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Is bigger really better?

Is bigger really better?

Mark Dunne
Friday 15th December 2017

The link between executive pay and company performance is widely debated, but, thanks to new research, is the era of unjustifiably high pay packets in the boardroom coming to an end. Mark Dunne takes a look.

“There are pay plans that seem to be working, but that is a minority.”

Ric Marshall, MSCI

A company that sells products for children has found itself at the centre of an adult debate. Toys R Us became the latest high street retail chain to lose the fight against online competition when it collapsed into administration in September. The story has remained in the headlines thanks to the company asking the courts for permission to pay its executives bonuses that could see them share up to $32m between them if Christmas sales targets are achieved. This request has fanned the flames of the debate on executive pay.

For investors looking for sustainable growth, the pay of those sitting around a boardroom table matching the performance of their company is a hot topic. The question many shareholders ponder is does setting high salaries or dangling large bonuses in front of executives produce better performing companies? And if not, does an underperforming company handing over a large proportion of cash to its directors create a less sustainable business?

Toys R Us is a case in point. It sought the protection of the courts after losing $1.8bn over five years. However, while standing on the brink of administration it shelled-out $8.2m to various executives to stop them jumping ship. This was followed by the request to share millions of dollars among 17 executives if sales targets are met.

Many might find it difficult to justify such rewards for people who were at the helm of the company when it crashed into administration. But for Ric Marshall, MSCI’s executive director of ESG research, offering bonuses to the directors of a failing company is not his main concern.

“Part of the problem here is that they are asking for an extraordinary amount in the face of what could only be a short-term solution to a bigger problem,” he says.

“To agree to pay-out a huge amount because they managed to turn it around for one season makes no sense from an investor perspective.”

Marshall believes that these bonuses could only benefit short-term traders looking for a quick bump in the stock. “For most institutional investors that is not how they work anymore,” he says. “They want to invest in a company that is going to last.”

He acknowledges the challenges bricks and mortar-based retailers face, believing that the board needs to find a strategy that will create sustainable value for decades.

“It may need to partner with someone, they may need to go online or they may need to think about what is beyond online,” he adds. “That is where the big bonuses should be in my view.”


Marshall believes his views stand on strong foundations. In October he published a report into the relationship between the remuneration packages of chief executives of US companies and the performance of their businesses. Its conclusion was an eye opener: the size of a CEO’s pay-packet does not reflect long-term shareholder returns.

The study – Out of Whack: US CEO Pay and Long-term Investment Returns – found that CEO pay in 61% of the 423 MSCI USA Index constituents was poorly aligned with the company’s total shareholder return (TSR) between 2006 and 2015.

Amongst the most poorly aligned companies, 23 underpaid their boss for superior stock performance, relative to their sector peers, while 18 overpaid for below-average stock returns. “I’m always sensitive to talk about cause and effect, but clearly they are not well linked [here],” Marshall said.

In around a third – or 163 – of the 423 companies sampled, the pay collected by the CEOs was generally well aligned with TSR performance. “There are pay plans that seem to be working, but that is a minority,” Marshall says.

The report highlighted that there is a stronger alignment between pay and performance in the short-term, but this evaporates when taking a longer-term view over 10 years.

Marshall says that three years is the typical testing and vesting period for most long-term incentive plans (LTIP). “The problem is that from a long-term investor perspective they are holding these positions for longer than three years, so longer-term that connection is lost and you end up with a random effect,” he adds.

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