The pay arrangements for top executives are far too complicated. I have a very simple proposal: abandon almost everything but fixed cash salaries.
It would be a big change. The most recent report from Carol Bowie of Institutional Shareholder Services shows that in 2010 salary amounted to only 17 percent of total compensation for the top people at the biggest publicly held U.S. corporations. The proportion has plunged, from 50 percent in 1993, according to Martin Conyon, a professor of management at Wharton, who used slightly different data. The other four-fifths of the remuneration package is typically composed of bonuses, share grants, share options, pension contributions and perks.
The preference for complicated contingent pay arrangements is based on four mistakes: about psychology, bureaucracy, uncertainty and the stock market.
Psychology. The prospect of a bonus may inspire lower-paid workers, but the panoply of variable and deferred payouts does not lead senior executives to work harder or better. Additional money cannot motivate much when the average cash salary is already around $1 million a year, three times more than the cut-off for inclusion in the top 1 percent of American incomes. On the contrary, any corporate leader who needs huge contingent rewards to concentrate the mind is in the wrong job. The desire to succeed and to beat the competition should provide ample motivation.
Bureaucracy. Top executives are not mostly paid to be bold and visionary. They are more like important cogs in a bureaucratic machine. The bosses’ tasks do not vary much from one year to the next. Like all other employees, they mostly follow well-established procedures in dealing with a series of fairly predictable issues – competition, technology, organisation, corporate transactions. Inconsistent pay is inappropriate for such consistent work. The prospect of huge contingent awards can tempt leaders to ignore helpful rules or even encourage them to run the machine recklessly.