Executive pay - the inconvenient truth

Income Data Services has released a report on executive pay stirring unprecedented interest and creating headlines across the UK. Top Directors’ pay was said to have risen 49% and editor Steve Tatton was quoted “Britain’s economy may be struggling to return to pre-recession levels of output, but the same cannot be said of FTSE 100 directors’ remuneration."

Predictably this research drew virulent condemnation from unions, politicians journalists and church leaders, though much of it was hysterical and all of it political. The Prime Minister even tried to use it to justify more women on Board’s, a clumsy attempt to deflect the political heat whilst demonstrating very poor logic.

The Harvey Nash Board Practice, in conjunction with the London Business School MBA consulting team has found that the issue of FTSE 100 CEO pay is just not as simplistic as many would have us believe. Executive pay is a serious topic for public debate but we need to ground the discussion in fact to have any hope of setting a sustainable path for the future.

The main assertion which caused such offence was that the ten highest earners received a 49% increase. This is simply false for three reasons as our research demonstrates.

Firstly, since the beginning of the recession in 2007 not a single CEO listed in the reports top 10 earners had a significant rise in salary and benefits. In fact the average rise was 1.6%, below the growth in average earnings during that time.

So, much of the growth has come from performance related pay. But for the report’s authors to pick one year where the economy started to recover and performance improved, places the report out of context. Over the four years the picture is very different: since 2007 CEO performance related pay has actually declined by 2%.

Secondly, the IDS report, in some instances, is actually misleading. Four of the top ten earners’ compensation is stated in their annual accounts in US dollars. To simply convert this to sterling during a period where sterling has devalued 25% further artificially overstates the so called rise in pay.

Thirdly, the report stated that CEO rewards were not in line with share price movement, invoking a sense of reward for failure.

Again, looking at the IDS data in 2010 this seems correct, however, the Harvey Nash / London Business School MBA Consulting Team research found that during the period Jan 2006 and Dec 2010 changes in share price explained about 30% of the variation in direct pay of continuously serving CEOs. In short, longer term CEOs are being rewarded, and penalised, for share performance.

The recession impacted performance related pay which dropped by 56% in 2009 compared to 2007. As the global economy recovered in 2010 along with company performance, flexible performance pay and long term share awards created a "rise" of 49%. The fact is that performance related pay is still 2% below the pre-crisis levels in 2007 on a constant currency basis.

The public tolerates actors, sports stars and entrepreneurs earning tens of millions per annum. So we must conclude that the main objection is around reward for failure, not quantum of pay.

So let’s take Sir Martin Sorrell, CEO of WPP, the world’s largest media company, employing 153,000 creative professionals around the world. WPP is the sort of creative digital company which Britain needs to champion if we are to rebalance our economy away from its dependence on financial services and public sector employment. Sir Martin started the business with a £250,000 loan and grew it from £1m to a global winner worth £8bn over 26 years. He has always invested his wealth in the company, never selling shares and is hired on a contract which allows the board to dismiss him “at will”. He has not had a basic salary increase over the last decade and over 50% of his package is company performance related. His pay package is very much in line with best practice recommendations by Harvard Business School and billionaire investor Warren Buffet, someone who has campaigned against the one way bet of executive share options. WPP competes in a global market where just 12% of revenues are generated in the UK market and almost a third are generated from fast growing emerging markets. By way of comparison, one of WPP’s competitors, Time Warner, paid its CEO Jeff Bewkes, a reported $26m in 2010 according to the Wall Street Journal, who acknowledged that the company had a history of wasteful acquisitions and the destruction of shareholder value.

When looking at the data on a short-term, year by year basis, the correlation was significantly less, with less than one per cent of changes in CEO pay being explained by share price performance. Two of the top five companies singled out by the IDS report are in the Resources sector (Rio Tinto and Xstrata), and therefore commodity price changes over the period were the likely driver of share prices in the short term and not the performance of the CEO.

One important note is that more than half of the top ten earners were either not resident or born in Britain and attracted from the USA, Europe and Africa reinforcing the global nature of the FTSE 100.

Increasingly London has become one of the most successful capital markets for large global companies, many of whom employ executives from all over the world. In seeking to attract the very best talent available Boards must offer compensation packages in international currency and compete with the USA, Europe and increasingly Asia in hiring wealth creators. This is no easy task.

The furore over the IDS report was unprecedented in stirring up a heady mix of politics and emotion with one union leader calling the top ten earners “greedy pigs”. Given that most of the executives are not British, this was extraordinarily ignorant and at a time when UK Plc is being encouraged to seek new growth in stronger emerging markets, it is disappointing that both the Prime Minister and the Leader of the Opposition did not take this opportunity to make the case for attracting and retaining the interests of large global wealth creating companies to the UK’s capital markets for the benefit of the country as a whole.

November 10, 2011 10:43 AM | Permalink