Tag: remuneration

Investors call a chief executive’s bluff

Don't ask these investors for a pay rise
Don’t ask these investors for a pay rise

News of a chief executive’s resignation following a failed bid for more pay reminded me that back in April, the FT’s Brooke Masters wrote an article about the difficulties faced by both governments and shareholders reining in the excesses of corporate pay.  Noting that in 2021 it was possible to believe that “corporate sermonising about the need to look beyond pure profit was beginning to bear fruit”, “that the pandemic had prompted most corporate chieftains to show financial restraint” and that CEO pay in the FTSE 100 had dropped by 10%, she noted that the tide had turned.

Her article was triggered by controversy around the salary to be paid to Carlos Tavers of carmaker Stellantis which attracted the ire of French presidential election candidates and was voted down by shareholders.  But this contrasted with larger remuneration packages in Stellantis’s US domiciled competitors, and much large packages in the tech giants.

These big packages have been facing challenges from shareholders. Masters reports that 18% of US companies with revenue in excess of $50 billion failed to get a majority voting in favour of their executive salary resolutions, and there was a 20% increase in shareholder protest votes on pay in Europe.  But often these have no effect and merely advisory, with no pain felt by boards that fail to comply with the expressed shareholder will.  She indicates that she feels that the pressures for restraint in public companies are insufficient, completing her article by giving the impression that the promise from the Stellantis board that the shareholders’ vote would be “taken into account” in next years’ pay report suggests that shareholders are not being taken seriously.

In contrast, the response on 7 August of the founders of private equity company Carlyle Group to the attempt to extract economic rent from shareholders, otherwise described as a pay claim worth $300m over five years, submitted by chief executive Kewsong Lee, suggests a that they have some backbone.  Admittedly, Bill Conway, David Rubenstein and Daniel D’Aniello are all billionaires and can absorb the immediate response of the stock market, a 10% decline in the share price, to the announcement of Kewsong Lee’s departure, but some of this soon recovered and the price remains 13% above the price one month ago.

But given that there is a vacancy at Carlyle and that Kewsong Lee received a total of $42 million last year (mostly in stock awards, but a fair bit of leverage on the base salary of $275,000), anyone willing to exercise a little restraint in the face of some hard-nosed shareholder may want to apply.

Norwegians have the power to tackle executive abuse of power

Norway mapNorway’s population and land area may be only 0.07% and 0.08% respectively of that of the world, but through their nation’s $1.2 trillion oil wealth fund they own the equivalent of 1.5% of every listed company.  If any single organisation is able to help overcome the market failure represented by the capture of economic rent by the managers (and the connivance in this of toothless or complicit remuneration committees), it is the custodians of Norway’s accumulated oil receipts.

It is reassuring to discover that Nicolai Tangen, chief executive of the fund, is on the case.  Not only has it just voted against the pay packet proposed for Intel’s executives, but it voted against the remuneration proposal at Apple in March, having voted done the same at IBM, General Electric, and Harley Davidson earlier this year.

In an interview published in this weekend’s Financial Times, Mr Tangen explains that it has remuneration proposals that are not justified by performance, are opaque or not long-term in its sights.  “We are in an inflationary environment, where we are seeing many companies with pretty mediocre performance coming out with pretty big pay packages. We are seeing corporate greed reaching a level that we haven’t see before, and it’s becoming very costly for shareholders in terms of dilution.”

He continues by blaming shareholders for not voting their shares: “We feel to a certain extent that shareholders haven’t really done their job in this area. We are sensing a bit of a shift in sentiment among the large shareholders in the world towards more scrutiny and more requirement for alignment.” However, he argues that the fault lies primarily with the boards themselves, stating that the “main blame is clearly with the CEOs and boards.” 

Blaming the CEOs may be a bit unfair, even if it suggests that they are being less than strategic and are failing to fulfil their fiduciary responsibilities given that this will probably damage the interests of the company in long term, certainly if the investment community ever gets its act together.  But it does point to a failure of the board as a whole, and particularly non-executive directors.

The FT also quotes the fund’s chief governance and compliance officer who says that the fund is currently targeting US companies because this is where the problem is most egregious.  This suggests that there is a particular problem in relation to governance in the US.  Part of the problem may be that although the US model places, in theory, greater power in the hands of the non-executives who generally compose almost all the board other than the CEO than models elsewhere, there is a tendency towards appointing a high proportion of NEDs who are either current or former CEOs themselves.  The problem is compounded further in the US in the ease, particularly in the tech sector at the IPO stage, with which corporations employ share structures that limit the voting power of external investors. In some respects, the US corporate governance is broken, but it most certainly is if other big investors fail to follow the lead of the very large investor from the very small country near the top of the world.

