The evolution of executive pay
Katie Jacobs, October 01, 2014
Media and shareholder scrutiny, coupled with regulatory changes, mean executive pay has become increasingly complex
In the years following the financial crash, executive pay racked up as many column inches as the average FTSE 100 CEO salary. But by the start of 2014, the debate appeared to have calmed down somewhat – until news that luxury fashion house Burberry’s investors had rebelled against CEO Christopher Bailey’s £10 million pay packet, propelling ‘corporate greed’ back into the headlines.
Hot on Bailey’s well-shod heels came the latest report from independent think tank the High Pay Centre, which claimed bosses at FTSE 100 companies are earning an average 131 times more than their staff. “When bosses make hundreds of times as much money as the rest of the workforce, it creates a deep sense of unfairness,” said High Pay Centre director Deborah Hargreaves.
With the economy on the mend and the UK job market heating up once more, HR magazine decided the time was right to look at how executive pay is evolving. What’s changed since the recession and where is the market headed? Are pay ratios the answer to tackling reward inequality? And what is HR’s role in ensuring a sustainable reward strategy that supports the long-term objectives of the organisation and all stakeholders?
Top pay is a notoriously touchy subject. Andrew Lambert, a partner at HR research company Creelman Lambert and author of the recent Parc report Organisational Effectiveness and Top Executive Pay, laments the “timidity” of HR leaders when it comes to discussing executive reward, leading to an “immature” debate with few willing to engage. When it came to this piece, HR magazine was lucky enough to find a few HRDs who are doing things differently when it comes to pay, and willing to talk about it.
More transparency ahead
A greater level of transparency is the direction of travel for most organisations, whether they like it or not, with recent regulation requiring companies disclose more information and increased shareholder engagement via the binding vote (see box on p8 for more).
“Regulators are trying to get companies to be more transparent so shareholders can make better decisions, and the binding vote gives that teeth,” says Andrew Curcio, a director in Towers Watson’s executive compensation practice.
“The more transparency we have, the more scrutiny we will have.”
Andrew Page, partner at reward consultancy New Bridge Street, which counts many of the FTSE 100 among its clients, says regulation has created a “much higher standard of reporting”.
“It has made remuneration committees [remcos] sit down and think very carefully about their remuneration strategies and how they tell that story.”
In fact, since the ‘shareholder spring’ of 2012, executive pay overall appears to have reduced. “Early indications are there hasn’t been a lot of movement on the salary line [in the last year],” says Page. “We’re seeing some drop-off in bonuses and short-term incentives, as that’s the area that investors have most scrutinised. Companies have been a lot more cautious about how much they’ve paid, which contrasts with the fact that most companies’ results have improved.”
Tom Gosling, the leader of PwC’s reward practice, has noticed a “greater mood of rigour and restraint”. “Bonuses have fallen three years in a row, base salary increases have been narrow and alignment between base salaries at the top and throughout the organisation has really taken hold since the financial crisis,” he adds.
Rewarding the non-financial
Gosling has also noticed an increasing focus on “making performance-related pay work better” for executives.
It could hardly be worse – a 2012 Hay Group report, The Trouble with Executive Pay, found 87% of remco members thought pay was not sufficiently linked to performance.
“There’s a feeling that incentive rewards in the past haven’t been terribly motivating or have produced [the wrong] outcomes,” Gosling says. “It’s about trying to get better measures that are more closely aligned with the strategy of the organisation. Now there’s a greater diversity of measures linked to strategic imperatives, values and behaviours.”
Page says he is seeing a bit more focus on non-financial metrics, “particularly where companies have a clearly articulated set of values or are in long-term industries where the way they create values is complicated”.
Any move towards integrated reporting, which focuses on long-term value creation beyond merely the financial, means companies may soon have no choice but to pay more attention to their non-financial metrics, such as CSR and people-related ones, and to link them more clearly to reward strategy.
According to Business in the Community’s CR Index 2014, 46% of the 96 companies surveyed already link CEO remuneration to the company’s CR performance, up from 24% in 2002. Manchester Airports Group (MAG) is one of these companies, tying executive incentive plans to CSR targets. “We target and measure a number of outcomes, such as volunteering hours, the percentage of employees involved in CSR initiates, carbon emissions and employment of people through our airport academy, which is aimed at the local unemployed,” explains Collette Roche, group HR and transformation director. “While at first glance these might appear to be not financial, there is a clear financial benefit from recruiting locally or reducing energy costs, so the business case always stacks up.”
Lambert says top pay needs to be framed in the debate of organisational effectiveness, and to consider long-term value creation. “To what extent are leaders satisfying multiple stakeholders?” he asks. “What is creating value, and not just financial value – will the organisation be around in 20 years time?” MAG’s reward strategy reflects this view. “We have a responsibility to all our stakeholders – customers, employees, service partners, shareholders and the communities in which we operate,” says Roche. “Our incentive schemes recognise the need to balance their expectations.”
Making values pay
Corporate values are also becoming increasingly important – at least on the surface. But if the values on the wall are not reflected in the behaviours of the organisation, reward can all too often be the missing link.
“Pay has to be based on values, because whatever you value as a company gets projected onto the rest of the organisation,” believes Jane-Emma Peerless, HR director at currency and international payments provider Caxton FX. “I don’t believe the pervading philosophy that reward should be based on financial performance works, so we’ve never done it.” Lambert echoes this view. “The more you get into targets and numbers, the more it becomes a dodgy area,” he says. “It’s true of sales people, why isn’t it true of executives?”
Senior directors at Caxton FX currently receive no form of bonus. “It’s always been that way, and they’re still there,” says Peerless. “There are ongoing discussions about whether we should [give bonuses based] on company performance. The purpose of that would be to bind departments together rather than being under pressure because everyone else does.”
