What a performance!
Performance related pay for senior executives rarely seems to achieve the returns that it promises, reports XpertHR's commentary editor Stephen Overell.
One of the many useful functions of work is that it provides a way for society to allocate its resources.
Because of their occupations, a baker is worth so much, a nursery nurse a bit less, a management consultant much more and Sir Christopher Gent of Vodafone £5.1m in salary and bonuses and £9.3m in share options. Hopefully, even the great man himself, flushed as he must be with his shareholders' largesse, might agree that the values placed on certain jobs are really very arbitrary.
As time goes by it often seems that such awards are becoming even more arbitrary. With Sir Christopher at the helm, Vodafone lost £13.5bn in the year to March 2002. From a share price peak of 399p, they now languish at around 97p. Of course, the glumness of the telecoms sector is beyond his control. But it still feels like an affront to common sense to learn that 80 per cent of this voluptuous remuneration package was performance-related.
Yes, indeed. According to Vodafone's 2002 accounts, the performance element in senior management packages sits at 80 per cent of the total amount. The rules that determine executive pay are entirely geared towards growth, with such inscrutable measures as one year cash flow, one year Ebitda, one-year ARPU and so on.
As any rational fellow would do, Sir Christopher seeks to maximise his income within the rules set by his remuneration committee. If it wants growth, it gives its managers incentives and viewed historically that is what they have delivered. Value is another matter. It is a question of what companies choose to reward that matters.
Expressed like this, Vodafone's pay policy seems entirely logical in a Kafkaesque sort of way - the shareholders are happy. But to the rest of the world it looks like fumbling in the greasy till by another name.
Over recent years, researchers have been at a loss to find a clear link between pay and performance - as most people would understand it - in executive remuneration.
The directors of FTSE 100 companies, for instance, received an average pay rise of 28 per cent in 2000 - five times as much as the increase in the UK's average wage, according to pay consultants Inbucon1. Overall, 2000 was a good year for the economy - maybe not 28 per cent better than the previous one, but good nevertheless. Most of the increase received by Britain's highest paid executives came from performance-related schemes and share options, as one would expect.
Yet Inbucon found that even when the effect of bonus schemes and long-term incentive plans was removed, base salaries rose by 22 per cent. And who did the best? Step forward 2000's winner: Sir Christopher Gent with a 400 per cent pay rise.
If asked for an intuitive definition of what 'performance' should mean, many people might say profitability. Yet it is on this very point that the pay-performance link seems most opaque. When the research group Incomes Data Services looked at the salaries, bonus payments, incentive plans and benefits packages of the UK's 350 largest companies, alas, think-of-a-number culture was most in evidence. The researchers could find "no statistical relationship between total cash movements and changes in corporate profitability", its report said2.
The problem has been taken to absurd levels in the US, where even those who bring about the collapse of their companies emerge from the rubble with a tidy fortune. A recent investigation into the remuneration practices of the 25 biggest corporate failures since January 2001 by the Financial Times found that the executives who brought about bankruptcies walked away with $3.3bn (£2.1bn) in payouts and share sales. In the good times, contracts are drawn up promising wild compensation and then the unstoppable gravy train cannot be halted.
Organisations such as the Institute of Directors often point out that by global standards Britain's bosses are not basking in richesse. To attract the best in an alleged (though highly debatable) 'global market', pay must be competitive. Yet the idea of 'competitive' remuneration depends on comparison.
Those who want to see British salaries levelled up tend to draw comparisons with the US. There, the average chief executive earns just under £100,000, against £550,000 for UK chief executives. Indeed, compared with the rest of the European Union, Britain's bosses are also doing well. In France, the average chief executive earns £383,000, while the Germans pay the least at just under £300,0003. As has always been the case in pay negotiations, 'fair pay' is a question of who compares themselves with whom. From the point of view of chief executives, it is a good thing those lower down the scale don't choose to employ the same logic as their bosses have to feather their nests. The wages of manufacturing workers in the US are a third higher than those in the UK.
Despite the shortcomings of performance-related schemes, the ideal of paying for performance remains a beguiling one - far superior to paying people for getting older, which is what used to happen. Yet it is unclear at the moment how far organisations recognise and are seeking to tackle the embarrassments it throws up.
IRS, the research body, says that while performance-related pay (PRP) continues to be the most common type of reward in UK companies, it has been falling for three years (54 per cent of them use it). Part of the reason is that there is "mounting evidence that it doesn't do what its advocates claim". In its place, organisations are adopting some complicated systems that honour both outputs (targets, defined objectives) and inputs (competencies, skills, contribution and behaviour)4.
However, Mark Edelstein, a consultant with Mercer Human Resource Consulting, argues it is "an absolute myth" that PRP is declining. Ninety-nine per cent of organisations want incentive pay schemes, he says, and go to great lengths to ensure their rigour.
"The results can look peculiar and there is sometimes a big reality gap between what looks fair now and how it will appear several years in the future. But I would dispute the claim that performance is unrelated to pay," he said.
It all depends what you mean by 'performance'. The suspicion is that what senior executives mean is as remote from popular understanding as the corporate aristocracy is from the rest of the workforce.
1 Inbucon executive remuneration survey, August 2001; www.inbucon.co.uk
2 Incomes Data Services, salary survey, October, 1999
3 Study by Management Today, July 2001
4 Paying for Performance, IRS Management Review, Issue 20, 2001
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