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Soaring rates of pay for top executives are unjustifiable

Since 1990 the remuneration of FTSE 100 chief executives has increased from
17 times to 75 times that of the average employee.

One non-executive director recently said: ‘There is neither a moral nor a
market argument to justify the explosion in pay, but once started, it is hard to
stop. You cannot be seen to be left out’.

A number of research projects have found that there is no evidence that huge
increases in pay have resulted in improved company performance. The price of
chief executives may be influenced by beliefs in their value to the business as
the generators of shareholder value. But there is spectacular evidence in both
the UK and the US that misjudged CEO and board decisions can contribute far more
to destroying value than creating it.

The banking crisis has highlighted this. Hector Sants, the chief executive of
the Financial Services Authority, noted last year that there is ‘widespread
concern’ that inappropriate remuneration may have contributed to the current
crisis.

Timothy Garton Ash commented in the Guardian this month that: ‘The conduct of
the bankers who pitched us into the slurry pit… may not have been illegal, but
it was selfish, irresponsible and immoral.’

How has this happened? The underpinning concept is that of agency theory,
which in essence says that principles (owners) cannot trust their agents
(managers) to further their interests. The managers must therefore be offered
incentives which will align their interests with those of shareholders. Of
course, that is exactly what doesn’t happen. High bonus expectations create a
moral hazard situation.

So what can be done? The Turner Report proposed that ‘firms must ensure
remuneration policies are consistent with effective risk management’. But there
is more to it.

Demanding standards for bonus schemes are required which meet the five key
criteria:

  • They are based on realistic, significant and measurable key performance
    indicators.
  • They do not present a moral hazard, ie. an incentive to act inappropriately
    in pursuit of a bonus.
  • They do not encourage the pursuit of short-term gains or engagement in
    unduly risky enterprises at the expense of longer term and sustained success.
  • They never reward for failure.
  • Payment is only made if a demanding threshold is achieved.

Michael Armstrong is an author of reward and HR books –
koganpage.com

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