Executive Remuneration; Are You Worth It?

This was written back in May, but somehow I missed it off my blog.  It has been on Rabbi Naftali Brewer's thoughtful site since then, here.  All I have done here is update a couple of numbers in the example.

It was a really useful discussion we had back in the Spring.  This article reflects the spirit of what was discussed.  As we say, we don't really expect it to come into practice - it is in the nature of a thought experiment: what could make a change in CEO pay?

Executive Remuneration; Are You Worth It?

By Naftali Brawer  and Ruth Bender

Background

This paper is the result of a ‘Creative Conversation’ hosted at the Cass Business School in partnership with Spiritual Capital Foundation. The participants in the conversation represented theoreticians as well as practitioners in the field of executive remuneration.  Each participant was asked to reflect on the state of executive remuneration today and to share their unique viewpoint with the group. What follows below is a structured account of the conversation.

Does higher pay equal greater performance?

It is often argued that the more a talented CEO is paid, the better h/she is able to perform. But this assumption is deeply flawed. In the space of a single generation CEO pay has increased exponentially and there is no evidence to suggest that today’s CEOs are any more hardworking or successful than those of a generation ago.

Unpicking the Arguments

So what are the justifications for this steady increase in executive pay? The question is crucial because their pay far outstrips that of middle to lower ranking staff within the same organisation.

One argument is that Chief Executives assume enormous personal risk in staking their professional reputation on the promise of running or turning around a large corporation. Thus it is compensation for this heightened personal risk, far greater than that borne by middle management, that is being reflected in the generous remuneration. The weakness of this argument is that if risk were the key driver of higher financial rewards, why is it that soldiers, police officers and firemen – in far riskier jobs than CEOs - are paid so much less? And if your answer to this is that these are public sector positions, in a different context with less money available, how about other jobs where high personal risk is assumed by low level employees, such as mechanics on oil rigs?  Many employees in high-risk occupations are not compensated to the same extent as executives.

Another argument put forward to justify executive pay is that it is recompense for the constant travel and the encroachment on personal time. While it is certainly true that CEO live highly pressurized and busy lives, the same can be said for a mid-level employee burning the midnight oil. And CEOs have much better working conditions than most of their staff, and have more people to whom they can delegate their load.

A third argument in favour of increased executive pay is that it would cost the company even more to replace the said executive if s/he were to be poached by a rival company. Embedded in this argument is the belief that CEOs possess rare talent that cannot easily be replicated in others. Against this backdrop it appears corporate boards have little choice but to pay the going market rate if they have any chance of retaining extraordinary talent. A similar line of reasoning is used to defend excessive footballer wages. It takes as its point of departure that there is a very limited pool of footballers who can play at the level of say, a Wayne Rooney. This being the case it makes sense for his club to pay him whatever the market will bear if it does not want to lose his rare talent to rival team. Yet while this may hold true for footballers, the parallel with chief executives can be challenged. Is it really true that the potential to be a star CEO is as rare as that of a premier league footballer? If a talented CEO left an organisation would it really be as difficult to replace him as Wayne Rooney?

What is lost by increasing executive pay?

Putting aside the arguments and counterarguments as to whether CEOs deserve higher pay let’s explore the question from a slightly different angle; what harm is caused by yielding to their demands for increased remuneration?

One response to this is that pay increases for a CEO are less significant to an organisation’s profits than are pay increases to other employees.  That is just basic maths.  Take as an example the UK-based supermarket, Tesco, which employs over 500,000 people.  An award of £1 extra to each employee each week would add over £26m to costs, which is more than all the directors’ salaries and bonuses for the last two years.  Any meaningful increase for a large number of employees is going to have a significant impact on profits, which a high percentage increase to one person’s pay is unlikely to carry.

So does it really matter in the end how much a CEO is paid?

The answer is it does, and for a number reasons.

