HR's role in executive pay
Nick Martindale, June 04, 2014
Concerns surrounding executive pay continue to grow. But HR can play a key influencing role
When does executive pay become too hot to handle? It’s widely accepted that the global economic downturn was caused by reckless business practices, particularly in the financial services sector. Such behaviour was symptomatic of a wider corporate culture that encouraged excessive levels of risk-taking in the persuit of huge financial gains.
Against this backdrop, excessive levels of executive pay have come under scrutiny, with the likes of WPP CEO Martin Sorrell, Lloyd's CEO António Horta-Osório and former RSB CEO Stephen Hester all feeling pressure from the media, shareholders and customers.
According to the High Pay Centre, today’s FTSE 100 CEOs are paid 185 times more than the average worker. Even those who are directly involved in setting levels of executive pay believe these are too high. According to the Hay Group report, The Trouble With Executive Pay, about three-quarters of non-executive directors serving on remuneration committees believe this to be the case.
On the face of it, as the guardian of employee reward and recognition, motivation and engagement, this is certainly an area HR should be looking to influence. And in smaller, privately owned organisations, this is often the case.
Gemma Bullivant, group head of HR at management consultancy Bluefin Solutions, which has 180 employees, sits on her organisation’s board and remuneration committee, along with the CEO, head of finance and an independent external non-executive.
“If the culture of the company is such that HR is on the board, it’s definitely closer to understanding that there is input needed from HR around executive pay,” she says. “The whole complexity of the people agenda is now being recognised, but it’s still seen as more important in a smaller environment.
”Dominic Ceraldi, HR manager at Pimlico Plumbers, also has an input around levels of executive pay. “I have a meeting with our managing director at the start of each year and we look at what we want our senior management to achieve and base any bonuses on that,” he says. “I’d link the performance targets to the long-term business plan.” Such involvement would have been impossible in his previous role in the public sector, he adds.
Ceraldi was also involved in the firm’s attempt to introduce a greater degree of fairness and transparency around pay at all levels, as featured on Channel 4’s Show Me The Money programme last year. This involved advising on how salaries for certain individuals – including managing director Charlie Mullins – would be perceived by the wider workforce. “The company now has an open culture around what everyone is earning so we have to be able to justify it,” Ceraldi says.
However, in larger, publicly listed organisations, where executive pay tends to be highest, the reality is very different. Jon Terry, a partner in professional services firm PwC’s reward practice, says that while HR has always had a role to play in setting up objectives and measuring performance against these – including in some cases advising remuneration committees – it has often been unable to impact the debate in any meaningful way. “HR is right at the centre of all the key processes in determining both the quantum and structure of pay for executives,” he says. “But the real question is whether they use that influence beyond running a process to actually influence key decisions.
”Often HR has very limited involvement in bigger organisations, adds Peter Reilly, director of HR research and consultancy at the Institute for Employment Studies. “I’ve talked to HR directors who have not really been involved in any of these processes. They are not board members themselves and are not necessarily brought into the picture by the chair or secretary of the board. What role they may play is in data-gathering, but they may not even do that because it’s often contracted out to an external consultant.”
The real ownership of executive pay and reward in listed firms (those bound by the UK Corporate Governance Code), and many larger private businesses, rests elsewhere – usually with remuneration committees. These tend to be populated by non-executive directors, frequently drawn from business and financial backgrounds, and often serving as lead executives in other organisations.
“One of the unintended consequences of this is that the decision-making then tends to take place in an environment which is detached from the rest of the organisation,” says
Charles Cotton, reward and performance adviser at the CIPD. Against such a backdrop, HR’s best chance of influencing actual levels of remuneration tends to come
when someone is appointed for the first time, he adds, rather than as part of an ongoing review process.
Other groups also have an influence. Reilly points to the growing role of external consultancies in advising committees, often drawing on their experiences with other organisations. “There’s a question of whether or not the members have themselves the expertise to really manage it, as opposed to going along with what is proposed to them,” he says. “It’s all too incestuous.”
External shareholders, too, are becoming increasingly vociferous, particularly large institutional bodies such as the National Association of Pension Funds and the Local Authority Pension Fund. The Hay Group study found 74% of non-executives serving on remuneration committees highlighted the growing influence of shareholders and wider public interest as the biggest change they had seen during their time on such bodies. In some cases, such as with WPP boss Sorrell, this has even led to the proposals made by remuneration committees being rejected.
But failing to fully involve HR and focusing on external comparisons and pressures can be dangerous. “HR can certainly bring a perspective to the discussion,” says Mark Szypko, managing director of compensation at employment solutions company Kenexa. “Plan, design and modifications need to tie back to the corporate vision and strategy, in a manner that would be consistent with the other plans and programmes already in place. This ensures the CEO or the executive team aren’t being rewarded to do something that is in conflict with what everyone else in the organisation is being asked to do.”
