Do complex pay schemes really encourage value creation?

If you were paid 50% more than your current salary for doing the same job, would be able to create 50% more value for your company?

The topic of executive pay is one regularly and eagerly debated across media of all colours. From the million pound bonuses of the bankers, to the rewarded executives of firms like BP, and G4S, it seems that the common consensus of those at the top is that they earn and deserve vast multiples of those workers they ostensibly manage through their leadership of their organisations. Indeed, business leaders are so certain of this that the FT recently published an article with seven excuses executives give to prevent slowing the upward movement of their pay.

Increasingly, however, complex executive pay structures are coming under scrutiny from regulators, shareholders and the media, with the perennial question being asked of how they can represent value for money. Some pay packages are so hard to explain as to be virtually impossible; a golden handshake for the leadership, when the troops below struggle with minimal or non-existent pay rises, benefits and pensions.

It is not my intention to state that no senior executive is worth their salary, rather question how effective it can be to pay these sums of money. Like most things, there will be shades of grey and exceptions to the rule, but I’m interested in  what effect these pay packets may be having on businesses of all sizes.

Take, for example, bonuses. It used to be the case that an employee was paid a salary for doing a job, and when they delivered something exceptional, they might be paid a cash bonus as an extra reward. Not only was this easy to understand, but it had the additional effect of demonstrably delineating extra reward from regular salary. The bonus was awarded on merit and so exceptional performance was no only rewarded, buy actively incentivised.

This system of linking reward to performance was spearheaded by senior stakeholders wanting to align management interest with their own, but the system has mutated beyond all recognition, with Long Term Investment Plans (LTIPS) being created and tied to metrics such as share performance. This has created multiple issues, including liberal ‘get out of jail free cards’ for those claiming bonuses, as whilst some executives are poor performers, there is no definitive way to determine this (as executive action is often poorly correlated with a company’s share price). This essentially leads to a situation where executives are rewarded bonuses regardless of performance.

This has meant that for many companies, what probably started out as a reasonable pay scheme has ended up being extremely costly because of favourable economic conditions, or an inability to determine correlation rather than anything specific that the chief executive might have done.

I do not believe that awarding high-salaried chief executives bonuses in the form of shares encourages them to perform better or stay longer at a company. When executives leave a company, they are more than adequately compensated for any potential loss of share income by the company they are joining. In addition to this, consider my first question at the beginning of this article? Whilst increasing your salary by 50% may create additional motivation to perform in the short-term, would you actually gain the skills and/or experience required to immediately increase output by 50% at the same time? If, like me, your answer to this question was no, then you have to ask why it is that the rule applies to those on lower salaries, but is seemingly ignored for those on higher salaries!

Is paying a bonus or increasing pay even the answer at all? Expectations in many sectors of our economy have become so inflated that delicate darlings throw a total tantrum if they are paid less than the GDP of an emerging nation! There is no real proof that paying a bonus makes people work harder for longer. It can even be a disincentive because when people find out that someone else has been paid a bigger bonus than they have they tend to become disillusioned and make less effort. Bonuses can also lead to inappropriate behaviour as we have seen in the financial services industry.

In my opinion, it’s time businesses stopped kidding themselves that throwing more and more money at a select few individuals was the answer to greater business performance. Increased investment in training, equipment and staffing levels will affect performance to a far great extent than extending a CEOs salary by tens of thousands of pounds. If stakeholders and senior management are serious about creating value in their businesses, they need to learn to invest sustainably in the resources which will provide the greatest return on investment, which I would argue is rarely, if ever, those on the greatest salaries already.