Firstly, immense gaps between a company’s highest and lowest earners sow deep resentment and jealously. Such differences poison a working environment and corrode a corporate culture. Board members have a responsibility to ensure the smooth running of the corporation and vast disparities in pay undermine this objective.

Secondly, it has been argued that not only does excessive pay not lead to enhanced performance but that it can actually produce the opposite effect, weakening performance. Research has shown that additional pay can reduce performance on complex cognitive tasks.[1] 

An unbalanced focus on monetary compensation can also have the effect of crowding out other important values such as responsibility, the satisfaction that comes from a job well done and identification with the success of one’s company. Michael Sandel makes this argument in a broader sense in his book “What Money Can’t buy: the Moral Limits of Markets.”

What is being done to address this problem?

At the moment very little is being done to address this situation comprehensively and constructively. Too much of the public debate around executive remuneration focuses on fixing the details of a broken system.  For example, the directors’ remuneration provisions of the UK Corporate Governance Code have not changed substantially since they were set out in the report of the Greenbury Study Group in 1995.  In reality what is required is a completely new way of thinking about executive pay.

Creative Solutions

In the open environment of this Creative Conversation, a proposal was made which would overcome many of the flaws in today’s system.  It was put forward, not in the hope or expectation that it would or could be  implemented, but as a thought experiment of what a radical solution might look like.

Three background issues were given as context:

1.    There is public outrage directed towards directors who are perceived as over-paid.

2.    There is public outrage directed towards the companies that pay them.

3.    Remuneration committees are unwilling to reduce executive pay, fearing that good executives will leave the company.

Three research findings, from the governance and psychology fields, were considered in determining a possible solution.

1.    It is not the money itself that motivates executives, but the bragging rights associated with their relative pay compared to their peers.[2]

2.    As discussed above, money does not motivate good performance in complex cognitive tasks.

3.    Giving money to others increases people’s happiness.[3]

Putting these together, one proposed solution as that companies should pay whatever they think appropriate in terms of the ability of the executive and ‘the market’. However executives should only accept part of what they are offered; the balance should be donated – in their name – to company-relevant corporate responsibility spending.

By separating the amount offered by the company from the amount taken by the executive, the demands of the situation can be met.  The executive can retain the bragging rights of a high (offered) package in relation to their peers, and can also benefit from the feelings of satisfaction and happiness of giving money to good causes.  Furthermore, they will not feel the adverse performance pressure that research suggests comes from too high a potential reward for a complex task.  Remuneration committees can be satisfied that they paid enough to influence executive retention, but have at the same time avoided the public opprobrium that they currently experience.  And the company can even take credit – by proxy – from the executive’s transparent generosity towards its CSR objectives.

Now, before readers start getting exercised about the impracticality of this proposal, we should remind you that it is offered in the spirit of a thought experiment.  We are not saying that it will happen; we are not even saying that it should happen; we are putting it forward as one way to address the current issues, in the hope that such a radical suggestion will unfreeze people’s thinking on the subject and lead to more creative, and perhaps more practical conversations.

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[1] For example, Ariely, D., Gneezy, U., Loewenstein, G., & Mazar, N. (2009). Large Stakes and Big

Mistakes. Review of Economic Studies, 76, 451-469.  McGraw, K. O and McCullers, J.C. (1979). Evidence of a detrimental effect of extrinsic incentives on breaking a mental set?, Journal of Experimental Social Psychology, 15(3), 285–294

[2] See for example Bender, R. (2004). Why Do Companies Use Performance-Related Pay for Their Executive Directors? Corporate Governance: An International Review, 12(4): 521-533.  Boyce, C. J., Brown, G. D., & Moore, S. C. (2010). Money and Happiness: Rank of Income, not Income, Affects Life Satisfaction. Psychological Science, 21(4), 471-475.

