Changes to employment contracts would reward successful executives and
protect shareholders
HR is uniquely placed to take the lead in the debate on how to change the
so-called "rewards for failure" culture. As yet another piece of
research (this time from the Labour Research Department) condemns ‘fat cat’
excesses, the profession has an opportunity to help protect both shareholders
and successful executives.
It is said that rewards for failure at the top come about because of market
pressure for a particular type of contracts of employment or senior executives.
Most such contracts have relatively long notice periods (greater than, for
example, 12 months) but do not contain a provision allowing the company to
terminate employment summarily without payment if the executive does not
perform satisfactorily.
Poor results
This makes sense from the executive’s point of view. There can be many
reasons for a company’s poor results other than his or her poor performance.
Market sentiment is sometimes irrational. Executives can be made scapegoats for
situations outside their control. Faces can no longer fit. Compensation for
unfair dismissal is capped at £52,700 – not a lot if you are earning half a
million a year – and it is uncertain how the statutory regime works at such a
rarified level.
From the shareholders’ point of view, this is very unsatisfactory when the
executive fails to perform. Letting him or her work their notice is not an
option. They want the executive to go immediately. But if the company does not
give the requisite notice then, generally speaking, it has broken the contract
and will have to pay damages.
The starting point for calculating damages is 12 months’ notice equals 12
months’ money. But in theory, an executive cannot just sit back and wait for
the money but must "mitigate their loss" – by finding another job.
And here is the rub. An executive who has been publicly fired because of the
company’s poor performance is very unlikely to get another similar job soon.
Thus, the worse the company does, the larger the payout on termination for the
executive.
Incentives
There are other ways though, this is where HR comes in. Performance related
incentives are common. What about performance related job security? For
example, a contract could have a variable notice period dependent on how the
company was performing against its peers.
Why HR? It is frequently they who set the terms of reference for debate in
companies’ remuneration committees. Moreover, senior executives are unlikely to
suggest this for themselves.
It will be said that the market would not accept such contracts. That is
almost certainly true at the highest level.
However, a company that is innovative in its allocation of risk in
remuneration may have the right, in the eyes of market opinion, to be
innovative in how it structures its rewards. There are opportunities for
successful executives to receive enhanced remuneration if, perhaps, they accept
there may be a downside if the company fails to perform.
Change is unlikely to start at the top of Britain’s corporate tree. But in
companies outside the FTSE 100, both public and private, there is no logical
reason why HR cannot at least suggest some creative solutions to a problem that
continues to disproportionately discredit corporate governance in the UK.
Key points
– Because of the way senior executive contracts work, sometimes the worse
the performance the greater the pay-out on termination
– It is legally possible to draft contracts to avoid this
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– HR is well placed to initiate a more balanced risk-reward structure of
senior executive pay
By Jonathan Chamberlain, a partner in the employment team of Wragge &
Co