Bullivant from Bluefin Solutions also believes HR can play a key role in helping to advise around what really motivates executives, and could even help reduce the overall level of compensation by introducing other non-monetary rewards – such as career progression or greater autonomy around how to hit targets. “The psychology of what motivates people has to come into the mix with executive packages, and HR can play a big role in that,” she says. Many executives are not particularly motivated by long-term incentives, she adds, which means organisations have to offer huge sums if
they are to go down this route.
Yet there are question marks over whether HR has the skills to take on this more challenging role. Amanda Flint, a partner in the employer solutions team at Grant Thornton, highlights the need for specific knowledge around finance and taxation. “So much of the reward package is influenced quite heavily by those two factors,” she says. “Whether it’s performance targets for bonuses or long-term incentives, you need to understand how the financials work; and within HR there isn’t necessarily an appetite to get involved with those subjects.”
There are, however, signs that in the current climate there is more of a willingness to involve HR and reward professionals in a more meaningful capacity. Michael Shields, managing consultant at HR recruitment firm Digby Morgan, reports a greater focus on finding dedicated reward directors with experience of working in and around executive remuneration, although he warns that such top talent tends to be in short supply. “Some now act as secretary to the remuneration committees so they will be responsible for the preparation and delivery of remco papers,” he says. “We’re being asked for people
who have shown previous capability to do that. Any decent reward director worth their salt would expect to be involved at that executive level, setting the overall compensation strategy and particularly within executive reward.”
In the longer term, HR or reward directors that can influence such deliberations can not only further their own reputation and career, but also that of the HR and reward function more generally. Ultimately, suggests PwC’s Terry, the litmus test may be whether such individuals themselves are considered for non-executive posts in other organisations. “That’s a piece where HR directors are perhaps somewhat behind CFOs, CEOs and COOs,” he says. Only once this starts to happen, perhaps, will HR be able to truly claim that it is genuinely able to influence the debate at all levels when it comes to the complicated and controversial topic of executive pay.
Focus on financial services
The recent Changing Banking for Good report, published by the Parliamentary Commission on Banking Standards, proposed the deferral of bonus payments for as long as 10 years to encourage executives to take a longer-term perspective.
In practice, regulators have already had the power to force banks to defer bonuses for some time, but this marks a signifi cant change in culture, says Jon Terry, a partner in PwC’s reward practice.
“It’s not good enough any more to say you have variable pay depending on performance; you have to show exactly how it depends on performance and it has to be risk-adjusted,” he says. “It puts a greater spotlight on being able to demonstrate what’s happening – for both regulators and the public.”
Yet attempts to link pay to performance – rewarding successful executives with bonuses and long-term incentive plans – run counter to moves by the EU to cap the amount that can be paid out in bonuses compared with salary, under the ‘CRD IV’ requirements that are due to come into force in 2014.
The proposals will impose a one-to-one cap on the ratio of fixed pay to variable pay, although incentives that are tied to a fi ve-year period will receive a discounted valuation. The Global Financial Services Executive Remuneration Report by Mercer, however, warned of an unlevel playing fi eld between EU banks and those based elsewhere, and found 63% of organisations believe the proposed compensation
caps will reduce their ability to pay for performance.
The disclosure regulations imposed by the Department for Business, Innovation & Skills are also likely to have an impact. Among other measures, these include requirements to demonstrate how total CEO pay compares with both general employee remuneration and total shareholder returns, tracked over a 10-year period.
Already there are signs that the sector is moving to introduce greater transparency, not just among executives but also highly paid employees such as city traders. Earlier this year, Barclays and RBS revealed how many employees received more than £1 million in 2012, and others have since followed.
Reward and HR in practice
FNZ is a private equity-owned investment platform used by businesses in the financial services and wealth management sectors.
The firm’s remuneration committee consists of the company’s board of directors, but HR plays an important role in salary benchmarking and advising the committee about executive pay. “I’m not a main board director, but I attend the remuneration committee meeting and steer the compensation in the right direction,” says Daniel Kasmir, chief HR officer. “Then, as a member of the leadership team of the business, I absolutely set and drive the agenda for how we reward people.”
Part of this involves balancing the needs of the business in attracting and retaining executive talent with the broader picture around the culture of the company and how decisions are viewed by both customers and employees, undertaking regular surveys of both groups. “We will challenge if pay is too much and if it’s too little,” says Kasmir. “We’re the independent, objective voice sitting in the middle of the business.”
Over the past couple of years, the company has sought to ensure its practices around pay and reward stand up to scrutiny; a process which led it to bring in Richard Bolger in a new role as group head of reward.
“Transparency is key when you’re putting together reward structures, so people need to know what they need to achieve in order to realise their financial aspirations,” says Bolger. “We have something competitive here and, as we continue to grow, we want to make sure we have the right reward structures in place to achieve that.”