Recent Study on UK CEO Remuneration
READING TIME: 6 MINUTES
Executive Remuneration has always remained a hot topic in the media, especially because remuneration packages have been rising steadily throughout the years. There have been many times where investors and the public revolt as some executives have been fortunate enough to receive an excessive pay-out one year due to how the remuneration policy was designed by the remuneration committee some years prior. Recently, a paper has surfaced where an academic team at the London Business School surveyed 200+ FTSE All Share company directors and 150 UK equity investors on factors to designing a CEO’s remuneration package. Below is a summary on their findings.
They discovered that 2/3 of directors surveyed saw that attracting the right CEO, and 1/3 of directors thought designing a structure that motivates a CEO, respectively, were the most important goals when trying to design the right package. Whereas investors were more 50:50. This indicates that directors view labour market forces as more important, whereas investors see incentive constraints as more important. It was also found that a minority of directors and investors saw keeping the level of remuneration down was the primary goal; however, it is understandable why this is not the most popular factor seeing as disincentivising could lead to demotivation, poor financial performance and retaining a lower quality CEO. The implication of forcing lower pay and offering an inferior remuneration structure because of closely abiding to shareholder guidelines can in fact result in damaging the shareholder’s value in the long term because of the aforementioned reasons. It was also shown that CEO pay was determined highly on industry peer compensation, not because it shows that alternative incentive packages are more enticing and thus the executive would move there instead (though this was reported to be the case for Entain’s CEO back in January 2021), but just as a reference point to assess whether their pay seems fair.
The authors suggest the directors, particularly remuneration and nomination committee members have a better understanding of the CEO labour market and thus a deeper understanding of what feels appropriate for what a CEO should expect. Whereas, understandably, investors push for change that would constrain a CEO’s pay, which could result in demotivating them. The paper explained that there is another view that some boards are just unable to correctly evaluate the credibility of their CEO, thus not aligning their pay appropriately. And when asked about what the consequence of offering a lower pay would do to the CEO and the company, the 77% of respondents who did in fact offer a lower remuneration package said that 7% CEOs left, 13% directors hired a less expensive CEO but 41% revealed there were no adverse effects – highlighting that some boards therefore overestimate the negative consequences of tough decisions on CEO remuneration, and value the CEO incorrectly. Unsurprisingly, nearly half of respondents claimed their CEO would be less motivated in looking out for the best interests of the company if that was the case. Most respondents reported that to increase remuneration would be dependent on good recent CEO performance, an increase in the firm’s size (usually by M&A activity, such as AVEVA and the acquisition of OSIsoft), a well-designed package such as adding additional holding periods (common in the banking sector) or a change in attractiveness in the CEO’s job at the firm such as their prestige, level of risk or complexity in terms of responsibilities.
Both directors and investors view the CEO’s intrinsic motivation and personal reputation as the most important incentives to a CEO performing their best on behalf of the company. Yet it is fair to assume being awarded for a period of good performance is deserved, and otherwise deemed unfair if not, reducing the intrinsic motivation in the first place. So, an increase in pay due to performance, could also boost the firm’s reputation as they feel confident in pay-outs due to having a good year. It is also believed that both directors and investors feel pay-out for good performance would be when the CEO also participates in sharing external risks with the investors and stakeholders, as they are further aligning themselves to looking out for the company’s and shareholders’ best interests.
Overall, the paper showed that differences on pay between directors and investors will still cause much conflict. It is seen that shareholders are the main reason for the pay constraints and when working with management, there is a lack of major consensus on how to maximise value of the package, showing the two find it difficult to ever align. Interestingly, the investors’ dissatisfaction on CEO remuneration seems surprising since say-on-pay reports state that investors will most of the time vote similar to a proxy advisors’ view. In this case, they would vote for, in preference to not vote against, feeling ironically constrained themselves, and have a constructive relationship with management instead to work on remuneration issues going forwards. This is because constant meetings to discuss say-on-pay can further disincentivise management and the belief they are doing what’s best for the company and shareholders; and the activity of discussing remuneration can be quite costly too. Perhaps more research needs to go into finding solutions to resolve the conflict between the two groups so that they can prevent these issues arising as commonplace as they may be in the future.
Source
https://corpgov.law.harvard.edu/2021/07/12/ceo-compensation-evidence-from-the-field/
