During the last decade, executive directors and
non-directors pay has attracted public and media interest mainly by reason of
the overly generous pay offered by employers to this specific category of
employees. According to research, in the period from 1998 to 2011 the median
total remuneration of FTSE100 CEOs recorded an average growth from £1m to
£4.2m. In 2011, nearly a quarter of FTSE 100 CEOs benefited from a 41 per cent total
reward package value rise vis-à-vis the previous year; however, the average pay
increase in the period has been calculated at 12 per cent. The findings of the
investigation also revealed that pay increases mostly occurred in the form of deferred
bonuses and long-term incentives, whereas base pay increased of just 2.5 per
cent on average (Manifest and MM & K, 2012).
The worth of the reward packages earned by CEOs and the pace
at which these have increased during the last years have both attracted public interest
and bad press, insofar as political leaders too have turned their attention to
this issue and laid specific laws down. In general, governments and regulators
of many European countries have imposed restrictions on public sector and financial
services organizations, mostly whether these are state-supported. None of the
European countries has, however, adopted any particular measures in regard to
the executive pay of the private sector organizations.
The main reasons why during the last decade executive pay
has remarkably increased are usually associated with:
Ø
The extended level of responsibility taken by
CEOs for organizations becoming increasingly larger and complex (Kaplan and
Rauh, 2007);
Ø
The drawbacks produced by the need for more
strict governance controls over executives’ pay, requiring many employers having
to disclose executives’ pay details. Since employers benchmark their directors
pay against the reward packages offered by their competitors, this has caused
businesses to offer executives more generous reward packages in order to retain
and attract quality professionals. For the same reasons, employers of countries
where no regulations on executive pay transparency are in place have felt a
fortiori encouraged to offer directors more generous reward packages (BIS, 2011);
Ø
The evolution of rewarding systems which tend to
become the more and more sophisticated, accounting for employers paying larger
amount of variable pay in a bid to more effectively link executives’ performance
and results to pay;
Ø
The trend pushing reward specialists to develop
more complex reward systems favouring deferred pay. Since according to these
arrangements the higher the level of risk the higher the pay, the base for pay
is usually inflated in that objectives
might not be attained and executives might in turn receive reduced bonus
payments, if any (PwC, 2011);
Ø
The complexity of reward arrangements which may
cause the link between performance and reward to be blurred, at best, and
completely lost, at worst. Moreover, being these systems based on a larger
number of reward options, it is very likely that in the end some of them will be
paid despite not completely justified by the real executive performance.
According to the Croner’s “Directors’ Reward Survey” (Cree,
2010), however, the typical director’s fat cat image can be considered just as
an executive representation of the past. Findings of the investigation revealed,
but this should not come as a surprise, that many executive directors work more
than 60 hours a week (21 per cent) and that some of them seldom take all of
their contractual holidays. As regards the link between pay and performance, only
half of the participants said that their pay is linked to performance; it also
emerged that this occurrence is mostly typical of large organizations. Nearly
50 per cent of directors reported just a 2 per cent salary increase, 37 per
cent said that their pay had been frozen and 9 per cent of the respondents to
the investigation said that they had even undergone a pay reduction. Only 40
per cent of the directors reported having received a bonus during the previous
twelve months. The investigation also revealed that the typical bonus amount
was of £25,000 for executive directors and £15,000 for executive non-directors.
The findings of the survey actually depict a scenery overly
different from that known to the general public. The investigation backdrop may
possibly help to find out the reasons for such different depiction. The
questionnaire was sent by Croner to 45,000 members of the UK Institute of
Directors (IoD) whereas only 745 executive directors responded to the survey,
namely less than 1.7 per cent. The final result of the overall investigation is
hence the result of the opinion expressed by a minority of directors, possibly
those less happy with their current experience and circumstances.
Notwithstanding, the real reason for executive pay having caught
the public interest and having had bad press during the last decade is not that
much associated with the generous sums of money paid in absolute terms by
employers to this specific category of professionals, but rather with the lack
of a clear cause-effect relationship between such generous payouts and
performance. In many cases, executive directors have received very large
amounts of money even for having failed to attain organizational objectives. This
bad practice, known as “rewards for failure”, has also actually had a
remarkable impact on executives’ and directors’ payment of severance packages.
