The credit crunch
The credit crunch: You get what you pay for and other important lessons Russell Connor The scale and impact of the credit crunch and the subsequent devaluation of assets worldwide will be so damaging that the BBC’s Business Editor, Robert Peston, and other informed commentators believe that a “new capitalism” is likely to emerge from the rubble. What is clear to Robert is that the system cannot stay as it has become over the last 30 years. He holds out the hope, among the loss of capital and gloom of massive job losses, that “the system’s salvation may require it to be kinder, gentler, less divisive, less of a casino in which the winner takes all”. This may be rather too rosy a view. What is absolutely clear is that those running our biggest financial and commercial businesses will have to be more visible. They will have to manifest not only a genuine understanding of their employees but taxpayers too. Those chief executives who succeed will be those that imbue their organisations with very simple common sense standards of decency. And they will almost certainly be paid less for doing it. This article deals with issue of how to pay and remunerate the business leaders of tomorrow.
Market-related pay and pay for performance Up until the late 1980s internal equity was a guiding principle of pay and its guardian was a myriad of often highly complex job evaluation schemes. Then, as liberal capitalism, the free flow of money around the world and light-touch regulation came to be the dominant modus operandi, these schemes were demolished in favour of more flexible person-based pay. This personbased approach knelt at the foot of market forces. Unfettered by issues of internal equity, headlines related to fat-cat salaries soon appeared and have been regularly spotted in the media for more than a decade. Despite some limited curtailing of executive compensation under shareholder pressure, packages have continued to rise to levels undreamt of even five years ago. This is reflected in the compensation plans of most senior executives in FTSE100 companies. Royal Bank of Scotland (RBS) is a good example to reference. Not because it is particularly different, but because the pay and pension of its most famous CEO, Sir Fred Goodwin, did rather come under the media spotlight. Sir Fred was paid £3,996,000 as stated in the 2006 accounts of which, £2,860,000 was bonusrelated. The deferred payment in the form of pension pots and potential lump-sum payments were not referenced in the accounts. However, they did make much of the long-term incentive plans which were largely geared to total shareholder returns (TSR) and increases in earnings per share (EPS). Using TSR and increases in EPS as the main planks of incentive schemes are common practices in a range of financial and non-financial organisations. Lauded as objective market-related data, they provide the means to pay large bonuses to a range of people — based on performance of course! However, there are serious flaws with using such measures. TSR and EPS compare companies’ performance via share price movements and these become a proxy for valuecreation. However, the link between share price and value creation is not direct or linear due to the fact that: 3 The future value of an organisation is already embedded in the share price now. The share price can over-estimate the future value creation potential or underestimate it. Compensation schemes that measure executives based on actual short-term stock prices or comparative stock price movement such as total shareholder return are being rewarded for the value that the market expects them to create — whether they are doing so or not.
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November 2009 Developing HR Strategy