[3] See for example Anik, L., Aknin, L., Norton, M., & Dunn, E. (2009). Feeling Good about Giving: The Benefits (and Costs) of Self-interested Charitable Behavior. Harvard Business School Marketing Unit Working Paper, (10-012).

What does 'Fair' mean in executive pay?

This is the text of my presentation at the High Pay Centre's event at the Tory Party Conference last night.  The question was:

THE BIG PAY DEBATE – CAN THE CONSERVATIVES BE THE PARTY OF FAIR PAY?

Other speakers were Frances O'Grady, General Secretary of the TUC; Nadhim Zahawi, Conservative MP; and Anthony Browne, CEO British Bankers Association. 

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In the New Testament, Matthew 19:27, we hear The Parable of the Vineyard Workers.  Some of them worked in the vineyard all day; some worked half a day; some worked only an hour.  But each of them was paid exactly the same amount at the end of the day.  There were some pretty angry people around at that point.  Let me quote you the vineyard owner:

“'Friend, I am not being unfair to you. Didn't you agree to work for a denarius? Take your pay and go. I want give the man who was hired last the same as I gave you. Don't I have the right to do what I want with my own money? Or are you envious because I am generous?"

Thankfully, this parable is about getting into Heaven, and not about fairness in pay.  Because most of us would think that he is being unfair, and that those who worked hardest should get more.

So, fair pay obviously isn’t about equality of outcome.  But what is fair pay?

I did a PhD to try to resolve this.  I failed – not the PhD! – just in finding the answer.  There isn’t an answer.  So instead of researching ‘How should we pay the directors?’  I decided to ask ‘How do we pay the directors?  How do you decide how many zeroes come at the end of the first number?’

And I can summarise my 100,000 word PhD in fewer than 140 characters – “I want this much, because he’s got that much.”

When you look at the research on executive pay, you come across ‘fairness’ in various forms.  I can summarise it like this:

·         Pay has to be fair

·         Pay has to be seen to be fair

·         Pay has to be seen to be set fairly.

What we need to consider is fairness of Outcomes; Transparency ; and fairness of Process.

We know from research that people are prepared to accept wide differences in pay if they perceive the process of pay determination as following fair and transparent rules.  It’s what academics call Procedural justice. And it is fundamental.

I think that that is one of the reasons why we use ‘the market’ as a benchmark for executive pay packages – if the sum is determined externally’ by ‘the market’ then we can see how we came by the number, and so that is a tick in the box.  The problem is, of course, that ‘the market’is a myth.

When economists talk about a market they mean the intersection of supply and demand curves for a product which is in wide supply and where every unit is interchangeable.  They also imply complete transparency and full knowledge and no transaction costs.  None of these things apply in exec pay – individuals have different qualities and experience, and jobs require different attributes.  And ‘the market’ only covers those companies against whom we choose to benchmark.  So it’s not really a market at all. 

However, if you take benchmarks out of the equation, what do you put in their place?  I’ve been asking that question a lot recently, but there aren’t any really good answers coming back.

What we need to do – somehow – is reset that benchmark.  I’ve always been struck by a comment made to me by one of the CEOs I interviewed for my research.  He said:

If the salaries for the average FTSE chief executive were half as much, … they would still be more concerned about that relativity than they would about whether it’s half.

At the top, it’s not really the amount – it’ all relative.

Please note – I am definitely not suggesting a statutory cap on executive pay to bring it down.  I don’t think that would work.  (The Roman Emperor Diocletian  tried it at the beginning of the fourth century, in order to ‘establish justice’ among his people, and stop inflation.  It didn’t work then, either.)

But …Moving on from just benchmarks…

I think the need to be Fair also influences the desire to reward performance with pay.  Performance-related pay has been a fundamental part of the UK’s executive pay system – indeed the world’s executive pay system – for the last two decades.  We say in the UK Corporate Governance Code that a “A significant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance.”

We ask for the pay-performance link because it is seen as fair.  Going back to the parable of the vineyard – those who do the most, who contribute the most, who achieve the most – they should get more reward.  But we haven’t got it right yet.