Moody’s says Lloyds’ ethnic diversity plan is ‘credit positive’

The Financial Times reports today that Lloyds Banking Group’s plans for promoting more black employees have been described by Moody’s as “credit positive”, the first time that a credit agency has explicitly linked a company’s stability to ethnic diversity measures.  Moody’s has not gone as far as to upgrade Lloyd’s credit rating at this point, but it clearly indicates that Lloyds’ plans  are “credit positive [implying that they have the potential to reduce the company’s cost of capital, even if not immediately] because they will improve staff diversity at all levels and reduce Lloyds’ exposure to social risk”.

Lloyds has stated that it recognises that some groups are under-represented in its ranks.  Anyone viewing the current TV advertising campaign for its domestic mortgage lending arm, Halifax, showing a diverse mix of staff ready to serve customers despite working under Covid-19 restrictions at home, can see that Lloyds is not talking about front-line staff in this instance.  It has set a target to increase five-fold the number of black staff in senior roles by 2025 and will be publishing data on its ethnicity pay gap.

Investors and rating agencies have been taking increasing account of environmental, social and governance (ESG) risks, reflecting the importance of sustainability, on all measures, to the corporation and to those who invest in it or lend to it.  The note about Lloyds published by Moody’s on Thursday is a welcome acknowledgement of the work Lloyds is undertaking.  Action of this sort should improve internal culture, communication, engagement and ultimately operational performance and profitability.  The motivation behind showing a diverse face to the TV audience is that it contributes to winning customers and increasing revenue.  The response of Moody’s suggests that yields benefits in addressing the capital market interface, ultimately increasing access to capital and reducing its cost.

Let us hope that Moody’s response to Lloyds’ efforts spurs others to recognise that action on equality, diversity and inclusion is good for business.

Response to Corporate Governance Reform Green Paper

I have submitted a response today to the Corporate Governance Reform Green paper.  The essence of the response is firstly support for the proposals submitted in a letter dated 23rd January to the Prime Minister by the Institute of Directors, the TUC, the ICGN (international Corporate Governance Network) and ICSA representing Company Secretaries which urges the Government at a minimum to:

  • Create a mechanism which allows those whose interests should supposedly be protected by the law, to make complaint and find an appropriate remedy.
  • Ensure investors and stakeholders are appropriately involved in the governance of that mechanism.
  • Strongly encourage, or mandate larger private companies to apply the principles of independence and transparency which have worked for public companies.
  • Help encourage frameworks for executive pay which are more broadly acceptable, and recognise that it, like other aspects of corporate governance will require a long term focus, from directors, investors, stakeholders and government.”

The second core element of the response is to call for employees to be polled alongside shareholders to approve the appointment of directors, as proposed in the letter published by the FT on 3rd November.

To see the text of the full response, follow this link:  Tom Hayhoe response to the Green Paper on Corporate Governance

Highlights from October 2016 Harvard Business Review

My two picks from the latest Harvard Business Review relate to two Escondido Framework themes: the way that executive teams have been the beneficiaries of the misunderstanding by shareholders (or, rather, their representatives on remuneration committees) of what motivates them and how the relevant market relationships work; and the need to think about employees as customers.

An article titled “Compensation, the case against long-term incentive plans” reviews the work of Alexander Pepper, set out in his book “The Economic Psychology of of Incentives: New Design Principles for Executive Pay (Palgrave Macmillan 2015). Pepper documents how pay for performance incentives, and Long Term Incentive Plans in particular, fail to work as proponents expected. The four reasons are summarised as follows:

  • Executive are more risk-averse than financial theory suggests
  • Executives discount heavily for time
  • Executives care more about relative pay
  • Pay packages undervalue intrinsic motivation

HBR’s review of Pepper’s work, in its Idea Watch section, comes not long after news broke in London on 22nd August that Woodford Investment Management was to scrap all staff bonuses, based on the belief that ‘bonuses are largely ineffective in influencing the right behaviours.’

