HR is complicit in the great fat cat pay heist. It is time it gave some thought to improving the link between performance and reward
Plato believed the income of the highest in society should never be more than five times that of the lowest. Ancient history, of course. In the past 10 years, median pay among FTSE 100 chief executives has grown by 92 per cent to £579,000 (before bonuses and incentives), while male median pay sits at £21,000, having dribbled along with inflation.
The amazing fecundity of executive pay is usually viewed with something bordering on detached indifference by HR professionals, as if it had nothing to do with them. It is not so: HR is up to its neck in it.
According to pay consultants Hewitt, Bacon and Woodrow (HBW), in 84 per cent of European companies, decisions about executive pay are led by the remuneration committee, made up of non-executive directors (Neds). Yet in two or three meetings a year, these committees hardly have time to scratch the surface of what is a very complex subject, let alone go into the rival merits of an alphabet soup of performance indicators. In practice, they are heavily dependent on the advice they get. In 57 per cent of companies, that advice comes from HR departments. In 31 per cent, HR commissions assistance from external consultants. But in 41 per cent, HR actually designs the entire package.
Obviously, it would be quite wrong to blame the HR function when pay does not bear much relationship to performance – lack of boardroom clout has its upside. The chairmen of remuneration committees must take primary responsibility. Yet such complicity in the executive reward heist is, nevertheless, striking. Should we take seriously all those post-Higgs claims that including HR in the ‘gene pool’ of Neds would magically improve corporate governance?
In the UK, it is the institutional investors and shareholder activists that hold companies accountable when so much is channelled into the trousers of so few with such questionable justification. So, perhaps it is time for a distinctive HR manifesto on executive pay:
1. Differentials disincentivise. Remuneration committees have an obligation under the combined code on corporate governance to consider the ‘wider employment conditions’ within a company when setting executive pay. HR should go further. Executive pay should never be isolated from pay in general because differentials are fundamental to the calculus of just reward. The National Association of Pension Fund’s suggestion that the annual ratio between executive pay and pay elsewhere in a company should be published in remuneration committee reports, ought to be heartily endorsed. Shame moderates – hopefully.
2. Separate the powers. Decisions about executive pay should be taken by non-executives. HR is part of a company’s management, therefore, its role should be limited to providing background advice. External consultants should be hired by the remuneration committee to give independent guidance.
3. Set demanding targets. If income is guaranteed, it should be called salary. The point of bonuses, options and long-term incentives is that they might not pay out. According to Halliwell Consulting, in 2003, FTSE 100 pay schemes expected companies to achieve an average of 19 per cent growth in earnings. This sounds impressive – until contrasted with analyst expectations, averaging 56 per cent. Targets should be demanding.
4. The comparator is king. Performance measures, such as total shareholder return (TSR) and economic value added (EVA), all have their pros and cons. HR should argue that the specific measure is less important than the comparator group. Which companies an organisation chooses to compare itself against makes targets more or less difficult. A comparison with the FTSE 100 index produces markedly different results than comparison against the best 15 in a market. More emphasis on comparators, less on acronyms, would expose get-rich-quick schemes.
5. Go long-term. The typical performance period for executives is three years – too short for any realistic sense of achievement. Five years should be the goal.
6. Disclose everything. Reading a remuneration committee’s re-port, it is difficult to tell if better performance has been achieved or whether the targets have been lowered. In the current climate, HR should argue that confidentiality is outweighed by the obligation to be open about reward criteria.
7. Don’t follow the herd. HBW’s study found the top priority when designing pay packages was to examine the responsibilities of the job. The second was to look at market practice. Individual performance came third – the priority for just 9 per cent. HR should press for performance to be a much more important consideration, second only to responsibility. Doing what everyone else does is irrelevant.
8. More humility, please. It is not clear how much of a company’s performance can be attributed to the actions of a small group of executives, let alone one individual. The late 1990s ought to have demonstrated that many people were paid merely for riding a rising tide. Linking performance to reward is, and will always be, an imperfect work-in-progress.
What risks making it slightly farcical is that it remains a complete mystery if aligning the interests of executives with those of shareholders really makes much difference anyway. It is implausible to believe top executives do it purely for the money: competition, kudos, achievement and leaving one’s mark on the world are all more powerful motivators.
What matters, therefore, is the attempt at an explanation of how performance relates to reward. The intentions should be absolutely clear, the mechanisms defensible, and the results, with any luck, justified.