During the past decade, the earnings of FTSE 350 directors more than doubled. Over that same period, the market value of those companies deteriorated. It’s not a sustainable model and boards in general need to be brave when tackling this issue, pursuing innovative pay policies that recognise and reward genuine performance, not complacency.

The essential purpose of any remuneration policy must be to attract, retain and inspire the talent capable of executing strategy in order to deliver the best possible level of stakeholder value on a consistent basis. A package that is centred on a large basic salary may not be enough to lift an individual out of a comfort zone and urge him/her to chase greater rewards over time.

Mark Phillips, SVP, Medicine & Process Delivery at pharmaceutical giant GlaxoSmithKline, says: “The package has to provide incentives to deliver in the medium term, not just in a single year. They must be realistic and attractive enough for talent to be prepared to accept the trade-off between the targets (the risk) versus the benefits (the bonus value). If the executive is not confident in being able to deliver two to three years of performance, I think it says something about that individual and their suitability for the role.”

Yet, it seems that many policies do not result in packages that can achieve this, usually falling short on the conditions of the performance-related element. Sir Rob Margetts, a vastly experienced chair of Remuneration Committees (Remcos) and former chairman of insurance giant Legal and General, says: “The great disease we have at the moment is in not demanding enough of those parameters that govern what real progress looks like in the variable [performance-related pay] element. All energies should be concentrated on defining those parameters, to determine real underlying progress, not as a random outcome of market volatility.”

Rob Burdett, Principal at remuneration specialist Aon Hewitt, says: “The targets companies employ in their annual bonus and long-term incentive plans [LTIPs] need work; the tools we have in the box are appropriate, but we need to think more cleverly about the performance conditions we apply to those rewards.”

Taking responsibility

Public anger over a pay culture perceived to reward failure has inevitably invoked controversy and confrontation. Much of the blame for this unsatisfactory state, where base salaries have drifted to unsustainable levels and bonuses don’t reflect real performance, resides with the Remcos, whose job it is to recommend appropriate strategies for executive pay.

However, as Peter Waine, Partner at the leading NED search firm Hanson Green, observes, some Remcos can be influenced too directly: “While it’s not an easy job being chairman of a Remco, many of them have too often acquiesced to bullish executives over the last 10 years. They should have stood up to them by saying, well, if you don’t think your pay is fair, there’s the door.”

Furthermore, the market events of 2008 have seen many remuneration advisers fail to wake-up to the new economic reality. Remcos need to demonstrate the agility needed to be competitive.

Rob Burdett says: “There’s a need for a broader range of incentive targets, both financial and non-financial. A more balanced scorecard of measures on LTIPs might be required, with more financial metrics specific to each business, such as debt reduction targets, cashflow, and so on. We should go further, too, with broader operational and strategic measures which will make the LTIPs more valued by participants. Essentially, performance-related measures must be seen to work better by all parties.”

Stakeholder value

While pay levels should remain market competitive, at the same time, the corporate world should understand that perceived greed is rightly being questioned by wider society and it must therefore be prepared to make some tough decisions. Jane Furniss, CEO of the Independent Police Complaints Commission, says: “My advice to the Remuneration Committee was not to award bonuses to me or my top team, despite the significant improvements in organisational performance and delivery we have led. We need to protect services and jobs and could not look those staff, who are being made redundant, in the eye at the same time as receiving cash pay outs.”

Engagement is the name of the game. A performance-related pay model that truly engages will be one where the rewards stimulate enthusiasm and the passionate execution of strategy, delivering value to all stakeholders. Rudi Kindts, an independent HR advisor, says: “What we are dealing with is the ‘new normal’ which goes beyond remuneration policies. The ‘good old days’ are over and we need to find new ways to inspire, motivate and bring out the best in our people.”

The yardstick for success should be set at the board level. Sir Rob Margetts explains: “It is very much a matter for the board, not just the decision of Remcos, to define what success looks like for that company. Executives that are encouraged to hold more shares will be identified by other shareholders as fellow travellers and perceived as suffering like other shareholders when prices fall. However, the means by which you pay them should be related to the parameters of progress as defined by the board.”

Rebalancing executive salaries to more sustainable levels will not be without problems, but Remcos should not shirk the challenge. Likewise, boards must decide what performance really looks like and advise how this can be linked with pay. The fact that it is difficult and change will be gradual is all the more reason to start now.

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon.

Matthew
www.twitter.com/criticaleyeuk