Five Proposals to make Executive Pay benefit Society

It is refreshing to see that the (endless?) discussion about the level of Executive Pay is not completely dominated by pious wishes, hand-wringing and nebulous remedies.

So I read with interest the contribution from Alex Erdmans in a recent article published by CityAm. He is not only professor of finance at London Business School but also a member of the Purposeful Company steering group.

Here is a short summary of the key proposals Erdmans makes:

1 - Give only Equity and Option grants with a long vesting period, preferably until after the executive has left - or even retired.

2 - De-emphasise long-term Incentive plans or bonuses that are only tied to financial targets.

3 - Grant deferred cash compensation or similar long-term awards so that they are eroded in case of bankruptcy.

4 - Launch a Fair Pay Charter and consult workers on the Charter.

5 - Require a binding vote on executive remuneration when less than 75% of shareholders support pay proposals two years in a row.

But while these proposals are a valuable contribution the observer is left with two key questions:

How will these ideas actually be translated into concrete action? And by whom?

And the 64,000 Dollar question regarding the absolute level of Executive Pay is not touched at all. As with so many proposals about pay reform, this is really the elephant in the room. All technical remedies are pointless if at the end all they achieve is that pay is ratcheting higher and higher even when modifications in the way it is set are introduced.

The key question is: Why should an executive be awarded 5, 10 or 20 million if his pay is somehow 'aligned' with company performance? Ultimately this is a question of morality and not economics.

All very well to see BlackRock pledging 'to hold boards' feet to the fire' when it comes to executive pay' when the most critical question of executive pay reform - the way the absolute level of pay is set - is left open.

As always your Comments are welcome, but please no direct messages - use this blog instead so that others can see your contribution!
(8-Dec-2016)

1 comments:

Alex Edmans said...

Dear Heinz,

Thank you very much for your kind comments about my work. We have done our best to base our recommendations on rigorous, large-scale evidence, as well as practical implementability and I am grateful you are recognising our suggestions as being different from "pious wishes". I appreciate this chance to respond to your two questions:

1) "How will these ideas actually be translated into concrete action? And by whom?"

These ideas are part of The Purposeful Company project, which started in 2014. I serve on the steering group with Andy Haldane (the Chief Economist of the Bank of England), Will Hutton (former Editor of the Observer, now co-founder of The Big Innovation Centre), Clare Chapman (RemCo chair at Kingfisher) and others. We have a broader Task Force which includes the likes of Sir Andrew Witty (CEO of Glaxo), Dominic Rossi (global chief investment officer of Fidelity etc.) The lead author of the Executive Remuneration Interim Report, from which the five ideas were based, is Tom Gosling, head of PwC's reward practice.

This is absolutely not to name-drop, but to highlight that we have built a very broad coalition of leading policymakers, investors, executives, consultants, and academics. We test all of our proposals against this wider task-force. Thus, with the great momentum behind our ideas, I believe we have every chance in translating them into concrete action. For example, the lengthening of equity vesting periods beyond retirement was implemented by Kingfisher this year. Our report was covered on the front page of the FT, so we hope that the ideas have influence.

2) Regarding the absolute level of pay, I actually don't agree that it's the $64,000 question. I write about this more fully in http://alexedmans.com/eight-common-myths-about-ceo-pay/, but here's a short summary. In the UK, the average level of pay is £5m. That's a lot, but that's only 0.06% of average firm size of £8b. In contrast, large-scale evidence has shown that getting incentives right - the focus of our reforms, creates 4-10% of firm value per year, i.e. £320-£800m. This is far greater than the level of pay. Our goal is to incentivise executives to increase the size of the pie (via long-run innovation, not short-term manipulation), rather than changing the distribution of a fixed pie.

In addition, to the extent to which high *levels* of pay are a problem, this is because the structure is wrong - i.e high pay is awarded despite poor performance, or short-term manipulation. Thus, the key thing to address is structure. Indeed, when shareholders take large stakes in firms (and often take action such as firing the CEO, improving innovation, and refocusing the firm), they change the structure of pay (to tie it more to performance) but, if anything, increase the level. This shows that when shareholders truly engage, they find that structure rather than level is the main thing to fix.

Thank you very much once again for your interest in our work, and more generally for the great work you are doing on this blog. The Purposeful Company Final Report will be out in February 2017, with our other policy proposals (e.g. addressing issues such as blockholding, the reporting of intangible assets etc.) You will be able to find it on www.biginnovationcentre.com.

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