We are all familiar with the perverse incentive that bankers had to take excessive risks, knowing that if the gamble paid off they got a huge bonus; and if it didn’t pay off we picked up the bill.  That, in part, is a function of the fact that it is really, really difficult to design performance measures and targets that will be meaningful, achievable, and not dysfunctional.

It’s also difficult to design pay that is fair to the Executives, to the Shareholders and to the other Stakeholders, because everyone has different interests.

But the other problem with performance-related pay is that we also know, from research, that pay is not a marvellous motivator.  Motivation comes in two flavours: ‘intrinsic’, that relates to one’ desire to do the job, and ‘extrinsic’, relating to the monetary reward, the pay.  There is a lot of work done that demonstrates that having a large extrinsic reward is actually detrimental to performance for people doing complex cognitive tasks.  Which is a pity; complex cognitive tasks are exactly what we want from our executives.  I’m not saying we should – or could – get rid of bonuses; I think they have their place; but it’s interesting that fairness in rewarding good performance might have negative implications.

I’m coming to the end of my time, so I’d like just to revisit the concept of ‘fair’ with a series of questions.

If an oil executive gets a multi-million £ bonus for producing great profits at a time when the oil price is very high, so anyone could make money: is that fair?

If that same oil executive doesn’t get a bonus when the oil price falls to $10 – which it has in the past – is that fair?  Even if he has managed to contain the losses so that the performance is extraordinarily good in the circumstances?  Is that fair?

If the pay of a female executive rises by, say 33% to be equal to the pay of her male counterparts: Is that fair?

If Stephen Hester, who gave up a well-paid position to come and run RBS and did a great job of it, and improved the tax-payers’ position … if Stephen Hester can’t get a bonus for doing that: is that fair?

Thank you.

Dear Hotel...

Dear Hotel

Let me make myself clear.  This post is not (totally) about the hotel in which I stayed this week. Nor is it (totally) about the hotel in which I stayed last week.  Nor the one last month.  Nor the one the month before.  Nor indeed the previous months' hotels.  But all of the matters raised in this post things have impacted on my hotel stays several times this year, in one location or another.

It is a heartfelt plea to hoteliers in general to incorporate some novel design features into their rooms. To think about how guests actually use the space, and to make some practical changes to help us.

The issues below are not set out in order of importance, nor order of annoyance, nor even alphabetical order.  I'll leave it to you to decide which to prioritise.

                                                        ---------------------

If I were in your hotel for a romantic assignation, the artful placement of lamps and the overall effect of subdued lighting would be ideal. Alas, romance is not on the menu and I'm at your hotel to work. Please provide lighting that is good enough for me to read by.  And, given that I will be trying to read both at my computer and whilst lying in bed, please make sure that I don't end up squinting in the gloom. 

Moving on.  I use my mobile phone as an alarm clock.  I also need to recharge the phone overnight, ready for battle the following day. Is it beyond the wit of Man to provide a spare socket by the bedside table so that I can do both of these things at the same time?  (A double socket would be even better, then I could listen to the radio though my iPad as I drift off to sleep.)

Speaking of sleep, I like spare pillows.
And spare blankets.
Thanks to those hotels who put some in the wardrobe for me.

(I’m also grateful for the tray of teas and coffees, especially those that give me enough milk.)

And I deliberately turned off the air conditioning when I first arrived in the bedroom, so please don't keep turning it back on.  It is wasteful environmentally to leave it on all day when the room isn't occupied, and it means it's freezing when I get back.

Oh, and speaking of environmental matters, I totally, 100%, support you in your aim to reduce the washing by using my towels for more than one day.  So I would be delighted to hang my towels up as a signal to the chamberperson (ugly word, but I am an equal opportunities hotel guest) to leave them be. Two problems. Firstly, it would be helpful if there were a towel rail, or even a hook, on which to hang them.  And secondly, please inform said chamberperson that if the towels are hanging up, s/he should not replace them with fresh ones.  So often, I hang them up but they are replaced anyway; you seem to be training your guests,  but not your staff.

