2001
Pay packet size has little impact on performance: Executive Remuneration
By
Michael Skapinker
Two studies examine the effect of financial rewards for top staff on corporate success, and come up with different conclusions. But they do agree that cash is not the key
The Financial Times,
26 October 2001
Bill Gates sees his personal riches decline by Dollars 9bn but is still worth Dollars 54bn, according to a recent table in Forbes magazine. Warren Buffett, who wisely missed out on the dotcom bubble, is worth Dollars 33bn. Paul Allen, Microsoft's co-founder, has Dollars 28bn to his name. The widow and children of Sam Walton, founder of Wal-Mart, are each worth Dollars 17.5bn.
These are extraordinary amounts of money, but then the owners of it are either the founders, or heirs to the founders, of extraordinary businesses.
Would they have worked any less if the financial rewards had been smaller? The effect of remuneration on corporate behaviour is one of the great unresolved debates of business life. Jack Welch, recently retired head of General Electric of the US, has little doubt that remuneration policy played a substantial role in his company's extraordinary success. The key to GE's progress, in Mr Welch's view, was the way knowledge and expertise was spread around its different businesses.
To Mr Welch, this does not happen by chance. Staff were financially rewarded on the basis of a combination of their own success and that of the company as a whole, providing an incentive to ensure other parts of the group did as well as theirs.
The money earned by those at the top of the US corporate tree might seem excessive, but the idea that people will perform better if they are given incentives for doing so seems little more than common sense.
What should those incentives be? The PA Consulting Group recently looked at the total shareholder returns of companies in the US, Europe and Australasia over a four-year period. The results varied widely. In looking at what distinguished companies with high returns from those with poor ones, PA found that the way the top management was paid made a crucial difference.
"The best approach for ensuring value is created is to pay low base salaries, but high - and unlimited - variable compensation if the results of the company are such that value is created for shareholders," PA said in its report, Managing for Shareholder Value.
Compensation surveys usually reveal that the bigger the company, the higher the chief executive's base salary. PA argues, however, that far from encouraging the chief executive to strive for outstanding results, a high base salary could have the opposite effect. "Indeed, there is a perverse incentive on managers to go into costly acquisitions to increase the size of the firm. However, as studies have shown, this tactic actually destroys shareholder value in 80 per cent of cases."
What should companies do instead? Make sure a percentage of annual bonus is paid in long-term handcuffed shares, PA says. Managers who are paid in this way have a strong incentive both to ensure the share price rises and that they stay with the company.
It would all make sense, were it not for a vast new study from the US that suggests it doesn't. Jim Collins, a former Stanford business school academic and co-author of the best-selling book Built to Last, decided to spend several years discovering what turned ordinary companies into outstanding ones. Like PA, he chose as his measure total shareholder return and he looked at the performance of 1,435 US companies.
What Mr Collins was searching for were companies with average or below- average shareholder returns over 15 years, compared with the US market as a whole, followed by 15 years of superb performance - at least three-times the US average.
He found only 11 companies that met these criteria. They included Kimberly-Clark, Gillette and Philip Morris. In his new book, Good to Great, Mr Collins describes how he and his team of researchers set about finding what distinguished the 11 companies from competitors that either consistently under-performed the market or prospered briefly before descending once more into mediocrity.
He looked, among other things, at remuneration. "We expected to find that changes in incentive systems, especially executive incentives, would be highly correlated with making the leap from good to great. With all the attention paid to executive compensation - the shift to stock options and the huge packages that have become commonplace - surely, we thought, the amount and structure of compensation must play a key role in going from good to great. How else do you get people to do the right things to create great results?" Mr Collins wrote.
The results surprised him. Remuneration appeared to play no role in turning average companies into excellent ones. "We examined everything we could quantify for the top five (company) officers - cash versus stock, long-term versus short-term incentives, salary versus bonus, and so forth. Some companies used stock extensively; others didn't. Some made significant use of bonus incentives; others didn't." Mr Collins said he and his team found there was no evidence that executive compensation played any role in producing substantially above-average returns to shareholders.
How can we reconcile Mr Collins' findings with those of PA? As ever, when such discrepancies occur, the two sides were not comparing exactly the same things. PA's time period was four years; Mr Collins' was 30. PA looked at companies around the world, including the US; Mr Collins examined only American companies.
But one sentence in Good to Great suggests the two sides were not that far apart. Mr Collins says the only difference he could find between companies with outstanding and mediocre performance was that the best companies paid their top executives slightly less in cash - close to PA's finding that the more remuneration varies by performance, the better the return to shareholders will be.
But Mr Collins argues that how you pay your top executives is less important than who they are. You need to set up a remuneration system that works, but you need to find the right people first. "If you have the right executives, they will do everything within their power to build a great company, not because of what they will 'get' for it, but because they simply cannot imagine settling for anything less," Mr Collins says.
Copyright: The Financial Times Limited
|
