There's a lot of commentary from a lot of sources these days arguing against a shareholder-centric corporate governance model. So far, the commentary is far ahead of any policy, and certainly in the US there is scepticism about the motives of those - like the Business Roundtable - who have almost overnight become advocates of a more stakeholder-orieted model.
One thing that, as far as I am aware, hasn't been discussed in detail is what all this means for executive pay. I raise this because the dominant ideas relating to executive pay in markets like the US and UK are derived from agency theory, and the version of agency theory that is applied envisages the boards of companies as agents of shareholders. Leading on from this, pay is structured in a way that aligns directors' interests with those of shareholders. Hence there is a lot of emphasis on both variable pay and equity.
But if we are looking at a future in which other stakeholders are also part of the governance of companies, and in which directors' duties are no longer conceived as being solely owed to shareholders (and thus directors are not agents of shareholders) this seems open to challenge.
If pay was aligned with the interests of the workforce, for example, it would surely have a much lower variable element and more emphasis on fixed, though perhaps also expanded short-term profit-based awards (provided these are shared across the workforce).
In addition, questions about how executive pay is decided and approved might also be contestable once more. After all, if directors are not solely accountable to shareholders the fact that only shareholders vote on who they are remunerated might seem a little outdated.
So I could imagine quite a shift in various aspects of pay - provided that the nature of corporate governance itself changes.
Sunday 13 October 2019
Sunday 6 October 2019
Problems with performance pay
It's been a few years since I read in depth about reward and motivation. I basically got to the point where I think most performance-related pay is junk, as are most of the 'reforms' advocated, because there is little attempt to engage with the psychology obviously sitting behind all these idea.
Over the summer I read a couple of books (this one and this one) by Sandy Pepper and it's reignited my interest. He comes at these issues from a similar perspective and his books are a treasure trove of further reading ideas. He's very much of the view that mainstream agency theory, and the executive designs that flow from it, are flawed and that to correct them we need to take account of human psychology. His work is also useful in that he undertook a large-scale survey of executives to gain a better understanding of how they think about incentives. His research confirmed that executives sharply discount deferred rewards. Another couple of fascinating nuggets from the research are that younger executives are less risk averse but higher time-discounters and that financial services executives were both *more* risk averse than those working in other industries and high time-discounters.
Notably Pepper comes down in favour of short-term, simple cash-based incentives. This is a long way from the conventional wisdom - even in the ESG world - that we should be pitching at long-term equity-based incentives with lots of targets (including ESG KPIs).
Anyway, I won't try and summarise his arguments here, so below are just a handful of snippets from The Economic Psychology of Incentives that I particularly liked.
"[I]nvestors are driven by relative measures. They are selecting stocks based on relative performance by category and are worried about beating the average in the shape of an index. However, an HR director pointed out that the starting positions of managers and investors are not the same: 'Most shareholders hold a portfolio and are therefore insulated against the capricious nature of shareholder returns. We as executives are not.'"
(this is a point I was sort of getting at in my third bullet in this blog)
"The effect of non-paying LTIPs is not merely neutral - it can be positively demotivating to hold an incentive instrument which you believe will never pay out. An HR director with particular experience of this problem described it this way: 'If you get reward wrong it is a much bigger de-motivator than it can ever be a motivator. It's like walking around a china shop with a sledgehammer in your hands.'"
"[B]oards of directors, acting on behalf of shareholders, increase the size of long-term incentive awards to compensate them for the perceived loss of value when compared with less risky, more certain and more immediate forms of reward. In other words, I argue that part of the explanation for the inflation in executive compensation is a consequence of the form in which compensation is provided."
"[I]s it possible to to alert certain features of long-term incentives in order to increase their perceived value? For example, complex performance criteria appear to increase the level of risk and uncertainty in long-term incentives and hence reduce their perceived value. Executives might be more effectively motivated by receiving smaller rewards which do not have complex performance conditions attached. Most radically, might it prove to be both more effective and efficient ti arrest the trend of placing increasing reliance on high-powered long-term incentives."
Over the summer I read a couple of books (this one and this one) by Sandy Pepper and it's reignited my interest. He comes at these issues from a similar perspective and his books are a treasure trove of further reading ideas. He's very much of the view that mainstream agency theory, and the executive designs that flow from it, are flawed and that to correct them we need to take account of human psychology. His work is also useful in that he undertook a large-scale survey of executives to gain a better understanding of how they think about incentives. His research confirmed that executives sharply discount deferred rewards. Another couple of fascinating nuggets from the research are that younger executives are less risk averse but higher time-discounters and that financial services executives were both *more* risk averse than those working in other industries and high time-discounters.
Notably Pepper comes down in favour of short-term, simple cash-based incentives. This is a long way from the conventional wisdom - even in the ESG world - that we should be pitching at long-term equity-based incentives with lots of targets (including ESG KPIs).
Anyway, I won't try and summarise his arguments here, so below are just a handful of snippets from The Economic Psychology of Incentives that I particularly liked.
"[I]nvestors are driven by relative measures. They are selecting stocks based on relative performance by category and are worried about beating the average in the shape of an index. However, an HR director pointed out that the starting positions of managers and investors are not the same: 'Most shareholders hold a portfolio and are therefore insulated against the capricious nature of shareholder returns. We as executives are not.'"