In some cases in fact executive directors have received extremely generous
severance payouts upon leaving their companies also after having outrageously failed
to attain their objectives.
Averting to reward
executives for failure
In many countries the awareness of the negative impact
provoked by such bad practice has prompted governments to take appropriate
actions. However, also the shareholders of many organizations have expressed
concern for the serious threat this undesired habit could pose to their
companies, not least from the reputational viewpoint.
The identification of a series of measures aiming at
preventing executives to be rewarded for failure has become hence necessary.
Amongst these, requiring shareholders vote on executive directors pay and
attributing to this a binding value is definitely considered of crucial
importance. Giving firms’ shareholders “say on pay” is believed to prompt these
to be more involved in the business management and to publicly provide evidence
of the significance organizations associate with their executives’ pay
decision-making process. Indeed, by reason of the relevance the phenomenon has
lately acquired, shareholders’ vote should also be introduced for severance
payments determination. In the UK, this requisite has been legally introduced
by the Companies Act 2006.
Since the largest component of executives’ reward packages
is represented by variable rewards, particular attention has to be paid to the
development of schemes establishing a clear line of sight between pay and
performance. Care needs indeed to be taken during the implementation phase too;
also in this case a sensible difference could emerge between what has been
designed on paper and implemented in practice.
The role of remuneration committees is clearly paramount and
members composing these should never forget that their main objective is that
to foster the long-term interest of the business.
Members of remuneration committees are habitually
individuals who have the professional experience and expertise to identify
challenging objectives, set appropriate reward packages and develop effective
assessment methods of executive performance. On the other hand, however, these
individuals, just by reason of their past experience, are also considerably
influenced by the “generous pay” culture, insofar as what may be deemed as
excessive for the general public could be simply considered as a norm for them
(The High Pay Commission, 2011). Additionally, remuneration committee components
usually tend to design and introduce pay arrangements based on traditional
approaches, rather than coming up with new methods fitting the business
circumstances (Main et al, 2008).
It is the more and more believed that diversifying the
composition of these committees, avoiding these to be entirely formed by
non-executive components of the board, may definitely help (BIS, 2011). To this
extent it may turn to be particularly effectual asking independent members
with, for instance, academic, consultancy and advisory background (Hay Group,
2011) to become part of the commission with no need for these to become full
non-executive members of the board (BIS, 2011). The different background and
expertise of these individuals could indeed enable organizations to gain new
perspectives and develop new approaches to executive pay practices (TUC, 2011).
An additional feature, more directly associated with the
full independence of the remuneration committee members and in turn with their
impartiality of judgment in terms of executive pay decision-making, relates to
the circumstance that many directors may cover at the same time different
positions in different organizations. This may cause that, for instance, a
person making pay decisions about the pay of another individual in a given
organization is subject to the decision made by that same person in a different
organization, still in terms of reward. This could clearly affect the pay
decision process in both organizations and cause evident conflicts of interest
which should be averted from the outset (BIS, 2011).
Some stakeholders in the UK have supported the idea that, in
order to implement a radical and effective change in the executive pay
decision-making process, employee representatives should be invited to be part
of remuneration committees. This recommendation is based on the assumptions
that employees would better dissect pay or severance pay proposals practically
aiming at rewarding executives for failure and would better assess extremely
generous executive pay offers and increases vis-à-vis those offered to the
other employees, especially when the latter have benefitted of very modest pay
increases or the business has made people redundant.
Where implemented this initiative has produced mixed
results, as well as has produced mixed reactions the proposition to introduce
this initiative as a rule in some other countries. According to research conducted
by Buck and Sharhrim (2005), for instance, employee involvement has produced
positive results in Germany; by contrast, several other investigations have
underscored the difficulties emerging when trying to execute this approach in
practice in other countries.