The second article of interest is an article by Cheryl Bachelder, CEO of fast food franchise Popeyes: “How I did it…… The CEO of Popeyes on treating franchisees as the most important customers”. It’s not so much the lesson expressed in the article’s title that excites me, but an extract in the middle of the text that takes the message a stage further, recognising staff as customers:

At one point in my career, I was touring restaurants to talk to team members about the importance of serving guests well. I met a young man who was not excited about my “lesson”. He asked who I was. “I’m Cheryl,” I said. “Well Cheryl,” he said, “there’s no place for me to hang up my coat in this restaurant, and until you think I’m important enough to have a hook where I can hang up my coat, I can’t get excited about your new guest experience program.” It was a crucial reminder that we are in service to others – they are not in service to us.

Failing the marshmallow test

The BBC World Service is the insomniac’s salvation. If you are lucky, a background of talk radio helps you back to sleep. If you are luckier still, you stumble on a piece of quality programming that Auntie has chosen to share with the rest of the globe but not with its domestic listeners.

“In the Balance”, a business programme presented by Andy Walker at 03:30 GMT on Sunday 2nd November, included a first class discussion of short termism between Bridget Rosewell, Geoffrey Franklin and Richard Dodds, following an interview with John Kay that marked the second anniversary of the publication of his report for HM Government on short termism in equity markets.¹

The essential conclusion of the Kay report [reference needed] was that there is too much short termism in UK corporate life at the expense of addressing long term competitive advantage. The top management of quoted companies focus unduly on hitting 3 monthly targets, which are a poor measure of management competence, and have been rewarded accordingly. The 1990s featured attempts to align management incentives with the interests of shareholders, but the net result was that “many people who were quite incompetent made quite a lot of money”. Kay concludes that regulation is not the solution, but that a change in culture is required, but that it is hard to know how to do this, and harder still to measure progress.

Kay expanded on the culture change required and the inherent difficulties. He referred to the “marshmallow test”, an experiment with 4 year old children. Most, when presented with a marshmallow and told that if they wait 5 minutes before eating it they will be given a second one, will eat it right away. (A celebrated study of children subjected to the marshmallow found that those who exhibited a lower personal discount rate and exercised sufficient self control to win the second marshmallow – or maybe just had the insight to understand the challenge facing them – prospered more in later life). Andy Walker asked John Kay whether he was saying that executives simply need to grow up, to which Kay responded “a lot of company directors would fail the marshmallow test.”

In the ensuing discussion among the panellists, Bridget Rosewell blamed her profession (economists) for promulgating the view that all the information about the future prospects of the company is captured in the share price, and consequently many board level remuneration packages have been structured around movements in the share price, and the panel as a whole seemed to conclude that we have spent years telling people to focus on the wrong thing. Further, Rosewell also observed that “All markets exist in institutional contexts and cultural contexts.”

Is John Kay right? Undoubtedly yes. But the supplementary questions are more interesting: why do so many fail the marshmallow test; and what can we do about it?

There are probably could be three underlying reasons for the behaviour Kay describes.

One is that, notwithstanding the experimental data that suggests that people who come out on top in later life are  those who as small  children passed the  marshmallow test, perhaps some of those who make it to the upper reaches of commercial organisations respond disproportionately to short term signals. (Or maybe, by the time that they have reached the upper reaches they are no longer capable or responding to anything other than short term signals?).  This is not something that I have observed myself, but there may be some revealing academic research lurking in the nether regions of a business school somewhere that addresses the personality types of chief executives and points to this failing.

A second explanation could be that human timeframes and organisational timeframes may be intrinsically misaligned. “In the long run, we are all dead.”  The career time horizon for a typical chief is only exceptionally longer than twenty years on first appointment.  Even then, the time horizon within the specific appointment is only exceptionally more than ten – and probably for very healthy reasons including personal boredom thresholds and the benefit from time to time for a fresh set of eyes on a problem.  Whether it is desirable is irrelevant, it is entirely reasonable for individuals to consider the rewards – both material and emotional – that will flow from what is deliverable and measurable within their own term of office. And although they may also be concerned for their own legacy in the role, they also have to reflect that they have little power to stop those who come after them frittering it away.

