Saturday 30 June 2012

Incentive scheme delusion

From Everything Is Obvious:
"[O]nce we realise that some particular incentive scheme did not work, we conclude simply that it got the incentives wrong. Once they know the answer, in other words, policymakers can always persuade themselves that all they need to do is design the correct incentive scheme - overlooking, of course, that this was precisely what they thought they were doing previously as well." 
Exactly what is going on currently in corp gov currently.

Monday 18 June 2012

The language of unintended consequences

Interesting comment here from a remuneration consultant in response to the idea of a max 1:1 salary to bonus ratio in banks:
“If they do put caps in, this could have disastrous unintended consequences. It could result in significant increases in fixed pay,” said Jon Terry, global head of human resources consulting at PwC. “It substantially affects the flexibility of the business.”

This is a commonly heard argument, and a popular spin on unintended consequences. It's also interesting from a linguistic point a view. One of the useful things in discourse analysis is the concept of foregrounding/backgrounding in the construction of speech/text etc. What is made explicit and what is not (intentionally or otherwise)? In the excerpt above, the threat of unintended consequences is invoked and action A (bonus cap) could lead to result B (increases in fixed pay). The implication is that A causes B. Though the phrase "could result in" is sufficiently vague to not quite claim this, the fact that the result is "disastrous" does imply an an unthinking effect from the initial action.

But A doesn't cause B. There is an agent missing (backgrounded if you like) in the description that plays a role in this process - the bank employing the bankers. Whilst the langauge implies that result B is suffered by banks, it is actually the banks themselves that will decide whether to significantly increase fixed pay or not. Especially if the outcome is "disastrous", why would banks make it happen? They could simply not increase fixed pay significantly, surely? In reality then A (the bonus cap) affects C (the banks) which can decide whether or not to make B (increases in fixed pay) happen. In addition the "consequence" (result B - increase in fixed pay) cannot really be said to be "unintended". Presumably if the bank raises fixed pay the intention is to raise fixed pay, and the consequence is raised fixed pay. (In addition, the EU's intention is to cap bonuses and if bonuses are capped the consequence is capped bonuses).

PS. In the last bit of the comment the argument is made that a cap on bonuses would affect the 'flexibility' of banks. Presumably this is a reference to the claim that high variable enables banks to manage staff costs during difficult condititions. But there is no suggestion that bonuses would be banned, only that the can only equal base pay. That means that, just through bonus policy, in a tough year a bank could cut its maximum potential staff costs by 50% (It could, of course, also consider cutting base pay and/or numbers of higher earners). It would be interesting to see what has happened to bankers' bonuses as a percentage of salary for the last few years when the economy has nearly fallen over. Presumably they must be zero or close to, right? I mean this type of period must be when they really need "flexibility".  

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.

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.

Thursday 7 June 2012

Having two shareholder votes on pay

The BIS proposals on executive pay include the introduction of a new, binding shareholder vote on remuneration policy, alongside the existing avisory vote on the remuneration report. One argument made against such a proposal is that in practice shareholders would vote the same way on both resolutions, so there's no point. But is that true?

Helpfully there's a test case. Amec Plc has an unusual approach to shareholder oversight of executive pay, in that it gives investors (at least) two votes a year - one on the remuneration report, and one on remuneration policy. It's been doing this for at least ten years.

Looking at AGM results for this year and last year, we can see that there's was a bigger vote against the remuneration report than the remuneration policy. In 2010 both votes against were very low, but there was still clearly a difference, especially if you look at abstentions. But look at the 2009 AGM - Amec received a 46% vote against the remuneration report, but only just under 10% against the remuneration policy. So on the face of it investors have used the two votes differently. 

The other thing we can check this against is asset managers' voting disclosures. Looking at UK managers (at least those who have, or had, 2009 data available) and how they voted at Amec's 2009 AGM the picture is a bit odd. Here's a list of voting decisions I could find. First letter represents the vote on the remuneration report, the second the vote on the policy. F=For, A=Abstain, O=Oppose.

