Executive Search

One of the most obvious consequences flowing from the global squeeze has been the renewed focus on various issues related to executive remuneration. Once again, shareholders and governance experts are up in arms as the level of rewards and the reward structures underpinning them have been brought into focus.

Particularly distressing have been those cases where executives have been rewarded at stratospheric levels despite the fact that their organization has been rescued as a result of a government bail-out.

For example, one major bank in the United States reportedly received US$45 billion ($53.7 billion) in US Troubled Asset Relief Program funds, and reported a loss in 2008 of US$27.7 billion, but was still able to justify a bonus pool of US$5.3 billion including more than 1,000 individual bonuses in excess of US$1 million!

The argument supporting this is that such organizations need to pay very talented people to get them out of the mess they are in. But at some point it must stop.

The slump has brought to light the fact that, in the vast majority of cases, the reward structures in place, particularly at large financial institutions, were clearly inappropriate.

Executive incentives were bumped up to levels many times their base salary through programs which were often based on incorrect assumptions. For example, it was not uncommon for reward structures to be based on return on equity or return on capital but for the managers or leaders of the businesses to be free to leverage that capital to the hilt, without due regard to the risk and with negligible controls, thus contributing to a major financial disaster.

Two clear examples of this were a leading US insurer, which was destroyed by its small financial services group of only 100 people out of the total of 120,000 it employed; and a UK bank, where 1,000 employees brought down an organization of 170,000.

The concept of inducing executives to perform based on remuneration structures that somehow align their interests with those of their shareholders is one which has obvious appeal. Regrettably it is very difficult to translate into practical and transparent reality, for a couple of reasons: First, if you are running a business in a highly competitive environment and the company is listed, why would you wish to share targets, however well thought through, with your investors?
By doing so you are also signaling to your competitors exactly what success with your strategy will look like.

In addition there is the question of defining Key Performance Indicators in a way that really ensures executives are motivated to perform and achieve the changes agreed to with their Boards or superiors. Once again this is much easier said than done.

As the financial crisis has shown, share-based rewards can be particularly inequitable when the movement of the stock market is totally out of the hands of any one individual executive or any company for that matter.

A second fundamental question is: which shareholders? The mums and dads, the superannuation funds, the institutions or the hedge funds? Each group has arguably legitimate objectives for the performance of their equities but the emphasis on growth, return and time frame can vary significantly and to reconcile these differing ambitions through an incentive scheme is a serious challenge.

All of this raises another fundamental question, and that is, do incentives really cause change people’s motivation and do they result in a change of behavior? Research suggests that money cannot buy motivation. While some may be simply greedy, most executives are generally motivated to perform because they wish to achieve improvement or to exert influence.

The stronger source of most people’s motivation is internal not external. External incentives such as remuneration will only help if they are applied to the right people and properly aligned with their internal motivators.

The reality is that most senior executives simply want equity in the structure and levels of rewards they receive. The risk we are now facing, particularly in Australia, is that we will introduce regulations that appear to aim at this target but in fact achieve only two things: removing accountability from boards for setting appropriate pay levels; and the development of dysfunctional structures seeking to get around contradictory and arbitrary rules.

This is an edited version of an article first printed in Australian Financial Review. It is reprinted with kind permission of the newspaper.