Why pay for performance is a mug's game

'No personal rewards for company success' might be the appropriate slogan from those who seek to restore market logic in the face of self-interested irrationality

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How much is too much?
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David Bolchover
On 23 November 2011 10:33

In its report on spiralling boardroom remuneration released yesterday, The High Pay Commission has made some very astute recommendations to enable increased transparency and accountability. However, pay at the top will continue to rise until we successfully challenge the automatic assumption that senior executives of public companies should be rewarded for strong corporate performance. This is an outcome that regulation alone cannot bring about.

Simplifying opaque pay packages designed to pull the wool over the eyes of the prying public, and introducing fresh blood into the cosy world of rubber-stamping remuneration committees, as suggested by the commission, would both be very welcome. And in straitened economic times, these measures might restrict the increase in executive pay. 

But come the next boom, there will be nothing to stop another huge rise. And when the next economic slowdown happens, we will be having the same debate, but this time focusing on sums far greater than those we see today.

This is because many opponents of high pay have failed to confront the two central fallacies – that top executives are largely responsible for corporate performance, and that they are virtually irreplaceable. Consequently, when companies post large profits, remuneration committees and consultants feel free to demand what they claim is commensurate pay. And few, it seems, are equipped with the arguments to stand in their way.

Look at some of the recent pronouncements of some of those who claim to be appalled by executive remuneration. “What I’m working towards is responsible capitalism where rewards are properly aligned with performance,” says Vince Cable, the Business Secretary. “There isn’t a close enough relationship between high pay for people at the top and the performance of the company itself”, says Nick Clegg, the Deputy Prime Minister.

By implicitly accepting the principle that top executives should become hugely wealthy if their company is deemed to perform well, Cable, Clegg and the many others like them are playing straight into the hands of those who support the status quo.

It is extremely difficult to reach an objective and incorruptible definition of what actually constitutes corporate success (or failure). Is it success when a company is hugely profitable during a boom economy, operating, as so many large corporations do, in an oligopoly with only two or three serious competitors?

Certainly, there will be millions of small business owners, many of whom have risked their principal possessions to sustain their companies in an intensely competitive environment, who would be delighted to be judged in such a benevolent manner. Because a clear definition of success is so hard to establish, those who benefit from high pay are free to impose their own subjective interpretation.

“We made a loss, but our chief executive is intelligently navigating us through a transition period”, or “our profits are down, but given the economic situation, we have performed extremely well”, or “our profits are up – that is obviously success, isn’t it?” Even if we reach a satisfactory definition of good corporate performance, why should we necessarily grant millions of pounds of our money to the top executives of the company concerned? We, after all, are the ultimate shareholders of public companies, through our pensions, savings, and other investments.

We should be asking the same questions as we would if we were asked to stump up millions of our money to state employees. It’s all coming from the same pot – ours. If the company actually did have to contend with serious competition and a difficult economy, there may be many different explanations for strong performance that have virtually nothing to do with the chief executive.

Perhaps the brand that predated his arrival by several decades is virtually impregnable; perhaps the company hit on a very popular product that he had no part in devising; perhaps the middle managers in the company are particularly competent. The connection of top executives to corporate performance is, of course, as difficult to disprove as to prove. But even if we reach a rational conclusion that they might possibly, sometimes, have some influence, we should only award them massive pay if they are really close to irreplaceable, if a significant number of other people couldn’t be assumed to have an equivalent chance of performing just as well.

When top football teams pay their stars huge sums, these salaries are entirely justifiable on market grounds. £200,000 a week for Wayne Rooney may make some eyes water, but there are probably five people on our planet of several billion who can match his skills. But what exactly is it about senior executives of large public companies, and indeed those much lower down the hierarchy in the finance sector, that is sufficiently rare to warrant multi-million pay packages? Intelligent, charismatic, articulate, conscientious, robust, good industry knowledge - all senior executives should ideally possess these characteristics (although quite a few seem not to).

But look around you – are these attributes really so very thin on the ground? “No rewards for failure” has been the mantra of those angered by extremely high pay despite apparently poor corporate performance. This is precisely the argument that their opponents want to hear.

“No personal rewards for company success” might be a more appropriate slogan from those who seek to restore market logic in the face of self-interested irrationality.

David Bolchover is the author of “Pay Check: Are Top Earners Really Worth It?” 

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