The pirates of pay

Aug 28 2006 by Robert Heller Print This Article

In his two decades as CEO of General Electric, Jack Welch built a billion-dollar personal fortune from a high salary, pension contributions, bonuses, and various capital incentives - mostly stock options. And this was probably the most highly admired executive in America.

The admiration was somewhat muted by the unhappy revelation, after the hero retired and suffered a bitter divorce, of massive fringe benefits that were plainly indefensible.

Welch's high reputation and visibility intensified the criticism, but there's no reason to suppose that other business leaders (including some of much lesser importance) have failed to dip their paws into the same trough of perks. And that, remember, is on top of financial 'compensation' and 'incentives' that always add up to colossal sums.

A few years ago, I reported some puzzling findings of business analysis by motivation consultant John Fisher. He noted that numerous studies over the years in the US had found virtually no correlation between increasing pay and corporate performance.

Numerous studies have found virtually no correlation between increasing pay and corporate performance

As for 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."

There's one obvious difference that I might have mentioned, though. The incentivised managers ended up considerably richer than the others by achieving exactly the same performance.

Looking at this business analysis, it's hard to avoid the conclusion that every device and every decision taken in the realm of executive pay has but one purpose: to enrich recipients as much and as often as possible.

In a sensible organisation, the principles for paying senior people would have a clear, strong base. Their reward would have the same rationale as rewards for all other employees. The only difference would be size, since plainly fairness demands that rewards should rise with responsibility, seniority and contribution.

Another basic principle is that the sum total of all these payments must leave a very healthy and wealthy share for the owners of the business. No payments other than base salary and pension should be made unless the organisation is covering its cost of capital, including equity as well as debt. The cost of equity belongs to investors, and they should explicitly receive that cost as a return on their investment.

That last paragraph should ring a bell. It's the same concept as that used in calculating EVA, or Economic Value Added. The EVA addict 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 handsome surplus, management hasn't been doing its duty and doesn't deserve any bonus or other extras.

An added advantage of the suggested regime is that the non-executives and the outside investors will have a clear idea of the reward system and how it relates to genuine achievement. My bet is that the atmosphere and shared commitment in the business would also be invigorated. The trouble with the present order isn't only that it's greedy and crude. Worse still, it doesn't deliver the goods - except to the greedy pirates.

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About The Author

Robert Heller
Robert Heller

Robert Heller, who died aged 80 in August 2012, was Britain's most renowned and best-selling author on business management. Author of more than 50 books, he was the founding editor of Management Today and the Global Future Forum. About his latest title, The Fusion Manager, Sir John Harvey-Jones wrote: "The future lies with the thinking manager, and the thinking manager must read this book".

Older Comments

Robert,

Good article and your conclusions confirm my experiences and research into the value of rewards (all types of rewards). America is beseiged by the notion that contingent compensation is needed to elicit exemplary performance from employees at all levels.

There is considerable evidence that the equity and ethics issues fostered by reward structures are widespread. Of the many situational factors that influence employee performance, supervisory style is more likely than pay to mediate daily effort.

Jerry Pounds

You are confusing correlation with cause, when there is neither. Franklin Raines made a fortune in performance-contingent compensation, but he cooked the books to falsify performance. And some boards, chums of the CEO, pay huge sums at the CEO's behest, regardless of performance. These rewards are NOT performance-contingent, so to expect compensation incentives to be cause performance is foolhardy. Fair, accurate, and honest performance-contingent rewards are the best ways to incentivize wealth creation, bar none. It's just that most 'performance contingent' 'systems' are not 'contingent' nor are they based on 'performance'.

Peter USA