(Note - that last comment is in no way a gripe against the hotel staff.  I have been fortunate to stay in places where the chamberpersons, receptionists, wait-staff and others were all really good at their jobs, and rather nice to deal with.  Thank you all.)

Right, where was I?  Oh yes, the bathroom.  Let me give you a lesson in anatomy.  Men are convex, women concave.  Without wishing to be indelicate, that means that if the only way to wash the body is a fixed overhead shower, men can wash themselves.  Fully.  Trying to wash the concave bits from just a shower head fixed to the ceiling requires a physical dexterity that I didn't possess even in my youth.  So please can we have a hand-held shower as well?  Or a bath? Or, bliss, a bidet?

Oh, and memo to one particular chain of designer hotels: having the shower head fixed to the ceiling above the centre of the bath would make much more sense if your shower guard were not also fixed, running from the wall to align with the centre of the bath. The shower floods the room, and to be honest, this is your fault, not mine.

While I'm in the bathroom, please can we have a magnifying mirror.  And place it somewhere near a good source of light.  That way, I don't need to use Braille to put on my makeup.

A couple of minor quibbles while I'm on my way through this list.  Why don't you ever provide enough hangers?  If I have to be in your hotel for a week's work, I need to bring a lot of clothes.   These need hanging up; four hangers per wardrobe really doesn't cover it.  (And I don’t like those wretched hangers that are attached to the rail; they are unnecessarily cumbersome to use.  Given the amount of valuable stuff lying round in the room, why assume I’m going to nick the hangers?)  And, incidentally, when did hotels stop providing drawers?  I've stayed in two recently where there was hanging space (assuming I supplemented the hanger inventory with my own, smuggled in from home) but no drawer space.  Is it a new fashion thing, that drawers ruin the line of the furniture?  Not impressed.

Speaking of 'designer', do people really like the trendy idea of having the room functions controlled by an iPad (other tablets are available)?  In the old days, when the alarm clock went off at an unearthly hour of the morning, I could reach out of the bed, feel for the TV remote, press the top button and generally get some form of news broadcast to bring me gently into a waking state without having to move too much.  When the only way to access the TV is a tablet, I first of all have to find my glasses, then wake up sufficiently to see which way up to hold it, how to switch it on, and which touch-sensitive menus to use to get to the required station.  Look, I know tablets are cool - I've already owned up to having one - but they have their place.  And this isn't it.

Oh!  And while I'm on about tablets:
Wifi. Is. Not. An. Optional. Extra.
Charging me an exorbitant day rate for using wifi in my bedroom is like charging me extra for hot water.  Or for the bed linen.  Or chairs.  For heaven's sake, do what most US hotels do and make it free.
(And words fail me for those hotels which charge a huge sum and then provide totally useless wifi.  The number of times I've ended up sitting on a hotel corridor a few yards from my room, waving my iPad in the general direction of Reception in the hope of picking up their weak and ineffectual signal...)

On a related matter...  We have already established that I carry an iPad and a mobile phone.  How do you think I carry them around?  I ask this because your magnetic keys are so pathetically sensitive that when my hotel key resides in the same handbag as my devices - which it has to, as I have no pockets - the key de-programs itself.  You are tired of me coming to Reception to get it re-set.  I've got news for you: so am I.  But no, I'm not keeping the key snuggled up to the devices; it's in a separate compartment, but, yes, in the same bag.  That's the best I can do.  Please sort this out at your end.

And so, dear Hotel, I come to the end of my plea for better design.  Please don’t take offence.  I think that your staff are often excellent, your beds largely comfortable, and your breakfasts generally very good.  But with a little thought it could be SO much better…