Thinking Managers

Robert Heller believes that, despite growing criticism, schemes for enriching top managers are worsening.

Pirates of Pay

In his two decades as CEO of General Electric, Jack Welch accumulated a billion-dollar personal fortune from a high salary, pension contributions, bonuses, and various capital incentives - mostly stock options.  It's fair to say he was the most highly admired executive in America.

However, the admiration was somewhat tempered by the revelation, following retirement and a bitter divorce, of massive fringe benefits that were simply indefensible.  Welch’s big reputation and prominence intensified the criticism, but there’s no reason to suppose that other business leaders and lesser lights aren't feeding at a similar trough of perks.  And, remember, this is all in addition to financial ‘compensation’ and ‘incentives’ that always add up to enormous sums.

A couple of years ago I reported some interesting findings by motivation consultant John Fisher.  He pointed out that numerous studies over the years in the US had found almost no correlation between increasing pay and corporate performance.

And in Britain: A study by management academics drawn from three universities looked at the FTSE 350 companies to see whether long-term incentive plans did affect performance - and came up with an astonishing result.

‘These LTIPs rewarded directors with free shares if they hit specified targets for total return to shareholders (in which the share price is by far the largest component). Companies whose bosses luxuriated in LTIPs increased shareholder returns by 20.71% over the period in question. As for those without LTIPs, the result was 20.74%. In other words, the schemes, costly to administer and a bureaucrat’s delight, made not a scintilla of difference’.

However, there’s one obvious difference that I might have mentioned. The managers with incentives ended up considerably richer than the others with exactly the same level of performance.
It’s hard to look at this evidence and avoid the conclusion that every device and every decision taken in the area of executive pay has the sole purpose of enriching recipients as much and as often as possible.

A sensible organisation has a clear, strong base in its principles for paying senior people.  Their reward would have the same logic as rewards for every other employee, the only difference being size, since it would be only fair that rewards should rise with responsibility, seniority and contribution.

A further basic principle is that the sum total of all these payments should leave a very healthy and considerable share for the business owners.  There should be no payments made other than base salary and pension unless the organisation is covering its cost of capital, including equity as well as debt.  The cost of equity belongs to investors, and it's only fair that they should receive that cost as a return on their investment.
This might sound familiar: it’s the same principle as used in calculating EVA, or Economic Value Added. The EVA adherent works out the cost of capital (including equity) as above, and compares it to the number for operating profits after tax. Unless there’s a wealthy surplus, management has neglected its duty and is not deserving of any bonus or other extras.

The suggested regime has an added bonus in that the non-executives and the outside investors will have a clear idea of the reward system and how it relates to genuine achievement.  I believe that the atmosphere and shared commitment in the business would also be invigorated.  The problem at the moment is that the system is greedy and crude.  Even worse, it doesn’t deliver the goods - other than to greedy pirates.

About the author
Robert Heller is one of the world’s best selling authors on business management.