(this is a point I was sort of getting at in my third bullet in this blog)
"The effect of non-paying LTIPs is not merely neutral - it can be positively demotivating to hold an incentive instrument which you believe will never pay out. An HR director with particular experience of this problem described it this way: 'If you get reward wrong it is a much bigger de-motivator than it can ever be a motivator. It's like walking around a china shop with a sledgehammer in your hands.'"
"[B]oards of directors, acting on behalf of shareholders, increase the size of long-term incentive awards to compensate them for the perceived loss of value when compared with less risky, more certain and more immediate forms of reward. In other words, I argue that part of the explanation for the inflation in executive compensation is a consequence of the form in which compensation is provided."
"[I]s it possible to to alert certain features of long-term incentives in order to increase their perceived value? For example, complex performance criteria appear to increase the level of risk and uncertainty in long-term incentives and hence reduce their perceived value. Executives might be more effectively motivated by receiving smaller rewards which do not have complex performance conditions attached. Most radically, might it prove to be both more effective and efficient ti arrest the trend of placing increasing reliance on high-powered long-term incentives."
Saturday 5 October 2019
Are unions coming back into favour?
Perhaps I'm grasping at straws, but I can't shake the feeling that attitudes toward trade unions are shifting amongst some key groups, and that this might point to a more hopeful future.
In politics the direction of travel is most clear. Obviously Labour has adopted more union-friendly policy positions that it has held for the past 20+ years, union leaders have more influence on Labour, and Labour MPs are now far more openly pro-union. But it's happening in the US too. Both Bernie Sanders and Elizabeth Warren talk a lot more about unions - and how to make them stronger - than Obama ever managed.
But there's also increasingly discussion of bargaining power (or the lack of it) and how this affects inequality / distribution of wealth to capital v labour etc in other areas too. Leo Strine's piece in the FT last week was particularly striking. In the detail of the critique of the failure of investors to look at what happens to workers, and some 'governance-y' reform ideas (like setting up board committees on fair treatment of employees) he calls for labour law reform to give unions a "fairer opportunity to represent and bargain for their workers".
More generally, an increasingly widely-held view is that the growth in economic inequality is at least partly about falling levels of union membership and collective bargaining (it's not just about technology, global shifts etc). And the flip side of this is that more policy wonks are attracted to the idea of more flexible ways of affecting distribution of rewards than trying to determine this all via legal / regulatory interventions (which can always be reversed). Unions look like a pretty good fit there too.
To be clear, this is all mood music, and mood music never won anything for anyone. If Labour and the Democrats don't win, nothing changes, at least for now. Trump won't lift a finger to make it easier for workers to unionise. And the sort of people that Boris Johnson surrounds himself with are more likely to think unions still have *too much* power, not too little.
And we also need to be open-eyed about the challenges to unions. They need to recruit a lot of younger workers just to stand still. Yet experience of, support for, knowledge of unions is not part of the cultural fabric, or passed down through families, in the way it would have been a few decades back. This is a deep problem to address.
However, overall it does feel like there should be grounds for some optimism. A bit of luck with politics, perhaps a big dispute or two that demonstrates that inequity working people still face on the job, and some principled leadership could start to reorient politics and policy around unions.
In politics the direction of travel is most clear. Obviously Labour has adopted more union-friendly policy positions that it has held for the past 20+ years, union leaders have more influence on Labour, and Labour MPs are now far more openly pro-union. But it's happening in the US too. Both Bernie Sanders and Elizabeth Warren talk a lot more about unions - and how to make them stronger - than Obama ever managed.
But there's also increasingly discussion of bargaining power (or the lack of it) and how this affects inequality / distribution of wealth to capital v labour etc in other areas too. Leo Strine's piece in the FT last week was particularly striking. In the detail of the critique of the failure of investors to look at what happens to workers, and some 'governance-y' reform ideas (like setting up board committees on fair treatment of employees) he calls for labour law reform to give unions a "fairer opportunity to represent and bargain for their workers".
More generally, an increasingly widely-held view is that the growth in economic inequality is at least partly about falling levels of union membership and collective bargaining (it's not just about technology, global shifts etc). And the flip side of this is that more policy wonks are attracted to the idea of more flexible ways of affecting distribution of rewards than trying to determine this all via legal / regulatory interventions (which can always be reversed). Unions look like a pretty good fit there too.
To be clear, this is all mood music, and mood music never won anything for anyone. If Labour and the Democrats don't win, nothing changes, at least for now. Trump won't lift a finger to make it easier for workers to unionise. And the sort of people that Boris Johnson surrounds himself with are more likely to think unions still have *too much* power, not too little.
And we also need to be open-eyed about the challenges to unions. They need to recruit a lot of younger workers just to stand still. Yet experience of, support for, knowledge of unions is not part of the cultural fabric, or passed down through families, in the way it would have been a few decades back. This is a deep problem to address.
However, overall it does feel like there should be grounds for some optimism. A bit of luck with politics, perhaps a big dispute or two that demonstrates that inequity working people still face on the job, and some principled leadership could start to reorient politics and policy around unions.
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