Podcast episode 34 Executive remuneration
You're reading the transcript to the CIPD podcast series.
Philippa Lamb: Hello and welcome to the CIPD podcast series. This month we're going to be looking at the highly charged issue of executive remuneration. It's a subject which began to receive a great deal of negative media attention as soon as the banking crisis emerged and as the global recession has mounted so too has widespread interest in the pay and bonuses awarded to senior executives in every sector, often it seems regardless of the success or failure of the organisations they work for.
To discuss the current state of play, the outlook for the future and of course the role of HR in the debate we are joined now by three experts from the CIPD Reward Panel:
Charles Cotton is the CIPD's Reward and Performance Advisor, John Beadle is Global Head of Human Capital Performance at Standard Chartered Bank and Vice President Reward at the CIPD, and Nicki Denby is Principal of Towers Perrin Executive Compensation and Reward Practice; thank you all for joining me.
Charles, we've heard a great deal about directors pay in recent months, not just from the media but from government, unions, a whole array of other interest groups as well. Most of it I think it's fair to say has been intensely critical, how fair do you think most of that criticism has been?
Charles Cotton: I think what is at issue is people are wanting to know how have people got to these large sums of money, what is the link between reward and the performance. Now a few years ago when the economy was booming there wasn't a great deal perhaps of focus so much on the performance because it was assumed, well obviously you can see how the organisation is doing, how the economy's doing. However, in the financial downturn there has been more focus on directors pay, firstly in the financial services sector, not necessarily because the directors have been held responsible directly for the problems, what happened is that there may have been some issue around oversight about what some of these traders were doing, how some of these people in the retail centres were actually selling mortgages for instance. Then flowing from that, as the rest of the economy started to slow down, people saying well, during the boom time we saw executive pay go up, how come now we haven't seen a similar fall in executive pay? Now, if you do look at some of the data you do start to see that the bonuses that these individuals are getting is going down.
One of the criticisms has been from (I hasten to add, not people around this table) but I mean some commentators or remuneration consultants, is that the problem that the media, the public or the politicians don't get it and I think the problem is not so much with the media or the politicians, I think the problem is that the executive pay has become so complex and that we've perhaps retreated into using such complex language it's now very difficult to explain to people what we're trying to do and why and how this has a positive impact.
PL: So it's about transparency really isn't it? I think, John, as Charles mentioned, your sector, the banking sector, has been at the heart of this debate. Do you believe there actually needs to be root and branch change in the way executive pay is handled across the board though?
JB: I think we've got to put it in context. There's an element of 'tall poppy syndrome' that goes on in this whole debate, particularly when you start comparing it to people like journalists or politicians or civil servants. We do have to re-establish the connection between pay and perceived performance and I think in many cases there's been a failure to actually articulate and communicate the rationale for some of the levels of payments that have been there and that is absolutely the fault of the HR community as much as the businesses they serve; we have a responsibility to do that.
PL: I mean, Nicki, it will not be news to you that remuneration consultants have been accused of sewing the seeds of this problem by ramping up pay in the affluent years before the recession, would you say that's a fair assessment?
Nicki Demby: No I don't think it's a fair assessment but I think one of the issues that we have had is we do have a high level of transparency around directors pay in particular in the UK and we are one of the few countries where individuals are named in the annual report and accounts and how much they get paid is disclosed, in some cases clearly, in other cases less clearly and wherever in the world higher levels of disclosure have occurred, seeming to be a good thing, we've had the unintended consequence of very rapid pay inflation in that market straight afterwards. You can see it, if you look back over the last ten years. Every market where governance has changed to increase the level of transparency, you suddenly had pay inflation. So it's not just the people who are reading those reports and accounts who are observers who are seeing how other people get paid, those who would compare themselves with other chief executives see how much everybody else gets paid and that has created its own pay pressure. It's one of the unintended consequences of transparency and a couple of good examples from other areas would be footballers pay has gone up since it's become much more widely known how highly they get paid and way back when, talking 15/20 years ago, when the first surveys of investment banking pay were published, that caused its own pay inflation, so transparency actually has some unintended consequences.
PL: And that perceived disconnect between the level of pay and the level of performance.
ND: I think John's absolutely right, I think collectively we haven't done a particularly good job of explaining how or why people get paid in the way that they do get paid. One of the things that I personally enjoy doing, rather sadly, is, I enjoy writing remuneration reports to make them clear, to make them tell the story about why pay is being paid in the way that it is done. I'm working on one at the moment where I have been given last year's remuneration report as a starting point, I cannot understand what they do by taking last year's model and having to get lots and lots of additional information to be able to explain it in the much improved version.
PL: So that's really concerning because if you don't understand it, what hope is there for the rest of us?
ND: Absolutely not. That is the point and I think we all take a responsibility for telling the story a lot more clearly about why pay, particularly variable pay, is paid in the way that it is and for what kind of performance and making those connections for people, that's our responsibility.