The final explanation relates to the institutional and cultural frameworks about which Kay and the “In the Balance” panellists agonised. The evidence here is compelling (although I would not go as far as Rosewell in condemning the argument that share prices capture all the information about a company – the point, for discussion in more depth elsewhere, is that the prices of traded financial instruments are corrupted because they also capture information about expectations about trader behaviour (in an economist’s version of Heisenberg’s Uncertainty Principle). Many management teams have been presented by academics, consultants, brokers, investment bankers, and journalists, arguably in error, that they must respond to and seek to affect short term share price performance, and the regulator environment has encouraged rather than discouraged this.  Given that the possibility that the first of these three explanations holds true for some executives, and the probability that the second of these three explanations holds true for most, it is all the more pernicious that the we have aligned cultural and institutional frameworks in this way. Instead, we need to bend over backwards to create a culture and institutional framework as a counterweight to the possibility that personal discount rates – driven by hardwired human appetites and instincts – are higher than those of companies and organisations in general, and society overall.

So, who’s eaten my marshmallow?

 

¹ The Kay Review of Equity Markets and Long Term Decision Making, July 2012

The allocation of income and wealth: power versus marginal productivity

John Kay has written a fine account of the distribution of the rewards created within an economic enterprise in his FT column today.  Reflecting on the rewards of looters in the London riots, and allocation of resources in professional services (“eat what you kill”), he comments:

“Two broad economic theories describe the allocation of income and wealth. The power theory states, broadly, that people get what they grab: from the forest, the markets, or the shop window. The distribution of income reflects the distribution of power. For most of history, this was plainly true – the landlord took what he could from the tenant, the baron what he could from the landlord, and the king what he could from everyone. The sixth Duke of Muck was rich because the first Duke of Muck had been an especially successful gang leader. The alternative theory is that what people earn reflects their marginal productivity – how much they personally add to the value of goods and services. The marginal productivity theory has many attractions, especially to those who are well paid: if what they receive is a product of their own efforts, their rewards are surely well deserved.

“Collaborative organisation was only occasionally necessary in an agricultural society in which there were no asset-backed securities and no electrical goods in the shops. But in a complex modern economy, as in the deer forest, production requires the involvement of many. Adam Smith marvelled at the resulting efficiency in his description of a pin factory. But if, as Smith described, one man wrought the iron and another stretched it, who could say what was the marginal productivity of each? And what was the marginal product of the chief executive of the pin factory, or the person who hedged the foreign exchange exposure on the unfinished pins, whose contributions the Scots savant unaccountably failed to mention?

“If the pin factory really did increase the productivity of the factory by a factor of at least 240, as Smith claimed, there was likely to be a surplus when the wage earners had received whatever their marginal product was. And when it came to dividing that surplus, the distribution of authority within that pin factory would be crucial. That distribution would surely favour the CEO. Since the CEO wrote – or at least commissioned – the pin factory’s annual report, the moral and economic argument could be turned on its head. If you were paid a lot, that showed that you contributed a lot. What the recipient earned was, by that fact alone, justified. So the ethic of just reward through effort gave way to the culture of present entitlement from possession.”

So how does this relate to the Escondido Framework?  After all, the Escondido Framework is about organisations and is underpinned by the idea that organisations are defined by their external market interfaces.

The market defined the minimum reward that must accrue to the wage earner, or the CEO for that matter, since if the rewards are insufficient the wage earner will move to alternative employment (after due allowance for the frictional expense of changing jobs, issues surrounding risk and uncertainty about joining an unknown organisation).  But given that the Escondido Framework recognises that most markets are imperfect, the firm that operates more efficiently than competition (so that Adam Smith’s pin factory enjoys at the very least an experience curve advantage over competitor pin factories) for whatever reason may be able to generate returns above and beyond those required to pay the market clearing prices in its markets.  Who gets the additional return: investor (only if he remains sufficiently engaged to address the agency problem of relying on a manager), the manager (whose position mirrors that of the investor), a monopolist supplier exploiting the leverage from his control over scarce resources, the wage-earners (particularly if their skills are in short supply or they organise into a union), or perhaps the customers if the pin factory if has high fixed costs, spare capacity and no alternative markets to serve, or if the company’s strategy is to defend market share by keeping prices low to discourage competition?

John Kay’s observations about the privileged position and likely hold on power of the “CEO” of the pin factory are characteristically perceptive.  All that is needed to reinforce the upwards pressure on rewards arising from the circular argument that high pay must indicate greater contribution is a remuneration committee displaying the Lake Wobegon effect and setting out to pay top quartile in the believe that those with the highest pay deliver more than those of their peers on lower salaries.