Boards are tone-deaf in a soundproof room

Why is it that executive pay continues to seem so out of line with what common sense would tell us is justified?

We’ve seen a number of striking examples over the past several months of compensation packages that, when exposed to the light of public scrutiny, evoke a range of negative reactions, making people anywhere from mildly annoyed to genuinely appalled. The packages seem out of line with results, and pay ratios are striking. Recent cases are unbounded by sector or location and include AstraZeneca, Barclays Bank and Shell. So what happens in the boardroom that lets such a package emerge?

In most board structures, a remunerations committee is assigned to set the level of compensation and determine the components of the pay package that senior executives receive, including base pay, bonus, stock and privileges such as use of the company jet. In recent years this committee assignment has gone from fairly light to as time-consuming as the audit committee.

There are several factors at play as the remunerations committee and the board as a whole try to weave together pay packages.

Compensation consultants. Often compensation consultants are used to help determine the packages of senior executives. Although many make a sincere attempt to prepare a comprehensive view, taking into consideration peer groups, market pressure, and many other factors, they may not fully appreciate how such a package will appear to stakeholders. What they advise may seem fair in the vacuum of the boardroom or on paper, but oftentimes it does not reflect other realities and pressures on the company from stakeholders such as investors, employees and the community at large. Also, there is a real danger that consultants can become part of the problem, driving up compensation packages as they create an aura of ensuring that the CEO and senior team feel fairly compensated relative to their peer group – a sort of “keeping up with the Joneses.”