Is the purpose of astronomical executive pay really to avoid losing and to incentivise excellent executives?

Company executives justify their magnificent pay with the ‘global war for talent’. Like so many wars, there are two fronts, one facing the enemy and the other at home:

• Enemy: Compete against other employers to recruit and then hold on to the talent.
• Home: Compete against the employee’s innate indolence, to ensure they work hard, don’t slack, and try their very best.

Two appointments in the summer of 2012 show the futility of using pound coins as shrapnel in this ‘war for talent’:

The first is that of Ross McEwan, who was poached by Royal Bank of Scotland (RBS) from the Commonwealth Bank of Australia (CBA). McEwan took the job of Head of Retail Banking at RBS, which was the same post he held at CBA. According to a report by the Guardian, at CBA McEwan earned

• Salary A$1.25 million
• Bonus A$647,657
• Equal to £1.2million for the year

For ditching CBA and moving to RBS, McEwan was paid a ‘golden hello’ of £3.2 million on top of his undisclosed pay package. RBS claim this £3.2m is what McEwan forfeited by leaving CBA. 

So much for ‘holding on to talent’: CBA’s golden handcuffs turned out to be a very portable pair of golden cufflinks.

The second is Antony Jenkins, CEO of Barclays. We haven't managed to spot what Jenkins was paid in his previous role as Barclays’ Head of Retail Banking. According to a report in the Daily Telegraph “Barclays paid a multi-million pound sum by way of compensation” to Jenkins for not getting the seat on the executive board that had been promised when he joined from Citi, an American bank, in 2005. However his new pay package is reported by the FT to be:

“worth up to £8.6m – a base salary of £1.1m, an annual bonus of up to £2.75m, a long-term incentive plan worth up to £4.4m and a cash allowance of £363,000 in lieu of pension.”

Barclays are smart enough to know the futility of ‘golden handcuffs’. Presumably we see in this generous package Barclays’ attempt to prevent Jenkins from slacking and do his very utmost.

When announcing Jenkins' appointment Sir David Walker, incoming chairman of Barclays, commented:

"The field of short-listed candidates that I met was very strong, and it was clear that Antony was the outstanding choice.”

Some questions needing answers from those who set Jenkins’ pay:

• What do they think he will he do because of the bonus that he couldn't be bothered to do without it?
• If Jenkins outstandingly met the unique qualifications to belong to this tiny talent pool, why didn’t another company snatch him up when he was languishing under Bob Diamond?
• To what degree are his bonus targets rigged to ensure he meets them?

• For example how is it that Stephen Hester, CEO at RBS, had to decline his bonus? What were the targets he had achieved to even have a bonus to decline? Whatever his achievements were that so impressed his remuneration committee, RBS’ shareprice shows they didn’t impress the stockmarket.
• To what degree are these targets subject to the vagaries of the market, rather than the cunning of the CEO?

• If the CEO is so key, then did the Barclays shareprice languish due to Bob Diamond’s professional limitations rather than prevailing market conditions?

What about claims that high pay reflects the responsibility, or providing customers with good service, or bringing success to a company?

Pay is clearly not a matter of ‘responsibility’. If that were so then those responsible for our health, education, and security – nurses, teachers, and cops - would be paid more.

Neither does Customer satisfaction seem to be a driver of high pay policy. In evidence to the Future of Banking Commission in 2010, Jenkins stated that customer satisfaction on his watch at Barclays Retail Banking was 67%, with 33% not satisfied:

DAVID PITT-WATSON Still on the same point, did you say that two thirds of your customers are either satisfied or very satisfied?

ANTONY JENKINS Yes.

DAVID PITT-WATSON And then 1% complain?

ANTONY JENKINS Yes.

DAVID PITT-WATSON That means then that one third of your customers are less than satisfied?

ANTONY JENKINS That’s correct.

DAVID PITT-WATSON That seems a really high number. I can’t imagine how this hotel would function if one third of its customers were less than satisfied.

We presume that this satisfaction level is no worse than the rest of the high street banks – just that high street banks don’t place much value on customer satisfaction. Any more than a mugger worrying about whether his victims like him.

Looking beyond Barclays and at large companies in general, performance seems to be unimportant when setting executive pay. Figures from the USA show:

Sixty companies at the bottom of the Russell 3000 Index in the US lost $769bn in market value in the five years ending 2004 while their boards paid their top five executives at each firm more than $12bn.

These sixty companies paid their top five executives more than US$12billion over five years? That’s on average US$8million a year for being in the bottom 2% of that index!

The fact is excessive pay is the driver of excessive pay. That is the secret to how company remuneration committees (who set top executive pay) provide cover for their bosses. In an article for the Sunday Times Sir Paul Judge, founder of Cambridge University’s business school, said:

“The remuneration committee first agrees with the pay consultants the composition of a group of typically 10 to 20 comparable companies…These typically show a spread of about plus or minus 30% around the average figure.

The remuneration committee then decides where its executive should fit. I have never known of a remuneration committee prepared to declare that its chief executive is below average (they would presumably then have to sack the person). Typically, a committee will pitch the salary at around the upper quartile [top 25%] of the comparator companies. The executive is happy that he or she is well regarded and the committee has used objective evidence.

However, when the pay consultants go through the exercise the following year — using the latest information incorporating increases resulting from companies having placed their executives at the upper quartile — pure arithmetic means the average must have increased. Detailed maths shows that if there is a plus or minus 30% spread and all committees separately agree the upper quartile for their executives then the average will rise by about 15% — exactly what it has done”

 

Using Judge’s estimated 15% annual increase, the effect is to double pay in 5 years, triple in 8 years, and quadruple in 10 years.

Could it be that excessive pay is like excessive use of alcohol? The abuser can’t get the high – in executive terms he doesn’t feel more motivated - by the money he takes. So he takes more? And wonders why he still doesn’t get that buzz?

In the words of Professor Christopher Bones, author of “The Cult of the Leader”:

“There must be a mechanism to restore the relative rewards for senior executives against all other employees to a level that has broad social acceptance. This is not a challenge to politicians to intervene; rather it's an ultimatum to business leaders themselves to change. After all, the only people who can curb the excess for good are those who benefit from it. That would be the real test of leadership.”