PwC report on exec pay

PwC's latest report (PDF) on exec pay paints a grim picture of the current state of play:

Over the last decade, executive pay in the UK has increased significantly. The increase in pay has mainly been in the form of higher annual bonuses and long-term incentive (LTI) awards, which are nearly always performance related. As our previous research has shown, the outcome has left almost everyone dissatisfied:
􀁕􀃊 Generally management feel that incentives have become too complex and prescriptive, and are not aligned to the business strategy or within their control. As a result, they do not believe incentives drive performance or change behaviours and many perceive incentives simply to be a lottery.
􀁕􀃊 Many institutional shareholders believe there is a tenuous link between pay and performance. The shareholder perception is that incentives ratchet up each year in line with annual benchmarking while incentive design and performance measures chop-and-change depending on management’s expectation of them paying out (or not). Underlying these perceptions is a feeling that remuneration committees are not being tough enough and exercise poor discretion that always favours executives.
􀁕􀃊 Remuneration committees are caught in a calibration hell trying to design incentives that are durable and balance the expectations of executives and shareholders.
􀁕􀃊 Few really believe that complex long-term incentives retain executives; they just make it more expensive for a new employer to buy-out the executive with golden hellos and guarantees.
􀁕􀃊 The public, particularly since the banking crisis, see executive pay as nothing other than a gravy train – pay regardless of performance rather than pay for performance.

I think this summary is pretty much on the money. We are in a strange scenario where many people (regardless whether managers or investors) seem to think that the system isn't working, and more of the same won't make any difference, yet there are no significant moves to challenge the fundamentals. Given this background there is the potential for really significant reform which could spill over into other areas. But I think many investors are stuck in a mindset that sees any critique of performance-related rewards as running the risk of letting directors get away with... something. So the opportunity is not being utilised. Yet.

Fascism

Just a thought, from The Great Transformation:

A country approaching the fascist phase showed symptoms among which the existence of a fascist movement proper was not necessarily one. At least as important signs were the spread of irrationalist philosophies, racialist aesthetics, anticapitalist demagogy, heterodox currency views, criticism of the party system, widespread disparagement of the "regime", or whatever was the name given to the existing democratic setup.

Behavioural bin banter

George Osborne's article with Richard Thaler has taken some stick. One bit stuck out to me.

Because the academic literature shows the importance of a way a decision is framed, the Conservative party is working with councils to replace Labour's bin taxes with schemes that pay the public to recycle. In Windsor and Maidenhead our pilot scheme has already increased recycling rates by 30%.

This is interesting for a number of reasons. First is the shift away from fining people. One of interesting stories in Dan Ariely's Predictably Irrational is about an Israeli day care centre that started to fine people who picked their kids up late. The result was that the number of parents picking kids up late went up. Ariely suggests that this is an example of a social norm (a responsible parent should pick their kids up on time) being replaced by a market norm (a bit of extra time costs/can be bought). So actually you can see a reason why fining people might not be the best approach to achieve the desired behaviour.

However coming from another perspective, one could see how paying people to recycle might also have a negative effect, because it might crowd out intrinsic motivation. The first third or so of Dan Pink's new book Drive (which I've mentioned previously) covers how and when this happens. On balance I actually think this is unlikely, because whilst I might be intrinsically motivated to recycle the task itself is repetitive, and Pink's review of the research suggests that actually tying rewards to such tasks can deliver. (That doesn't mean that there won't be some people who are negatively affected by being paid to do something that they want to do, but it might not be a significant proportion).

However Pink also suggests that over the longer term dangling carrots can become less effective - and if you take them away (perhaps because the council needs to cut costs) there can be damaging results. The extrinsic motivation - the reward - has gone, but in the meantime intrinsic motivation has been eroded by the introduction of payment.

Chuck in another concept - loss aversion. Given that we are supposed to feel losses twice as much as gains, wouldn't we think that actually fining ought to work more effectively? So maybe we should question if there something else going on that has caused the changed behaviour?

