Why eye-popping CEO pay is inevitable

24 May 2015 - 02:00 By Ann Crotty

What if we've been paying corporate executives much more than was actually necessary to get them to do a good job? And what if the way these executives were incentivised actually guaranteed a poor long-term outcome, not only for the company that was paying them but for the entire economy?The independent UK think-tank the High Pay Centre suggests that this might be the case. The pressures and trends driving the UK's executive remuneration policies are the same as those in South Africa, so it's safe to assume remuneration committees here are guilty of the same errors and excesses.After a year's research, the centre found that the performance measurements used by remuneration committees don't always align with the company's long-term interests, and can in fact create perverse incentives; there is a weak relationship between pay and company performance; it's difficult to isolate the contribution of an individual executive to results; and the processes and individuals that set performance-related pay are not subject to sufficient challenge or accountability.story_article_left1And it might just be that this system of rewards is totally inappropriate for executives."For a boring, repetitive task where no intrinsic motivation for doing the job exists, a reward can provide some incentive to work harder or more effectively," the centre reported - and stated that for more complex tasks, individuals may possess an intrinsic desire to do the job well. It is that intrinsic desire that motivates the vast majority of workers who stretch themselves to complete tasks without the immediate promise of enormous wealth.In the case of executives, you have to wonder why somebody was appointed to a senior role in a company if he is so devoid of this fairly common intrinsic motivation that his every action requires the promise of a large reward.As disturbing as the thought that this generous reward system is unnecessary is the likelihood that it is incentivising the wrong behaviour. Amazingly, the definition of "long term" in the life of a remuneration committee member is three to five years - so every major decision taken by a company is measured in terms of a three- to five-year payback period. If you're a CEO with R500-million in the kitty, are you going to invest it in a project that might take five to 10 years to generate returns? Or will you use the R500-million to repurchase the company's shares in a risk-free "investment" that will immediately lift earnings per share and the price of the remaining shares (automatically lifting the value of all the executives' share options)?story_article_right2Unsurprisingly, CEOs around the world opt for the latter strategy. Frequently, they will justify share repurchases - described by one legal expert as a partial liquidation of a company - by referring to high levels of risk or low levels of demand in the economy.That such a profoundly suboptimal remuneration system prevails is attributable to several factors, chief of which is that the key decision-makers in the process are all beneficiaries and there is no effective independent oversight.It would be difficult to design a system that would better guarantee excessive executive pay than the current model of shareholder capitalism. At its core is the flawed assumption that executives are acting as agents on behalf of shareholders, and are actively overseeing their investments.The reality is that the role of shareholder falls to investment professionals who manage money on behalf of millions of pension and provident fund members and savers. These fund members and savers usually have no idea what companies they are invested in, so are incapable of holding the professional manager to account for anything other than an increase or decrease in investment value.The majority of investment professionals don't even attend shareholder meetings - and any temptation they may have to raise the issue of executive pay is muted by the realisation that their own pay is similarly extreme and linked to short-term movements in share prices.Excessive and wasteful executive pay is thus inevitable...

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