' rewarded, all the talent, the argument goes, must be the best.

If the talented ones nevertheless produce poor results, the system fails to penalise the miscreants. Heads they win, tails they don't lose - unless the share price nose-dives, and their options follow suit. Even then, the fact that the stock market correlates erratically with real-life performance is a saving grace for the highly paid. Exxon enriched its shareholders annually by 16% compound in 1986-96 and earnings per share advanced by a miserable 1.9%. But over $100 billion has been added to Exxon's market value in 15 years. The tens of millions poured into executive pockets are the merest drops in an ocean of shareholder wealth. Even wealth superstars like General Electric and Coca-Cola enjoy swollen market value thanks to share booms that outpaced earnings over the 15 years. Exactly the same pattern exists in Europe.

Executive effort deserves no credit for this. Share prices are even worse indicators of performance than other financial measures, whether conventional (such as return on capital employed) or newfangled (market value added, for example). The truth is that profits and cash-flow are only the effects of the non-financial causes which truly count: the combination of operational effectiveness with strategic choice.

That explains growing the interest in the balanced scorecard (see also Best Practice article). This was devised by David Norton, president of the international strategy consultancy, Renaissance Solutions, along with Harvard Business School professor Robert Kaplan. Financial performance is only one of their four categories of measurement, alongside others to ascertain knowledge of the customer, internal business processes and learning and growth. Scorecards are tailored to specific companies to achieve a system that 'aligns individual, organisational and cross-departmental initiatives in building long-term strategic advantage'.

According to Norton, 60% of large US corporations now use methods of integrating financial and non-financial measures - but how many apply the latter to chief executive pay? What you pay for is what you get. If the true top task is to provide successful medium and long-term strategic direction, and ensure its implementation, then this should loom largest in determining rewards: and never mind the short-term price of the shares.

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