Reflecting on the recent controversies over executive pay, it is clear that many of us find it difficult to understand why executives seem to get paid huge bonuses even when the companies they work for aren’t performing very well.
Although there can be an element of perception here, for example when current year and longer term performance do not align, the reality is that there are two aspects of typical executive pay that do not reflect what is important to their ultimate bosses – the shareholders.
Firstly, many executive pay plans pay out based on relative performance against comparable companies. Little wonder that shareholders are continually surprised about the big bucks awarded to executives – they got rewarded for not being as bad as the other guys!
Secondly, the issue of share options to executives are one way bets – if performance is good, then quids in, but if performance is bad the executives still get all the other elements of their pay and are still relatively cheerful. Often this means that executives are actually better off with driving down value further – with no value from last year’s options left, they can benefit from having a lower share price for setting next year’s share option awards.
One suggestion that I think should be examined is the use of leveraged share awards, with clawback provisions that mean pay would be reduced. For example, awarding a highly paid chief executive with shares of £1,000,000 offset by a loan of £800,000, would be a pretty generous (and hopefully appropriate) bonus equal to £200,000 in net value. But if the company (say) subsequently lost value by 50% then the executive would need to cover the £300,000 shortfall between the value of the shares and the loan. In other words they would benefit from increases in shareholder value, but there would be a clawback if shareholder value fell.
Clearly this is not a complete solution, as closer attention by shareholders into controlling excessive executive pay is going to be much more important. However, a move away from pay plans that reward declines in shareholder value, or options that can only go up in value, towards pay awards that directly link to shareholder value would be a start.