Saturday, 24 November 2018

Chief execs, incentives and discounting

A quick plug for Are chief executives overpaid? by Deborah Hargreaves, formerly of the High Pay Centre. Spoiler alert: the answer is YES.

The book is a quick run through what top pay looks like, why it has changed and grown, some of the attempts to tackle it and so on. Of interest to people in the corp gov microcosm, the book is pretty critical of shareholder primacy. As I've argued previously, this has already become the "common sense" amongst left-of-centre policy wonks (last year's IPPR report fleshed out what I think is the centre of gravity now) and I have seen the odd similar approach from the Right too. It does feel like the ground is shifting, so it will be interesting to see if we start seeing more policy / regulatory ideas in this space - one to keep an eye on.

On pay specifically, as always my eye was drawn to the section on motivation (where again I think opinions have shifted, though practice has not). So here's a chunk:

[R]esearch by Professor [Alexander] Pepper... undermines the argument that top executives need ever bigger carrots dangled in front of them to improve their work ethic. He has found executives 'are much more risk averse than standard economic theory would suggest'. This means they value a 'sure' thing such as money more highly than a risky option such as the promise of a share award.

At the same time, 'executives are very high time discounters'. This means that if they know they will not get their share award for another three years, they disregard its value. 'This empirical evidence challenges conventional wisdom about the merits of high-powered incentive plans and pay for individual performance. It suggests that long-term incentives may actually be fuelling increases in executive pay, rather than helping to contain pay inflation.'  

I've always found the point about discounting very interesting, and wonder how execs compare against the rest of us. But it also blows a hole in some of the ideas being pushed as 'reforms'. For example, if you advocate that LTIPs have a 5-year timescale rather than a 3-year one, aren't you just diminishing the value of it in the eyes of execs even further?

I had a back and forth with a defender of the "make pay more long term" school a year or so back, and their argument seemed to be that execs say they don't value long-term rewards because they want short-term ones. To me that sounds self-evident. If you say "I put a lower value on Y than X", you can also express this as "I put a higher value on X than Y" (unless I'm missing something?). So I don't see why we don't just accept that when execs say they value long-term incentives less they mean it.

Of course the reason why some people don't like this conclusion is because then you have to question why - if the function of incentives is to get execs to do what shareholders want - would you change the structure of rewards in a way that makes them less attractive to recipients? If you have a lot invested in a set of beliefs including "long term = good" and "performance-related pay = good" that's going to be lead to some major cognitive dissonance.

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