Executive pay under scrutiny

by 30 Oct 2008

THE CURRENT economic climate presents an opportunity for boards to reposition performance-based executive remuneration around a more strategic scorecard of metrics, according to Deloitte.

“It’s open season on boards with shareholders looking to express their disappointment for the retreating value of their investments and declining corporate profits as economic conditions tighten,”said Stephen Cornwell, Deloitte Reward partner.

“And executive remuneration is under attack, such as fixed pay, annual bonuses and long-term incentives. Boards can bunker down and try to weather out the storm. Alternatively, boards can steer away from an over-reliance on company annual profit results in favour of basing executive remuneration on a suite of metrics reflecting current performance and future value underpinned by rigour and analysis.”

Such an approach not only puts some granularity into the performance equation, but also provides boards with a clear basis to communicate remuneration policy to the market, educate shareholders on the strength of the link between pay and performance and manage executive pay risk, he said.

“Investor view seems to be that performance-based pay is about rewarding corporate profitability. Many investors believe that when profits fall, executive pay should fall, too – irrespective of whether market sentiment and forces way out of executives’ control drive market prices sharply lower,” Cornwell said.

“There are consequences for companies and investors alike from such a ‘blunt edged’ approach. It raises a pertinent question about ‘short-termism’and the lack of focus of reward on sustained performance. This is being conveniently overlooked in the simplistic view that falling corporate profits should mean markedly lower incentive payments.

“It’s the first time we have faced challenging economic conditions since the advent of the new age of governance scrutiny around executive remuneration. So, it’s an obvious position for shareholders to take, given the leverage they can now exert through mechanisms such as the annual vote on the remuneration report at the AGM.”

Adam Sorenson, a practice leader with global HR consulting firm WorldatWork, said the current economic crisis seems to be prompting organisations, governments and the general public to take a closer look at executive compensation programs.

“On an even more practical level, declining share prices and profit margins will almost certainly reduce the amounts of real compensation being paid to executives, particularly among companies hardest hit by the financial crisis,” he said.

“Senior executives of troubled companies may find that they are able to negotiate better packages in less troubled industries. It’s not clear whether this will lead to long-term challenges in retention and motivation of key executives, but organisations should be thinking about how well their compensation programs are matched with their business objectives and human resource strategies.”

Sorenson said there seems to be a lot of uncertainty among HR professionals about what this crisis means to them and their organisations. Most seem to be adopting a “wait and see” approach, responding to issues as they arise.

“A few organisations are looking at reducing non-essential benefits as a cost-savings measure, while others are looking to increase no-cost or low-cost benefits (such as flexibility) as a way of boosting morale. But few seem to be making radical changes to their compensation and benefits programs.”

If the crisis continues to deepen and expand across industries, Sorenson said, HR will likely play an increasingly uncomfortable role in decisions about headcount reductions, plant closures and more serious cost-cutting measures.

Given the financial realities, he said that organisations will likely need to be both strategic and creative in their approach to attraction and retention.

“From an employee’s perspective, things such as job security, meaningful work and a supportive environment may help compensate for a smaller merit budget,” he said.

“But organisations must continue to focus their limited financial resources (such as merit increases and retention bonuses) on their key talent and top performers.”

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