The effectual implementation of this initiative implies
first and foremost that employees have or gain an in-depth knowledge of the
business strategy. Additionally, it should be clearly defined what their
responsibilities are and this aspect could be clarified only determining whose
interest these are supposed to protect: that of the employer, that of the employees
or both? Whether these should be representative of the employer interest, it
should be assumed that it would be up to the employer nominating these, whereas
in the case they should be representative of the overall workforce interest it
should be most appropriate these to be elected by the employees.
The implementation of this approach should be also clearly
based on the company law in force in each country. Europe, for instance, is
characterized by a fair level of heterogeneity in term of employee
representation at board-level insofar as three different grouping of countries
can be identified with reference to this aspect (Worker Participation, 2013):
Ø
Countries without any specific legislation
(Belgium, Bulgaria, Cyprus, Estonia, Italy, Latvia, Lithuania, Malta, Romania
and the United Kingdom),
Ø
Countries where employee board-level
representation is limited to state-owned companies (Greece, Ireland, Poland,
Spain and Portugal),
Ø
Countries where employee board-level
participation is extended to private sector employers (Austria, Croatia, the
Czech Republic, Denmark, Finland, France, Germany, Hungary, Luxembourg, the
Netherlands, Norway, Slovakia, Slovenia and Sweden).
Notwithstanding, board-level employee representation is
differently regulated in each nation. In many countries, for instance, it is
subject to the number of employees forming the overall workforce. The lowest
threshold has currently been set in Sweden with 25 employees, whereas the
highest in France with 5,000 individuals. Differences are also concerned with
the rate of board seats occupied by employees and the title seats are occupied,
namely whether these are taken on a supervisory board or single tier board
title (Worker Participation, 2013).
The introduction of laws regulating board-level employee
participation can also have an impact on, and may require hence a revision of,
the company law accordingly. In the UK, for example, company law entails that
individuals participating at board or committee meetings are companies’
directors. The introduction of a rule extending employee participation to
remuneration committee would, by extension, require the amendment of the
company law accordingly.
Irrespective of the legal constraints, however, it can be
considered questionable assuming that employee involvement in remuneration
committees could reveal to be beneficial for organizations. Once employees
would be invited to participate to the committee meetings these should clearly
have an active role and it is unlikely that these may have the technical
knowledge and experience to actively participate on a decision-making process
for which committees members, when needing advice, are used to have recourse to
accredited national and international firms. As discussed earlier, executive
pay arrangements tend to be the more and more complex and sophisticated;
employees not having the required expertise and experience would clearly be in
difficulty and would be essentially unable to have their say in such meetings.
As mentioned above, even though responsibility for
executives’ pay will invariably rest with remuneration committees, it is
possible for their members to seek external professional advice. Since
consultancies could hold sway over the remuneration committees final decision,
in 2009 was introduced in the UK a voluntary Code of Conduct in relation to the
executive remuneration consulting activity. The Code, developed by the
Remuneration Consultants Group (RCG) in representation of the major
consultancies of the UK listed organizations, as stated by the same
Remuneration Consultants Group, basically “sets out the role of executive
remuneration consultants and the professional standards by which they advise
their clients, whether their clients are Remuneration Committees or the
executive management of the company.” It therefore aims at clearly explaining
the scope and conduct of consultants when providing advice to the UK listed
organizations as regards executives’ pay and defining the standards of the
information that consultancies should provide to their clientele.
The conflict of interest which might potentially arise when
remuneration committees have recourse to external consultancies has prompted
many governments around the globe to take some actions. In 2011, for instance,
the Australian government enforced stricter rules on the type of relationship
which can be established between companies’ remuneration committees and
consultants. Similar initiatives were also adopted in the United States were
remuneration committees have the obligation to unveil how these have managed
and sorted out the conflicts of interest eventually arisen (BIS, 2011).
Excerpt from Rhetoric and Practice of Strategic Reward Management
To read the whole paragraph (Par. 110, Section XVI, pages442-456)
Longo, R., (2014), Rhetoric and Practice of Strategic RewardManagement; Milan.
