UK: WHEN THE SHARE IS LESS THAN FAIR. - Top pay should be linked to good strategy, not the stock market.

by Robert Heller.
Last Updated: 31 Aug 2010

Top pay should be linked to good strategy, not the stock market.

The issue of excessive pay for top management, long debated in the US, is rearing its unlovely head in Britain. When so respected a figure as Sir Owen Green (recently retired from BTR) protests, he is liable to have good reason. Defenders of the gravy train can hardly dismiss Green's comments. Few managers matched the vigour and vision with which he ran BTR, but many pocketed far greater reward for much lower performance.

Green's shareholders had wonderful value for money. But is that a meaningful criterion? The popular American argument (popular, that is, with the beneficiaries) is that those who enrich shareholders deserve to share the booty.

It sounds fine - until you look at cases such as that of Robert C Goizueta. His 1992 emoluments were a minute fraction of the wealth Coca-Cola investors have reaped. Throw in all his stock options and the take is not even 1% of the cornucopia.

The problem is the overall size of that bonanza - $50 billion. How do you fix a sensible share of so vast a sum? You don't. It simply absolves the fixers (the Goizuetas themselves) from justifying the amount fixed. That is what happens on the upside. The logic is further weakened by events on the way down. The fixers still dig deep into a leaking trough.

The year before John Akers was removed from IBM, he received $3.7 million after five years in which investors suffered compound annual losses of 11.3%. Admittedly, Akers's pay added only a smidgen to the losses. But salaries, bonuses and option gains all represent losses of profit - even though the accounts don't actually show the impact of options (as they should).

Some companies, like Eastman Kodak, now force senior executives to put their money where their jobs are, buying specified amounts of shares. They would thus share the investors' pain, not just the joys. The beleaguered chairman responsible, though, also pocketed $425 thousand of optional extras last year. Things have not reached the same pass in Britain. But the same processes are at work.

One is 'comparability'. As with lesser ranks, the company must pay 'the rate for the job' to attract, motivate and retain the employee. At lower levels, no single employee can sway the balance. Higher up, every bad example becomes a good excuse. Gerald Ronson of the Heron Corporation lumbered the banks with duff loans: if they give him a £4-million package to run the shipwrecked Heron, why should better achievers make do with less?

Comparability becomes a game of leapfrog, which explains how the average director of the FT-SE Index companies earned 13% more in 1992 - double the rise in average UK earnings. Comparability has also helped to jack up US rewards. In 200 companies studied by Fortune, 33 bosses earned over a million dollars, before bonus; another 20 were on the brink. Throw in bonus, and two-thirds of the CEOs made seven figure salaries.

That sounds fair and good. Pay should be tied to performance, right? But the boss of Ralston Purina, the dog food king, got $350 thousand of bonus in a year when profits fell 18.2%; IBM's Akers received $375 thousand. What for? Given such well-rewarded non-performance, no wonder the much-admired Jack Welch of GE picked up $1.9 million (more than his salary) when the firm's profits rose by a mere 6.5%.

In truth, the linkage between earnings and top pay is as dubious as that between remuneration and share prices. There is a real long-term relationship between the latter and earnings per share (EPS). But how far does the individual boss influence long-term EPS? Certainly, it is an appropriate element in judging achievement - though typically the linkage is short-term, which is even more questionable. The measure, anyway, needs to be accompanied by several others.

Customer and employee satisfaction, productivity, quality, innovation, corporate rating - all should count. The tailoring of pay to specific, measurable, non-financial management objectives is now a well-established method. Peter Bonfield has used the technique to excellent effect in his near-miraculous transformation of ICL. But few top managers are prepared to commit themselves to a range of strategic targets - and to link remuneration to their achievement.

To set strategic targets, anyway, you need a real strategy. If that is non-existent or defective (all too typically), neither the chief executive, nor his closest colleagues, nor the board as a whole, are earning their pay - great or little. And if the company isn't controlling its future, shareholders and the other employees will be lumbered with this sort of lumpen management: 'When I first came, I had not seen so many layers of bureaucracy since I read Milton's Paradise Lost. There were archangels and angels, and seraphim and cherubim everywhere I looked'. (All, presumably, were earning heavenly salaries.). That senior manager, quoted by the Financial Times, works for a clearing bank which is now striving vigorously to clean up its skies. But the line could apply to a legion of British (and American) companies.

Once companies start paying managers for their deeds, rather than for comparability or the behaviour of stock markets, then sense will begin to enter a largely senseless system.

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