But finally, does this initiative necessarily have anything to do with framing (or any kind of insight from behavioural economics), as is suggested? The results could just come from the way the incentives are structured. The fine may not have been large enough to make incurring the cots of recycling (ie lost free time) the most attractive option. In contrast the council may now be paying more than is necessary to get people to give up the time to recycle. The jump in recycling could easily be a perfectly rational response to the incentives on offer.

Would be interesting to find out a bit more about the scheme to see the real story. I'm not convinced this article has nailed it.

Myners plans to write to CIOs over remuneration

Paul Myners is keeping up the pressure on institutional investors to take remuneration reform seriously. Below is from an exchange in the Lords yesterday:

Lord Dykes: My Lords, I thank the Minister and HMG for their commendable efforts to try to get a much more civilised regime here. We are now armed with a much more robust and alert FSA. We have the Walker proposals. We have the EU getting stuck in with its wider framework. We have Stephen Green of the HSBC and BBA with his interesting revelations on dodgy practices to have artificially structured bonuses. Then along comes Goldman Sachs with around 300 £1 million snouts in the trough-that is just the leading partners and leaves aside the traders and what they will get-completely undermining the official effort to get civilisation in this whole regime, and other bankers now, privately and with their cronies, the traders, once again quietly preparing to unleash excessive bonuses when the time comes-

Noble Lords: Question!

Lord Dykes: This is a very important matter. I know the Tories have different views. It is a complete free-for-all. They do not mind at all. Can the Government at long last persuade the big institutions in this country really to insist on proper behaviour?

Lord Myners: I am grateful to the noble Lord, Lord Dykes, for his pertinent and correct observations about many aspects of the culture of bonus payments in banks. I, too, was very struck by the comments of Stephen Green, the chairman of HSBC and the British Bankers' Association. He described inflated and distorted structures of bonuses and argued for lower and more rationally calculated figures in the future. The Government's perspective is that bonuses must, first, be a matter for the shareholders, subject to the banks being adequately capitalised. Secondly, the bonus system should not contribute to unmanageable risk. Then it falls to the shareholders. I am afraid that the shareholders, notwithstanding the comments from their trade associations, appear to have been less than fully engaged with that matter.

I intend to write to the chief investment officers of the major UK institutions in the next few days, asking them to share with me the actions they have taken to ensure that boards of directors are aware of their position on the payment of bonuses. It seems extraordinary that, over 10 years, an investor in UK banks will not have had a positive return at all. Clearly, the traders and senior executives of these banks have earned huge amounts. This is a distortion of the consequences of trade to the employees, away from the owners. The owners need to be more concerned and the pension funds need to ask their fund managers, "What are you doing to stop this process?"

Would be interesting to see what kind of replies he gets. Will they be made public, or is an FOI request in order?

A share-owning democracy... or not

From the Daily Telegraph, 10th January, 2010:

new estimates from the Office for National Statistics appear to show that Margaret Thatcher's dream of creating a shareholder democracy has taken root.
The ONS found that 15pc of British households – 3.75m – own some shares directly on the London stock market.

From the Daily Telegraph, 27th January, 2010:

Just 10.2 per cent of the value of shares traded on the UK stock market were held by individuals at the end of 2008, down from 12.8 per cent two years previously. This fall equates to a substantial decline of £120 billion.
Back in 1964 more than half of the UK stock market - 54 per cent - was held by individuals.
The data highlight how the Thatcher revolution in private share ownership failed to create a lasting impression on the stock market, while more recent turmoils in the market such as the dotcom bubble bursting and the financial crisis of 2008 have led to individual consumers owning ever smaller share portfolios.

errr...

Actually if you read both articles the stats make sense - one study takes a wider view than the other. But you might have thought that the Torygraph might read it own news.

Motivational blah

I've been thinking quite a bit lately about pay and motivation. On the bus home tonight it struck me how little pay affects how I work, let alone how hard, and I can't believe that this isn't true for lots of folks.

To get into this first a very basic take on the framework I think I am using to approach work. I think I have a sense in my head of what the broad objectives are for my job. Then below this are a set of broad tasks that I am required to undertake, and below that sit the day to day stuff that needs doing.