JB: And building on Nicki's point, I think we are at the stage now where we have to reappraise why we are paying what we are paying, the rationale for it in the context of regulation and government influences and make sure that we've communicated to our stakeholders whether they be shareholders, the general public or our own employees, why we're doing this and do it in a transparent and clear manner and I don't think we're there in many cases.
PL: You bring me neatly to my next point because indeed it is all about clarity now isn't it and the CIPD is currently producing new guidance on executive pay in the form of ten principles I think it is, isn't it Charles, for organisations to use when they're formulating senior salary packages. Now, obviously there is a limit to how much detail we can go into in this podcast but can you talk us through the main points?
CC: The thinking behind the CIPD coming up with the principles is to give practitioners and interested parties such as REMCO Chairs or members of the REMCO as well as people in the public and voluntary sector a framework to help them in their thinking, in their development of executive remuneration policies and their practices and their structures. I suppose what we would say is that while there are executive remuneration best practice guidelines out there, they often tend to change quite quickly and tend to focus on a particular industry. At the moment, perhaps unsurprisingly, there's a lot attention in the financial services sector but what we're doing is perhaps writing it from a perspective of a practitioner, a reward professional and we've consulted and talked to a number of reward practitioners about this topic and they've come up with these ten quite high level principles of what organisations should be working towards. In some instances I'm sure many organisations are quite far down the road towards these, in other instances I'm sure, possibly in the public or voluntary sector, among smaller organisations, there's still some way to go for them, so that's the reason behind it. We've got ten high level principles and obviously it will take quite a long time to go through all of them but for instance one of them would be that the mix of fixed and variable remuneration should be commensurate with each executive's role and their level in the organisation and not lead to inappropriate risk-taking, such as incentives that drive inappropriate behaviour, such as revenue to the detriment of profit.
ND: Yeah I think the most important thing, we've been focusing on in developing the principles, as Charles has said, is that we wanted them to be broadly applicable. Every organisation that employs and pays people could get some benefit from thinking about them, so we've been very careful to say that the way that you pay people needs to be appropriate to your organisation. There is no one-size- fits-all model which I think is an easy trap that people could fall into from reading the newspaper, thinking there is best practice. There's some best practice thinking but every organisation needs to think through the model. Things that organisations will be thinking about today will be affordability. What's their financial situation and the foreseeable future prospects? Who owns the organisation? Is it owned by shareholders in the public market or is it in the voluntary sector, one which is very much set up with not for profit objectives? Those need to be taken into account when working through how best to pay people. No matter what the organisations' objectives are, what are the talent implications? Who are the people, the skills, the capabilities, the experience, that need to be brought into that organisation to help that organisation be as effective as possible in achieving objectives, profit making or not profit making. All those important pieces of context need to be brought to bear in thinking through the reward agenda and it's very easy to forget those.
JB: Yes, one of the principles we've been talking about is that those that are involved in decisions in this space need to have access to appropriate independent advice and while that is valid, I think it's important for us in the HR community to be aware that despite having advice and access to advice, we need to continue to act as a conscience to the CEOs and the Board on HR issues generally and reward is no different. We need to stand up and be counted on these issues and it does require a degree of personal courage and a degree of personal integrity and it's a particular challenge in certain sectors in a certain environment but if we're talking about what HR brings to the party, it needs to have the skills in order to take part in a debate and it needs to have the personal courage to stand up and be counted in those discussions.
Charles, I'm interested in your thoughts on that because I think it probably is fair to say that in many cases HR has perhaps failed to stand up to their CEOs on this issue in the past. Clearly it's a very loaded issue now. Do you think they will stand a better chance of doing so in future?
CC: It rather depends on how the HR department is viewed by the organisation. In some instances the HR department or the reward function is seen as almost an execution only department not physically, I hasten to add, executing people, but actually executing the reward policies and principles that have already been devised for them and actually they've all said this is the answer, now go out and implement it. In other organisations the HR department is actually seen as important in helping create and add value to the company and hopefully going forward, we're going to see more organisations taking that approach with the reward and HR departments to ensure that what the organisation is trying to achieve with its executive reward actually is adding value to the organisation and that does involve not only HR having the guts to stand up to the Chief Executive and actually saying how it is, as far as they perceive it, but equipping themselves with the necessary skills and knowledge to be able to enter into that debate about what the organisation's about; what are its corporate objectives.
PL: So they can actually reposition themselves in that debate.
CC: Yes.So that they are seen almost as a valid party by the organisation because these people are speaking the language of business and they have got the credibility to take part in it.
