What’s wrong with ex­ec­u­tive com­pen­sa­tion?

Financial Mirror (Cyprus) - - FRONT PAGE -

Nonethe­less, a con­certed push­back has be­gun, led by a group that com­pa­nies and their boards might ac­tu­ally pay at­ten­tion to: their largest and most in­flu­en­tial in­vestors. Hedge funds, pen­sion funds, and sov­er­eign wealth funds are stat­ing that they are look­ing closely at C-suite re­mu­ner­a­tion, and that it is time to take re­form se­ri­ously.

Nor­way’s sov­er­eign wealth fund, worth $870 bln, has said that it is set­ting its sights on pay struc­tures. Aberdeen As­set Man­age­ment and Royal Lon­don As­set Man­age­ment were among a group of share­hold­ers who strongly ob­jected to BP’s pro­posed 20% in­crease in com­pen­sa­tion for CEO Bob Dud­ley in a year when BP made record losses, and they joined 59% of in­vestors in re­ject­ing the pack­age. Though the BP vote was non-bind­ing, it was a clear sig­nal to the com­pany and its board.

Sim­i­larly, 54% of Re­nault SA’s share­hold­ers, which in­clude the French state, op­posed CEO Car­los Ghosn’s EUR 25 mln ($28 mln) re­mu­ner­a­tion pack­age at the com­pany’s AGM in April. It, too, was a non­bind­ing vote, and the board chose to dis­re­gard it.

But ig­nor­ing share­holder sen­ti­ment is be­com­ing un­ten­able. Dis­con­tent cuts across all sec­tors, from bank­ing, with calls for a re­view at Lloyds Bank, to me­dia and ad­ver­tis­ing, with an out­cry, yet again, about the pay awarded to WPP’s Martin Sor­rell; at GBP 70.4 mln, his lat­est pack­age makes him the United King­dom’s high­est-paid CEO.

At Berk­shire Hath­away’s AGM in April, War­ren Buf­fett ad­vo­cated for com­pen­sa­tion plans that fit the needs of the busi­ness, rather than vice versa. This hap­pens when a “very greedy chief ex­ec­u­tive… de­signs a pyra­mid so that a whole bunch of other peo­ple down the line get over­paid… just so it doesn’t look like he’s all by him­self, in terms of that fan­tas­tic pay-off he’s ar­ranged for him­self.”

Part of the is­sue re­mu­ner­a­tion pack­ages is that ex­ec­u­tive have be­come too com­plex. Gone are the days when CEOs did the job and were paid a wage. It is al­most as if re­mu­ner­a­tion com­mit­tees have taken a leaf from Sun Tzu’s The Art of War: “The whole se­cret lies in con­fus­ing the en­emy, so that he can­not fathom our real in­tent.” Ex­pla­na­tions for re­mu­ner­a­tion cal­cu­la­tions can run for pages, and of­ten board mem­bers who aren’t on the re­mu­ner­a­tion com­mit­tee can­not un­ravel them.

More­over, bonus tar­gets are fun­da­men­tally flawed. Mar­kets are fraught with “un­known un­knowns.” Boards of­ten don’t know now what will need to hap­pen later. And that means goals based on the past or the sup­posed fu­ture re­ward what we cur­rently think rather than ac­tual per­for­mance. When pay is driven by strict ad­her­ence to tar­gets set 12 months be­fore, CEOs look back, in­stead of fo­cus­ing on the present and on what comes next. Com­pen­sa­tion needs to re­flect whether the CEO won all the bat­tles but lost the war.

But avoid­ing what might be called the “Dud­ley Para­dox” – a CEO is paid a huge bonus for hit­ting tar­gets, even as the com­pany suf­fers ma­jor losses – re­quires boards to stop del­e­gat­ing the en­tire pay dis­cus­sion to the com­pen­sa­tion com­mit­tee and wait­ing for the de­ci­sions to ar­rive, fait ac­com­pli, tied up in a bow. The full board should re­view the com­pany’s op­er­a­tions and strat­egy thor­oughly; only then should the com­pen­sa­tion com­mit­tee set about cre­at­ing the pro­gramme to act on it.

Hav­ing such a pro­gramme in place is es­pe­cially im­por­tant when a new CEO or se­nior ex­ec­u­tive is hired. At a time of great hope and a de­sire to woo the can­di­date, des­per­a­tion or en­thu­si­asm can lead to poor judg­ment and badly for­mu­lated pack­ages, which, once ne­go­ti­ated, are not sub­ject to share­holder vote. A prime ex­am­ple is Ya­hoo’s fir­ing of Hen­rique De Cas­tro in 2014. Af­ter only 15 months on the job as COO, De Cas­tro walked away with $109 mln.

Lastly, CEOs should show lead­er­ship in how they man­age their own com­pen­sa­tion ne­go­ti­a­tions. If they are re­spon­si­ble for all as­pects of the com­pany, then they can­not ab­di­cate re­spon­si­bil­ity with a “Be­cause I’m worth it” at­ti­tude when news of their large pay pack­ages be­comes pub­lic. More im­por­tant, they need to recog­nise that no law obliges them to take what they can get. They could hit the tar­gets and earn the pay, but look at the com­pany’s re­sults and choose to ad­just the to­tal ac­cord­ingly. The CEO needs to be talk­ing about the busi­ness of the com­pany to its work­force, in­vestors, and the wider world, not be stuck at the AGM de­fend­ing the ex­ec­u­tive team’s salaries.

The re­volt against large pay pack­ages won’t go away. For all the re­ported cases, many more are sim­mer­ing be­neath the sur­face of pub­lic scru­tiny. Un­less th­ese com­pa­nies ad­dress head-on the quiet hand­wring­ing among board mem­bers and grum­bling among in­vestors, they will find them­selves on the front pages next.

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