In terms of motivation I sense that the things that drive me to work are either pure enjoyment (because I like getting stuck into a particular task) or a slight sense of dread (can't think of a better word) that if I don't get moving I will not be delivering what I understand to be 'doing the job properly'. But broadly I am using the above framework to judge how I am doing and whether I need to do more. I do not consider the financial arrangements of the job. (As an aside I would add that when I worked at the TUC I also felt a very strong responsibility to try and work in a way that I thought was genuinely of benefit to union members. I'm not claiming that's what I actually did (!) but a broader sense of responsibility was a definite factor in how I approached the job.)

I can honestly say that in none of this does the amount I get paid even enter my head. Going further I can't see how my pay could be structured in a way that would actually get me to do my job differently, because a) I can't see how you could measure some of this stuff in order to tie rewards to certain bits of it and b) I think I would carry on largely as before in any case.

Just as a quick example, in a previous job I was offered a reasonable bonus if I recruited someone for a given role within a short space of time. We quickly interviewed two people who I thought could have done the job well, but neither wanted it. After that I was unsure about other candidates and as a result didn't appoint someone within the timeframe so no bonus. So did the incentive of the bonus work or not? In theory I could have appointed someone I wasn't convinced by to get the money, but I didn't. In practice I think it was simply a dumb idea to tie a bonus to a task like this, but hey.

In fact when I think about it what I get paid has far more importance in my non-work life (making sure the mortgage is paid etc) than in influencing how I work. Maybe if bonuses were a bigger part of it that would make a difference, but in reality I don't think so. I'm interested in the finding that tying rewards to tasks can actually make performance worse, because I think this is exactly how I think I have reacted in such a situation. Instead of simply trying to reach the best decision/do the best job the overhanging knowledge of the incentive makes you second-guess yourself.

Anyway, enough blah for now, but this is a topic I'll be returning to, you lucky people.

A small chunk of Cadbury's

I'm not surprised to not find myself agreeing with Jeff Randall about Cadbury's, but I found the following para in his opinion piece interesting:

Valuing companies is a subjective business; it's what makes markets go up and down. But for those union leaders and investment managers who insist that 850p a share is a rock-bottom price, there are questions. As recently as last April, Cadbury's shares were 500p. So, why wasn't Unite's pension fund piling into the stock at that time? How many of the City's wise guys spotted all that value before Kraft turned up?

The key point I want to address is in the last sentence. The question effectively is why didn't fund managers (I assume that is who he means by City wise guys) realise Cadbury's was worth 850p earlier. There are several answers to thus. Firstly, of course, they may well have thought this. Excuse me stating the obvious but a key strategy in fund management is to try and spot companies that are trading below what the manager thinks they are worth and by their shares in order to make money when the market comes to that same valuation. You don't wait until the company hits the price you think it is worth and then buy it. So there may well be managers that bought into Cadbury when it was trading at 500p because they thought it would increase in value.

Secondly, in theory all kinds of factors could have affected how investors valued Cadbury last April compared to how they value it now. In fact presumably if you think that market prices tell us something useful, that it's signal rather than noise (which is presumably what Jeff Randall must believe to some extent to use changes in share prices to make a point), then that's exactly what we must believe. Otherwise why would the price move to such an extent?

Thirdly, in practice we obviously know that there has been a significant development that affects the valuation of Cadbury's - the Kraft bid. Some of those investors that valued Cadbury's at 500p previously and 850p now may believe that the deal will create value. Or they may simply be punting on the shares going up because of the bid. The point is that you can't isolate the current valuation and the bid. The current price wasn't there to be "spotted", as he puts it, because the deal and its implications weren't part of the story.

And finally, and most obviously, he seems to be ignoring the fact that the whole market has increased dramatically since last April (having hit bottom in March). You might as well ask why was everyone so negative about economic prospects last spring compared to now. And I suspect that if you go back to April last year the one thing you won't find are opinion pieces from Jeff Randall predicting a bull market, because that in turn would imply optimism about economic prospects.

PS. Any thoughts on what Jeff would say if union pension funds had piled into Cadbury in a big way last year and had made money out of it? I suspect he would have called them opportunists/hypocrites/capitalists or something similar.