Salaries good, big bonuses bad

By Edward Hadas
June 26, 2013

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.

Uncertainty. Some bad corporate decisions bear their bitter fruit quite quickly – think of banks’ investments in subprime mortgages in 2006 – but most germinate over years or even decades. By the time they reach fruition, too much has happened to apportion responsibility to individual contributions in particular years. Add in luck, which can masquerade as skill, and “pay for success” turns out to be little more than random guesswork.

The stock market. The performance of the company’s shares determines the size of many contingent rewards. But the stock market is a poor guide to corporate success. Not only are investors often wrong about stocks for many years, but corporate managers should not be paid to please shareholders, but to balance their demands with other concerns. A focus on the share price frequently leads managers to pay too much attention to the whims of faddish portfolio managers, many of whom wouldn’t recognise the long term if it walked into a room with a name-tag.

In sum, the usual arguments for complicated remuneration packages are all specious. These arrangements do not motivate. They do not encourage long-term thinking. They do not align executives’ interests with anything helpful. They do not make pay rewards more just. Rather, they are misleading to outsiders and distracting to insiders.

The non-contingent elements only make things worse. First are gargantuan pensions – this week the Wall Street Journal reported McKesson Chief Executive John Hammergren has a pension account of $159 million. Then come numerous perks, such as taking care of club membership fees. These make no sense when it comes to people this well-off.

For outsiders, the complexity makes it harder to compare companies, and to gauge in advance what a boss might receive in a given year. It certainly looks like the welter of apparently objective calculations serves as a fig leaf, to justify corporate chieftains taking home an ever-increasing multiple of what employees receive.

Of course, bosses, like everyone else, benefit from tokens of appreciation. Considering their starting pay, monetary tokens will either be too small to matter or unjustly large. Something symbolic, like the gold stars teachers give children for keeping their desks neat, is more appropriate. I suggest a solemn ceremony to bestow a medal or a plaque.

The replacement of complicated remuneration packages with an annually adjusted salary, plus the odd plaque, is just about the easiest reform in the world. All that it takes is a decision by the board of directors and a polite letter to the consultants explaining that most of their services will no longer be required.

I don’t expect anything like this to happen soon. Many outsiders share my scepticism. But most board members, who set pay, and the large shareholders, who could object, feel differently. They are members of the pay elite themselves. So they probably feel more comfortable with the pseudo-science of a calibrated system than with a few great big numbers.

 

2 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Mr. Hadas, I agree with you, but I don’t believe we’ll ever see change. They can do what they want and it’s that simple. Just like Congress.

Posted by JL4 | Report as abusive

In general, this article has some excellent points. However, the multitude of decisions that led to massive investment in low-doc/no-doc loans did not happen quickly, occuring over years. And, most of the collapse of the mortgage-backed financial derivatives in which the Wall Street Casinos gambled were “regular” ARM loans that were not subprime.

Posted by ptiffany | Report as abusive