Performance-related pay or fat-cat clap-trap?

2004

The argument commonly trotted out by corporate PRs to defend massive executive pay packages is that pay is related to performance. So it should follow that the highest-paid fat cats would also be the most effective, right?

Wrong. In fact in an analysis in the Observer newspaper, market historian David Schwartz reveals that in the UK at least, there is actually an inverse relationship between pay and profitability – the more the boss gets paid, the worse the company tends to perform.

Last year, we reported research that found that executives in most FTSE 100 companies were still receiving performance-related incentives even when they fail to perform. The link between pay and executive performance was a "nonsense", according to compensation consultancy, Halliwell Consulting.

But David Schwartz has found that the truth about executive pay is even more startling.

In 18 of the 30 sectors, shares of companies run by the highest-paid executive in the sector disappointed investors, rising by less than the sector average. There was no systematic benefit associated with paying executives above the odds. In fact, a hypothetical investor who bought shares in all 30 sectors would have gained higher profits by steadily avoiding the fat-cat company and flipping a coin to select another company from the same sector. . . . Just 11 high-pay companies outperformed their low-pay competitor.

Last week, Trade and Industry Secretary Patricia Hewitt announced that the government would not be introducing legislation to curb excessive executive pay, say that she was: "clear that the best way forward is through the application and development of best practice in negotiating contracts which deal with performance issues effectively."

But on the strength of these figures, it seems clearer than ever that there is still no relationship at all between pay and performance, let alone any sign of "developing best practice".

So the next time you hear the performance-related line being trotted out to justify another vast payout, remember David Schwartz’ sage words: "High pay is a signal for investors to invest elsewhere."

The Observer | How the fat cats offer slim returns