Sunday, 7 September 2008

Exec pay again

There's a bit in today's Observer about the lack of linkage between pay and performance. This bit caught my eye:

The conclusion of 30 years' experience is that pay for performance in shareholder terms is probably unachievable and often counterproductive. It is a formula for increasing pay whatever the performance. So why not abandon trying to focus top management attention on things they can't influence directly, like the share price, and concentrate on the things they can and which drive value in the long term, such as quality, resource efficiency and so on?

This seems reasonable enough but I can see several problems with it. First, are we seriously saying that without being rewarded for doing so, directors don't/won't focus on these issues? Much as I am deeply sceptical of how much control senior management can ever have, I don't think they are stupid. I'm sure they are concerned about running their business effectively. Second, on a related point, this could be a recipe for paying directors even more money to do what we ought to reasonably expect them to be doing already. Thirdly there's some evidence that if you pay people to do things they were doing already they actually don't put as much effort in (since now they can quantify the value of their effort). Financial incentives can actually 'crowd out', to use the lingo, other motivations.

Two things leap out at me from all this. First, depite executive remuneration becoming ever more complex in recent years it hasn't got any better at incentivising people to do the right things. In fact some might argue that the use of options has done the reverse. Might it not be better for shareholders to simply strip the system back to its original components of salary and bonus? Second, this is clearly an area where working assumptions are still based on homo economicus - if we just attach the right number of carrots to a given factor, directors will manage it effectively. Such assumptions could do with a bit of a rethink to say the least.

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