Aberdeen - FF
Aviva - OO
Baillie Gifford - FF
F&C - FF
Fidelity - FF
Hermes - FF
L&G - OO
M&G - FF
Royal London - OO

So in a small sample (don't blame me, blame the nature of the voting disclosure regime) we see both little differentiation in voting behaviour and mainly support for the remuneration report. Maybe other, non-disclosing, asset managers were taking a differentiated approach. Particularly overseas ones? 

The other point worth making is that people might differentiate by deciding to make any point they wish to through their vote on the remuneration report, simply vote in favour of the policy resolution. So the different voting outcomes may not necessarily indicate both votes being utilised.

And actually different voting outcomes on pay resolutions shouldn't be a surprise given that investors will often vote differently on a proposed incentive scheme to the way they vote on the remuneration report, see Kofax for example (resolutions 2 and 13).

But the broad point is that we can't assume that shareholders will vote the same way on these resolutions. It's another example of anecdotal 'common sense' in the corp gov world that may not be supported by evidence.

Wednesday 6 June 2012

WPP smash up

The first thing I think we can say about WPP is that it's likely that it will lose the vote on it's remuneration report. I'm struggling to find anyone who says they're voting in favour. Also all the proxy advisers Appear to have recommended an oppose, with the ABI red-topping it. So this one could go down in flames.

Secondly, there seems to be no desire to avoid this outcome. I think shareholders have already dug in on this one but, perhaps more surprising to some, the company isn't giving ground either. Martin Sorrell's comment piece in the FT has only cranked up the pressure, giving no indication he believes the company has done anything wrong.

In fact what is notable about his article is the emphasis he puts on the role of ISS. You would never get the impression that asset managers are ticked off, just those pesky proxy advisers. This may provide some indication of how WPP will respond to the result. It would also be in line with the corporate lobby's agenda at the moment. There's even a bit of speculation that WPP may delist from the LSE if it gets spanked, which would be a bit puerile, but hey.

So maybe a defeat over remuneration at this AGM suits a number of different parties. Shareholders can show Vince Cable another scalp. More importantly it will be one at a company that isn't under performing or where there are concerns about the leadership. This is about when to say "enough". From Sorrell's perspective it's also about shareholders saying "enough", but how ludicrous that is when the business is successful. And just as there are those willing shareholders on, there are also those who want WPP stand firm, and see all this executive pay stuff as dangerous populism.

How people respond to a defeat will be interesting, since the dominant idea in corporate governance is that it is shareholders who are best placed to deal with top pay. Will anyone within the corporate world argue publicly that things are getting out of hand? It would lead to more questions if they did, and could lay bare how real the notional commitment to shareholder primacy is, but I wouldn't rule it out.

Finally, since the vote on the remuneration report is advisory, will WPP actually do anything to address it? Again it could be quite inflammatory if they don't (or if they do something more ridiculous). But it would also strengthen the argument for a binding vote.

It's very nicely set up for a proper scrap.

Friday 1 June 2012

Voting data doesn't tell you anything

That's something I've heard repeatedly over the past 10 years. Someone offered this fashionable opinion to me only last week as it happens. And I've heard it most often from asset managers, sometimes those whose voting record looks rather... well... weedy.

I am a complete geek about this issue, and in my spare time I've been rounding up a load more data from asset managers' disclosures. Some examples below, based on disclosures relating to the last couple of seasons, of how voting data doesn't tell you anything include - 
  • At least three well-known asset managers appear to be abstaining much less often on remuneration reports, and either voting for or against (and in practice voting against more often).
  • Most managers oppose 10% to 20% of remuneration reports at big PLCs.
  • Three well-known managers (not necessarily the same three as above) failed to back more than a quarter of the remuneration reports that I've looked at. 
  • In contrast two well-known managers supported 95% of the remuneration reports I looked at (and one of these two would be a real surprise to most people I suspect).
Clearly 2012 will mark a further change, and voting records will show some interesting trends. As we can already see in AGM results, some managers have turned up the heat (one big one in particular I suspect). But even before this year it is possible to see who the outliers are on both sides. If I can form a view of where various managers sit on the voting spectrum, I bet some smart IR and/or proxy solicitation people are alert to it too. No doubt knowledge of who the soft touches in the market are can underpin planning around key proposals.

Except, of course, that the votes tell you nothing, and the information is meaningless.