Sunday, 17 June 2012

Norms and pay

One of things I was trying to get at in my last post was that it might be useful to look at executive pay from different perspectives. Over the last two or three years I've read quite a bit about the psychology of incentives (principally, but not exclusively, financial ones) though I also think sociology can help.

To recap, my basic argument is that executive pay as currently structured (and as advocated by many shareholders) is implicitly based on certain economic and psychological views of motivation that are worth exploring further. The economic perspective is pretty clear - individuals are self-interested and rational, and hence execs will maximise their own utility in ways that may not align with shareholders unless pay is structured sensibly. The (implicit) psychological perspective is that properly designed financial incentives can focus attention on the right issues and enhance performance (through reinforcement presumably).

Seen from this perspective, the post-crisis reform effort on pay makes sense. If pay in the banking sector was a contributory factor, this wad because the incentives were poorly designed. Therefore the logical conclusion is to redesign the incentives with, for example, better targets, more emphasis on the long-term, ownership etc. It is simply a design problem, the underlying assumptions do not need revisiting.

There is a nascent discussion about those assumptions, and some emerging interest in whether we ought to amend them. However, having spoken to a few people, including rem comm members, about these questions there are some (somewhat contradictory) counterpoints made that are worth noting. one is that, yes, in experiments you might well find that incentive pay either doesn't work well or backfires. But real life executives are not the type to choke under performance pressure. Another is that incentive pay might not 'work', but it provides feedback to executives (the 'keeping score' point). (finally some simply argue that whilst performance pay may not be great it's difficult to shift course now.)

On the first point, I think we are getting closer to the point where we can directly challenge it. The recent PwC report was useful because it was based on surveys of actual executives. A striking finding was that only a small minority fit the model of risk-taking 'entrepreneurs' (ignoring the question of whether this is who we want running PLCs anyway) who might be more likely to be incentivised by performance pay. Most, like the rest of us, value a safe bet much more than a possible reward. (Another important finding was that attitudes to incentive pay vary by country, even amongst executives.)

The second point, for me, has more going for it. From this view pay is less about motivation, more about recognition and status. From this perspective odd decisions like making awards despite performance targets not being hit (Shell) or trying to get high increases in base salary through (WPP) make a bit more sense. But it also hints at the possibility that we could approach executive motivation, and standards of behaviour, from quite a different direction.

Pushing this point a bit further, we may have (created) a situation where the emphasis on performance pay means executives expect to be judged/valued in terms of cash, even if it doesn't motivate them in the way the rationale behind incentive schemes assumes. This in turn may create a culture in which a focus on self-enrichment, as opposed to fiduciary duty, becomes seen as normal (a point made in Identity Economics).

More broadly this feeds into the idea that an emphasis on market solutions can mean that social norms are displaced by market norms, a big concern of Michael Sandel, for instance. This might explain, for example, why attitudes to performance pay differ by country. In some markets there is still an expectation that executives have a duty to the company (and its stakeholders?) that over-rides their own financial gain.

Once again, I can already hear the voices of people in the City dismissing the idea we can appeal to other norms. I am not misty-eyed about the motivations of executives. Indeed I think an important one is the desire for power and influence. However, I do question whether an incessant focus on financial incentives as a way to "bond" executives, or align their interests with those of shareholders, is a sensible strategy. I would also point to the (isolated, as yet) example of Sir Michael Darrington as a successful business person who thinks executive pay has badly wrong.

What really strikes me when looking at the corporate governance world's response to the financial crisis is a general lack of curiosity about the importance of norms and values. In the pay debate the overwhelming effort is expended trying harder to get executives to follow the money, not to make them think about how they are expected to behave in return for any reward, even their salary. If there is a problem with displacing a professional norm with one of self-enrichment then many people are not only doing nothing to address it, they are arguably making it worse.

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