In turbulent times the management of payroll costs becomes a priority; people costs are often the easiest, and largest, costs that are controllable by management. As Jeffrey Pfeffer’s contribution suggests, ill-considered large-scale redundancies can do long-term damage to organisations: the vital knowledge and experience assets of the organisation can be permanently lost, doing great damage to the business in any future upturn. A more immediate move, with less downside, is to bring remuneration levels more closely under control. In an environment where the link between individual base salary increases and inflation has been loosened, salary increase budgets can be cut or even reduced to zero. Obviously there will need to be effective communication, and some care needs to be exercised in ensuring that limited budgets are wisely spent on high-performers, key staff, or those whose pay falls well below the market, but in the short term effective control of the salary budget can yield significant savings.
However, as the CIPD 2008 Annual Reward Management Survey Report shows, base salaries are not the only potentially flexible cost in the remuneration package. In the private sector virtually all executives and senior managers, and the majority of middle management and professionals, participate in annual incentive plans. The management of these plans in turbulent times is a critical factor in retention of talent, bringing focus to actions that will see the organisation through a difficult period and reducing costs where performance has declined. Similarly pension and benefits costs need to be reviewed. With new actuarial assumptions regarding life expectancy coming into effect and greater potential pension deficits as a result of poor equity investment returns, organisations will yet again have to revisit how the costs of defined-benefit plans are split between employers and employees and the potential for reducing risk. The introduction of flexible benefit accounts can also ensure that limited benefit budgets are spent in ways that are most valuable to the individual employee.
None of these measures are likely to be welcomed by employees but, in turbulent times, job security can be worth more than a pay increase, or a high bonus; and maintaining medical or pension rights is a price that many people are prepared to pay through additional contributions. However, one of the tests of leadership in implementing these policies is how far executives themselves are prepared to share the pain.
In the past ten years executive remuneration has increasingly become divorced from the policies applied to managers and other staff: base salaries have been increasing at a faster rate (last year the median increase for FTSE 100 executives was around 8%), annual bonus opportunities and annual bonuses in payment have been climbing (last year the median annual bonus for a FTSE 100 CEO was just over £800,000 in cash), and long-term incentive grants and payments in shares averaged around £1m. In addition the majority of FTSE 100 top executives still continue to participate in defined-benefit pension arrangements, with supplements of one sort or another to give additional coverage to pensions above the earnings cap.
In my view the high remuneration of many executives can be fully justified by their performance. There is compelling evidence that the right leader can make a tremendous difference to the performance of an organisation in terms of providing long-term superior returns to shareholders, better products and services to customers, secure jobs that pay competitive remuneration and returns to the community in which it operates. But when performance declines, whether it is through specific issues in the company, or the impact of a general decline in economic activity or customer confidence, there is an expectation that this will reflect in executive reward.
But, in periods of turbulence where share prices are falling and performance expectations are declining, remuneration directors can find themselves in a dilemma. Although activity in the executive labour market does tend to quieten down during an economic downturn, for really talented executives the telephone calls from the headhunters don’t stop. And a downturn in the fortunes of a company harbouring a great up-and-coming talent is a good moment for a rival company to strike.
Top executives are generally required to hold large numbers of shares, and also have a significant element of their remuneration linked to the achievement of stretching performance targets with payment in the form of shares or cash. If the current or expected value of these remuneration elements drops significantly or indeed drops to zero, there is little to hold a high-flyer with alternative job offers and no immediate successor in the organisation.
This situation, which is perceived to be common, needs to be approached with a cool head and a realistic outlook. Executive remuneration that has climbed in a generally benign economic climate needs to reflect the less certain outlook in both remuneration opportunity and outcomes.
This needs to start with base-salary management; if there is salary freeze, or a cap on salary increases, at lower levels in the organisation, it should probably equally apply to the leadership team. Base salary is seldom the ‘make or break’ of a recruitment negotiation at the top.
The approach to annual incentives is a key matter for consideration by remuneration committees and reward professionals, and in recent months I have found there have been two particular issues. The first relates to bonus amounts. Most annual incentive plans are tied in to budgets, so if budgets are lowered, should bonus payments be lowered accordingly? In the 2001–03 economic downturn we know that they were not. Executive bonuses earned in 2002 were on average as high as those earned in 2000, despite average financial performance in 2002 being lower than 2000. Since then annual bonus opportunity for UK top executives has more than doubled, and 2007 was a record bonus year for many CEOs in the FTSE 100. There is a strong argument that to achieve these levels in the future, absolute financial performance should be at or near the 2007 level. The second key issue is performance measures. Having worked through two other periods of economic downturn and turbulence in the past 20 years, one observation I would make is that coming out of these periods, some companies recover powerfully and others continue to lag behind or fade away completely. Going into the downturn it was difficult to identify who would win and who would lose. This echoes Jeffrey Pfeffer’s case study: in managing through turbulence, leaders need to have a vision of the other side and be working towards this through the cycle. Maintaining focus on these developments can be reinforced through incentive measures, which may include product development, identified opportunities ‘in the hopper’, or people development.
Lastly, rewarding leadership has to be about the longer term. When share option plans go underwater and performance share plans fail to vest, it is easy to lose sight of the fact that sustained high performance is a long game. Several executives owning large blocks of their companies’ shares have made substantial paper losses in recent months. In some cases losses have been significantly larger than the post-tax salaries and cash bonuses they have earned. This is obviously demotivating, but is no more so than for investors. Keeping faith with share plans is a way of maintaining shareholder alignment and holds out rewards in an upturn for those who lead their organisations through difficult times.
If leaders are to justify their substantial remuneration packages based on the performance they achieve, and choose to exert tight controls on the remuneration of all employees through the current turbulence, then intelligently controlling their base salaries, staying with performance plans and refining them to meet new business challenges is the best strategy to retain talent committed to a successful future.