“COMPANIES DON’T WANT TO RISK A PAY DISPUTE”

Q: Is it true that many executives don’t understand their long-term incentive plans?

A: Yes. It seems strange – these are very sophisticated people, and it’s not that the plans are incomprehensible. It’s that executives don’t view them as relevant on a day-to-day basis. Also, they get a new plan every year with a three- or four-year term, so at any point they have three or four plans, all with different performance criteria. When I used to do financial planning work with CEOs, I’d be handed a box of award certificates – “I’ve got this stuff”. The executive would have no idea what it was worth – and often it was millions of pounds. They’re busy people, and they don’t have time to go into the details. Why do you think existing pay systems are flawed? If you look at the research, you’ll find two main problems. First, so much emphasis on performance pay puts massive pressure on the target-setting process. That leads to unintended consequences – in particular, it leads people in senior Tom Gosling is a partner at PwC and heads the firm’s UK reward practice. He has spent 20 years advising boards on executive compensation, but he says the system is “broken”. In a interview, he told HBR why. Edited excerpts follow. positions to focus on targets to the exclusion of more-holistic performance goals. Second, the complexity of incentives means that executives discount them very heavily. That’s another reason they rarely deliver the results you might hope for. People created these plans with good intentions, but I don’t think the plans contribute to better performance. If they’re not working, why do they persist? The investor community and the proxy-voting agencies, such as Institutional Shareholder Services, are still wedded to performancepay models. There is quite a debate in the UK about executive pay, and there is increasing scepticism about the effectiveness of existing models. Personally, I favour simpler plans that replace long-term incentive pay with a requirement that executives own company stock and hold it for long periods of time. Many clients like that model but think it’s too chancy to pursue. Most companies don’t want to risk a pay dispute, so they stick with conventional models.