Tuesday, 18 January 2011

Executive Remuneration: fat cats v's the future

If Britain’s Liberal Democrats had their way, they would limit bankers’ bonuses to £2,500 per year. It doesn’t look like they will, however. UK banks are readying themselves for a predicted £7 billion bonus season. As the bank tills ping back open, the Conservative-dominated Coalition stands accused of a climbdown on a promise to curb “unacceptable bonuses”.

No one likes fat cats. Much of that, let’s be honest, derives from envy. Not always, though. Sometimes the public’s dislike is justified. Why should BP’s Tony Hayward walk away with a £1.045 million handshake after overseeing one of the worst environmental disaster in US history (not to mention leaving an £11 billion hole in investors’ pockets)? Pay should be commensurate with performance. When bankers so spectacularly failed during the recent financial meltdown, their pay packets should be adjusted accordingly.

Away from the contentious issue of bankers’ bonuses, however, giving your top dogs an annual ‘extra’ has a well-attested business rationale. It’s there in industrial and organisational psychology 101. In sum, bonuses are supposed to motivate those managing certain assets to work those assets harder and more profitably. Hence a large chunk of executive pay comes in the form of share rewards. Perform well and the share price goes up. And then everyone wins, both the managers (executives) and owners (shareholders) of those assets.  

Corporate Responsibility advocates are not blind to the appeal of such thinking. They want companies to improve their non-financial performance. They know general business case arguments can get them so far. Those that live in the real world of business and not in do-gooderville know they can get a whole lot further if they can link their agenda to executive pay. A CEO will nod benignly and make vague commitments on responsible business if he has nothing at stake personally. He’ll be sure to pick up the phone and make it happen, meanwhile, if he knows his bonus is one the line.

The move from theory to practice is taking time. Precious few companies have integrated corporate responsibility into senior management pay. Among Europe’s 300 largest companies, the percentage is under a third (28%), a study by specialist analysts EIRIS finds. Those that have, have done so in a way that could be best described as “opaque”, according to Ethical Corporation writer Stephen Gardener.

The reasons are easy to identify, but tricky to fix. First, there’s the deep-seated issue of corporate culture. Remuneration policies lack transparency, full stop. Companies start making noises about confidentiality and commercial sensitivity as soon as the light shines too brightly on their pay schemes. More importantly for corporate responsibility, the metrics for identifying the drivers of value with respect to non-financial factors are not there yet. Even in measurable areas, such as accident rates or greenhouse gas emissions, establishing a direct causal link between the top dog and the target is not straightforward. To do so requires very strict vertical integration.

That’s not to say companies aren’t trying. Gardener highlights the example of Dutch paint and chemicals firm AkzoNobel. Half of the share allocations that the company’s directors receive is dependent on the company’s average positioning over a three-year period in the Dow Jones Sustainability Index. It’s not just the board that is impacted. AkzoNobel’s top 600 managers are similarly incentivised. In the same vein, shareholders at banking giant ING recently approved a remuneration plan that links 40% of the variable element of directors’ pay to sustainability targets. Again a sizeable number (this time, 200) of senior managers are directly affected.

It’s notable that both cases derive from the Netherlands (Dutch life sciences group DSM and mail operator TNT are other examples). Dutch law makes executive remuneration packages subject to a binding shareholder vote. Shareholders in countries such as the UK, France and Germany also vote on executive pay, but only in an “advisory” capacity.

There are some important lessons here. First, when it comes to remuneration, it’s investors (as asset owners) that hold the clout. They need to be convinced that sustainability impinges on their long-term interests. The arguments are there. They just need to be made more clearly and more urgently.

Second, investors need to act. If more countries adopted the Dutch voting norms that would certainly help them do so. Whatever the case, it can’t be left to company boards alone. However well intentioned they might be, the language will inevitably be general and the targets vague. Clear deliverables with direct lines of responsibility is what’s required if sustainability is ever to be seriously factored into executive pay.

Hopefully come bonus season we then can begin to talk about the future and not just fat cats.

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