Monday, 11 June 2012

Fairness and executive pay

As I've blogged recently, there's growing chatter about whether the obsession with 'refining' performance-related pay is a waste of time. There are two elements to this. First, as most people now recognise, the more you try and engineer performance pay, the more complex it gets, meaning more time gets spent trying to understand and/or explain it. Second, there is the question about whether perfomance-related pay actually motivates effectively when you're dealing with complex tasks.

Clearly the two points overlap. As PwC have pointed out, complexity makes it less likely that incentive schemes have a motivating effect (the behavioural stuff also points away from ideas like bonus deferral). Looking at this from the other perspective, a view of pay that was more sceptical of the motivational value of performance-based rewards could be used to attempt to reduce complexity. (This, incidentally, could be a *positive* unintended consequence of getting investors to think more about pay & motivation).

However, it's also important to recognise that even if a consensus emerges that performance-related reward is complex, and probably not working to motivate recipients, it will still have its defenders. This is in part because of the deep-rooted attachment to the idea of rational self-interest as a model of human behaviour. Within corporate governance this inevitably leads to the idea that executives need 'bonding', via contracts and incentives, to prevent them doing their own thing. From this perspective, wooly stuff about motivation will only let execs off the hook. I suspect for such people no amount of evidence will ever be convincing.

But arguably more significant is the idea of fairness. It's odd because you might assume that fairness is the last line of argument that defenders of executive pay as currently structured would advance. This is because most people consider that rewards for those running PLCs are 'unfair', certainly in relation to what others in society earn. Yet I would argue that making the case that executives 'deserve' performance-related rewards is more compelling than arguing that it achieves alignment, motivates recipients etc. I don't mean that I accept the argument, but rather that it has more impact.

By getting into the territory of what people deserve for their effort, we think more about them as individuals, and about the 'story' of their achievements. It seems 'fair' that if you put in a lot of effort you are rewarded, regardless of whether it 'motivated' you or not. (In fact some of the more interesting textbook defences of performance pay talk more about the informational content than motivational value - recognition, not incentive). For example, defenders of Martin Sorrell's pay sound much more convincing when they talk about the story of WPP, and his defining role in it, than whether his interests are aligned with those of shareholders and all that blah. At the end of the day I'm still not convinced, but I know what sounds better. So, weirdly, for me an appeal to fairness works better.

More generally these days when I think about executive pay the book that keeps coming back to me (though I found it quite a struggle) is On Justification. How people argue for and against executive pay seems to be rooted in broader explanatory frameworks. The executive pay discussion is usually one largely between boards and shareholders, but increasingly (see WPP again) played out in public. In such a scenario, it seems pretty obvious to me that if shareholders are sticking to a technical 'market' critique, a company can sort of  talk above that discussion by putting their arguments in way that appeals to other principles.

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