JB: Just to make a slightly contentious statement; I think one of the issues in our field is that part of an average HRD's career progression isn't necessarily through the reward community and actually, if their career path hasn't taken them through reward, then it's in everyone's interests for them to get versed in this space before they are taking on a Board position and having these kind of discussions, because it is very easy to step aside and allow others, including the independent advisors who clearly are skilled in the area, to just occupy the space and that's not a healthy situation for an organisation.
PL: So from what you're saying it's rather the ball is in the court of HR on this?
ND: And HR has, as Charles said, a very big responsibility to make the remuneration committee work well. The role that the HR function needs to play to ensure that good quality decisions can be made, is to provide good quality information to the committee decisions can be made, is to ensure the right information is provided to the committee in a timely form, there needs to be a good two way interaction and conversation going on. I think it's very poorly understood outside organisations, that whilst the actual decisions are made in remuneration committee meetings, a lot of work goes on in advance and if good quality work isn't allowed to happen so there are good processes around the committee, you ensure your committee is well trained, up to speed on current developments, then you're not really supporting them, in the way they should be supported, to enable them to make great quality decisions and that's a responsibility of HR too.
PL: Let's talk about the specifics of some particularly contentious areas and one that springs very much to my mind John, is clawback.
We've seen an enormous amount of coverage about this, where organisations have attempted to claim part, or all of a bonus awarded in one year, if it subsequently emerges that actions taken, have had the adverse affect in future years, what are your feelings about that?
JB: I think it's interesting in several respects. Some organisations have clearly had clawback for some years and it's in the form of performance related stock. If an organisation doesn't meet its long-term goals the long-term goals, incentives do not vest and therefore major parts of remuneration that were on the table have been taken away so I would argue that clawback in some form has existed for a very long time.
PL: Should it continue to do so?
JB: I think it is inevitable, I think there is no alternative. In the sense that every, albeit conflicting guidance, that's come out of shareholder bodies or regulators, has said that this is an absolutely key aspect of remuneration design.
If we focus on clawback of bonuses of course we know again if there has been some really thoughtful planning in the creation of bonus pools taking into account things like economic profit, then there is a less need to engage in some difficult, if not very costly and legal minefields, in clawing these pieces back. The planning upfront in terms of things like decisions on bonus pools, even before you get into the distribution of bonuses, I think is at the heart of trying to square this particular circle.
PL: So it's not the principle you have any issue with it's the specifics of how you do it.
JB: Yeah. I think, in summary, a lot of organisations are doing it and may not even be aware of it and secondly there can be a lot of thought in the upfront design of creating bonus pools to distribute in the first place that mean you don't need to go down the legislative route thereafter once you've distributed.
PL: Charles this is all part of the wider question about the link between reward and risk isn't it, the fact that banks in particular, perhaps rewarded excessive risk taking has been widely covered, how can organisations strike a sensible balance between motivating appropriate levels of risk taking, which is clearly desirable, and sustaining long-term high performance?
CC: I think organisations, perhaps, almost need to step back. You could almost say that they focused on the reward and then worked out the performance so they could justify it.
I think, going forward, organisations need to start thinking - well actually, what are we trying to do with this element of the reward package? Are we trying to recruit people, are we trying to incentivise them or are we trying to motivate them? Sometimes there seems to be confusion so you may have something like a deferment. Is that actually going to encourage somebody to stay with the organisation or, actually, is it linked to performance and is it part of both? Just to touch on what John was saying, I think there's also confusion by the public, about what clawback actually means and many of them will actually think it's clawing money out of peoples account once it's been paid which obviously is very difficult to do so I think John's point is very valid is that, actually, before you start looking at this you've got to think well,actually, what could go wrong, what are the risks, what do we need to start looking at to ensure that we don't end up in such a situation going forward? Similarly, when you're talking about redundancy packages, severance packages, thinking about that quite clearly upfront, rather than suddenly having to respond if your Chief Executive doesn't work out the way you thought they would work out, or possibly have done a good job but actually the environment has changed and it's time to say goodbye to them. We are doing some research in this whole area around how organisations identify, manage, measure and mitigate risk and I think what we'll see is not only a focus which there is at the moment, on the process of reward but more so around the behavioural aspects as well. What behaviours are we trying to encourage? What values are we trying to encourage and are we, actually, inadvertently encouraging the wrong behaviours and the wrong performances and the wrong values?
PL: As you say it is about being clear about what you're actually rewarding; but Nicki, when we talk about remuneration packages, this is a big thing isn't it? We're talking about pay, incentives, pensions, benefits, severance, as Charles has just said; where do you think we're going to see the biggest change?
ND: Well at the moment it's quite hard to know where the biggest change is going to happen. One of the questions that we're asking at the moment is, is the current system broken, so exactly the model that you've described, of base salary, short and long-term variable pay and benefits, is that model broken? As we're talking to people, both employers and institutional investors, the general consensus is no the fundamental model isn't broken. There's quite a lot of evidence that the model is working exactly as John said, long-term incentives are not paying out or paying out at much lower values when the share price goes down. Bonuses are going to come down in 2009 in direct reflection to how businesses performed. Bonuses were generally pretty good in 2008 because the performance for that year was very good.
