WRONG TARGET
There are many components to an executive’s pay package. There is the basic salary, which can be topped up by pension contributions, but there is another element that could be the problem. Bonuses are typically paid annually and so are linked to short-term achievements. Marshall explains that on average 60% to 70% of an executive’s pay is a bonus, which in the US is almost universally equity-based. “So if you see targets that are blatantly short-term you have got real problems,” he adds.
Bonuses, or awarded pay, are intended to align an executive’s interests with those of the company owners and they came under MSCI’s microscope in the Out of Whack study. The result might surprise you.
MSCI discovered that the bottom fifth of companies by equity incentive award outperformed the top fifth by nearly 39% on average on a 10-year cumulative basis. Marshall says that a reason why pay has become so dysfunctional or poorly aligned is that there is an over-emphasis on stock-based performance measures, such as total shareholder return.
“When an equity award is combined with targets that look primarily at the value of the stock and not revenue growth, return on equity or operationally-based performance measures, that is where you get the biggest problems,” he adds.
One solution is to dilute the potential effects of relying too heavily on stock-based targets. So look for companies that have incorporated environmental, social and governance (ESG) factors into bonus targets, such as having a low negative impact on the environment.
Lucia Meloni, an SRI and corporate governance analyst at Candriam Investors Group, agrees that investors could benefit long-term if performance is linked to sustainable success. “It is a good step for companies to set ESG-performance criteria, which is a long-term measure,” she adds.
One company that has penalised the boss for a poor operational performance is BT. The telecommunications group announced in May that it was scrapping its chief executive’s bonus following a profit warning.
An accounting scandal that left the group more than £500m out of pocket was blamed alongside a £42m fine for a variety of problems, which included delays in installing broadband. In the end, the CEO’s pay for the year to the end of March was 74% lower than it was 12 months earlier.
THE SHAREHOLDERS STRIKE BACK
Investors have become more proactive in the area of executive remuneration. In recent years, more and more investors have voted to reject the pay deals offered to executives.
Meloni says that this was because some packages are seen as excessive and are not linked to performance, adding that shareholder revolts against remuneration reports are a “signal that they are not fair”.
In one example, almost a third of shareholders in luxury brand Burberry did not back the remuneration report on the pay of its executives in July, believing it to be too generous.