Metro Bank HR director Danielle Harmer also knows the importance of putting “our money when our mouth is in terms of reward being aligned to behaviours”. “Whether it’s the CEO or the cashier, we take the same approach,” she adds. This means everyone’s performance is judged on behaviours and delivery, with behaviours coming first. If the behaviours don’t add up, no bonus is given.
“If someone is struggling on behaviours or delivery, they don’t get their bonus because a bonus should be just that,” continues Harmer. “Other banks give 100% of the salary as a bonus, but ours are nothing like that. We focus on the long-term growth and value creation. Everyone who receives a cash bonus gets to share in long-term value share options – and it is very long-term. When I saw the new seven-year clawback rules [announced by the Bank of England in June], I thought ours aren’t far off that.”
She acknowledges that as the new kid on the block, Metro Bank doesn’t have to deal with the tricky legacy issues around reward that other banks are facing: “If you’ve been getting a short-term cash bonus for years, it’s what you expect and it’s hard to move away from that. How can you suddenly dial it down from 100% to 20%? It’s a horrible challenge.”
At the Financial Ombudsman Service, executives don’t receive bonuses at all. Instead, a percentage of their salary is held back unless they meet certain objectives. “We benchmark salaries, work out what we can afford and the market rate, and then deduct 15% of that,” explains HR director Jacquie Wiggett. “They have to deliver the organisational scorecard, their own departmental objectives and demonstrate they are living the values. If they achieve those three things, they can have the rest of their pay. It’s a held-back payment rather than a bonus.”
Cascading down the organisation, FOS also doesn’t allow new joiners to barter on pay, appraises and rewards on values, and has replaced individual rewards with group ones. “It’s really important to us that people share knowledge and we found if you reward people individually, they don’t share,” explains Wiggett.
Curcio says he has noticed reward for middle managers and below become more values-based, but is it mainstream for executives? “Measuring values and behaviours is challenging,” he says. “[For leaders] it’s about being role models in the business. HRDs have a critical role to bring that alignment and values piece to the rest of the organisation.”
Are ratios the answer?
With values and alignment coming to the fore, the concept of fairness can’t be far behind. “The whole fairness debate has become very prominent,” says PwC’s Gosling. However, he believes setting maximum pay ratios, mooted recently by the High Pay Centre and committed to by organisations including John Lewis (capped at 75:1) and TSB (65:1), are “not a particularly helpful disclosure, because they will inevitably get wrongly compared”.
Page agrees ratios “are a pretty blunt instrument”. “I’m concerned that if you go down the ratio route, you end up with all kinds of strange behaviours,” he adds. “If you wanted to improve your pay ratio, you could do it by increasing your cost base across the organisation, or by outsourcing your lower-value jobs.”
Roche thinks pay is too complex a subject to be reduced to a ratio. “I can understand why, post financial crisis, attention is drawn to executive pay, but I don’t believe the issue will be addressed by highlighting individual data sets and looking to one solution, such as setting pay ratios,” she says. “Pay is not a simple formula – there are many factors such as market forces, public perception, organisation size, accountability, risk and so on.”
However, Lambert believes “ratios are a healthy debate to have”, and some of the HRDs we spoke to agree. Wiggett says that at FOS, she is keen to “reduce the ratio between our lowest and highest pay”. “Ours is very low because we think we should treat people fairly,” she explains. “We find it’s useful [to talk about] because it fits with what we’re about. We have a curious, challenging workforce. If we weren’t [transparent], they would ask anyway.” She adds that when FOS holds ‘ask me anything’ sessions with executives, employees have asked about pay ratios.
However the pay ratio debate develops, Gosling believes the days of huge salary increases are over. “It’s easy to forget that between 2000 and 2008, CEO salaries increased by 7-8% every year – that’s completely broken now,” he points out. “This has still got some way to run, but remco thinking has changed. A lot of the forces that drove the great executive pay inflation have largely died away.”
He predicts that a greater focus on internal succession planning, building rather than buying in talent, will mean executive pay “goes sideways” for the foreseeable future.
But Page warns the global market for executive talent “has become a lot hotter”, with companies all over the world competing for a limited pool of top talent. “One can debate whether Burberry has the right structures, but there’s no doubt a company like that is operating in a global marketplace,” he says. “If [Bailey] went to another role, the chances are it wouldn’t be a UK one. Those pressures are only going to become stronger.”
The balancing act of competition, public perception, shareholder scrutiny and culture means the role of HR is becoming increasingly complex, and vital. “HRDs will only become more important in this space, which puts a lot of pressure on them,” predicts Curcio.
“There will have to be expectations reset among executives who are used to year-on-year increases,” adds Gosling. “HRDs are right in the middle of potential conflict and are critical in making sure the dynamic is collaborative rather than confrontational.”
Metro Bank’s Harmer believes HR needs to be “totally” involved in executive pay: “Who else is going to tell the CEO if he’s being too generous or have the technical expertise to get data, benchmark and act as an independent council?” Wiggett adds that “HR really are the gatekeepers”, making sure reward really fits with culture, values and organisational strategy. “Unless you’ve got a real grip on where you’re trying to head, you lose that control and the whole essence of what you’re there for,” she adds.
“There is a lot of rubbish about [executive pay],” concludes Lambert, bluntly. “We need to go back to basics: what works, what doesn’t work and where’s the evidence? As an HR director, [when it comes to executive pay], are you a patsy, an ethics warrior, a technical expert, staying out of it, or a great facilitator who brings up these issues?” As the debate continues, it could be time to decide.