PL: So it's the lag the wider public don't understand.
ND: Yeah, the lag is an issue, but the other thing, exactly as Charles has said, is to make the system work better. What everybody's focused on now is how can we make the system work better? Not rely on clawbacks (exactly as John and Charles have said) but to design better incentives in the first place and to make sure that they are focused, not just on the 'what' of the results that are produced but the 'how as well. There's some very interesting work being done at the moment on using lead indicators, so things like market share, employee engagement things like that, which are not just financial metrics, they are hard metrics (makes me very cross when people call them soft metrics because they're hard metrics) but they're not financial metrics and trying to see if we can measure more holistically business performance so that pay is reflecting more accurately a wider perception of how a business is doing.
PL: So it's a much more sophisticated approach.
ND: It will be and that is a challenge for everybody in HR because everybody has to raise their skills in this area and even though I'm a consultant now I've worked in the reward function in a business myself in the past and one of the issues with internal reward functions becoming highly skilled these days is that there is a tendency for HR Generalists, or HR Business Partners, as they're called in some businesses, to think they don't need to know very much about reward, it's a kind of delegation to the experts and the trouble is, is it's normally glowing in the dark by the time a problem gets to the reward function and we would have much much better and quicker business answers if HR Business Partners built their own capability in this area to spot the issues earlier. They don't need how to solve them but to identify them.
PL: So they stop fire fighting.
PL: Charles we're coming to the end of our time. Before we close, I would like to ask you all your thoughts about what executive pay is going to look like in five years or ten years time or whether you actually think we will see fundamental change in the way this is looked at once we get out from under the existing economic chaos. What's your thought about that?
CC: I think it's back to what Nicki was talking about earlier, it's about what the purpose of an organisation is and from that, the remuneration practices flow and from talking to the investors it doesn't seem to be the case that they think the model is broken, it just needs to re-examined, re-vitalised and if that is the case then I think the typical structure will remain, though there'll be increasing emphasis on performance, trying to link reward to performance, increasing emphasis on actually deferring reward elements. The issue is whether the investment community or society as a whole think that perhaps the corporate purpose is actually going to change rather than focusing on maximising shareholder value, it may perhaps go back to perhaps a longer term perspective that there used to be in the forties, fifties and sixties such as the focus on the long-term creating an organisation that creates value over time for the investors, in which case you may actually see a shift. You may see a change in reward approach, you might see salaries becoming increasingly more important and perhaps the short-term bonuses less important but longer term investment plans may become more significant.
PL: John, what do you think? I mean we always talk about long-term thinking don't we during recession and everyone has lots of good stuff to say about it and then when we see an upturn it tends to fall away doesn't it.
JB: I guess my fear, if I look ahead, is that we increasingly get pushed down by what I call the cookie-cutter approach where we are highly constrained by often conflicting regulation in terms of what we can do and therefore the degree of innovation and the degree of appropriate solutions we can give to our businesses are very limited. My hope is that actually if you look the organisations that have come through the recent storm most successfully I think, have had HR at the heart of their business. The leaders in it have shown a high degree of integrity in challenge and I think that shows that if HR is well constituted and well positioned it can actually be a very successful contributor of business and avoid some major issues.
PL: Nicki, are we going to see a fundamental shift do you think?
ND: I really just want to build on what Charles and John have said. I think we will not only be looking over the longer term as Charles referred to it in terms of business but the longer term employment proposition as well. We have some very significant issues about the future of post-work pay is going to look like in the UK around what retirement is going to look like. I think we're going to have to take a longer term view about how executives are building their wealth and there are some quite interesting models that have been used by a handful of companies around the world typically called something like career shares where rather than long-term incentives vesting after three years as we typically have it in this country, people have to hold shares in their company for their career with that company and goodness gracious me will that mean that your ultimate wealth reflects the value that you created? Yes it will. It's actually a very simple mechanism as well so one of the things, like John, I fear desperately that regulation will push us towards 'cookie-cutter' inappropriate solutions, we were already on the verge of that even before the recent credit crunch and my aspiration is that we will have simpler remuneration that is right for business and right for the talent strategy that that business has to make it all happen.
PL: Thank you all very much indeed.
That's it for this month's podcast, many thanks to my guests. If you'd like more information on executive remuneration and a detailed copy of the executive reward principles we've been talking about you'll find everything you need in the show notes which accompanies this podcast, and remember, if you are a CIPD member you can discuss any of the issues we've been looking at on the communities page of the website, you'll find that at www.cipd.co.uk/community
Thanks for listening, join me again next month.
There's a new CIPD podcast every month. Coming soon… Executive Remuneration panel discussion.