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A quantum leap from politicians’ to directors’ pay

Where is the research on ‘how much’ not just how we reward our directors?

Like many UK citizens (albeit an expatriated one) I have been stewing this past week about revelations in the press that the country’s Right Honourable Members of Parliament have been ethically, if not illegally, abusing their expenses. Some of the more ridiculous and demoralising claims on the taxpayers’ purse have been for dog food or the changing of household lightbulbs. The more serious ones – running into tens of thousands of pounds annually – involve charging for repairs and decoration of dubious ‘second’ homes, some of which have then been sold on free of capital gains tax. I apologise for starting this column with an Anglo-centric rant, but feel some justification in the sense that this is almost certainly not only a UK problem. I say this because most politicians globally who mix with leaders from the financial and corporate worlds regularly – perhaps humanly – compare their own rewards ‘up’ with their sometimes substantially better paid peers, rather than down towards the average employee, often three or four times less well paid. I’m simplifying here, but this has caused a serious crisis of democracy: how can we expect to be governed by competent, honest politicians when the reward structure across society is so skewed, leaving our elected representatives open to venality and the bidding of those with financial power?It’s a problem that I think equally translates into the structure of corporates and the interests of shareholders. We have heard much intense debate in this credit crisis about bonuses, golden parachutes, executive pensions, long-term pay structures, and frustratingly the ability of investors, notably in the US, to even get such issues onto the company proxy. These proper debates are supposed to bring about a much-needed alignment of financial interest and risk awareness. Shareholders, notably those with a strong ESG bent, are increasingly stepping up to lead them. However, they miss the wider point. We’ve heard little or nothing so far about the so-called ‘quantum’, or the amount board directors get paid in comparison to the rest of the company. Even the courant use of the term ‘quantum’ seems to imply that this is an issue that needs in-depth study by physicists (within a highly-paid benefits remuneration team, perhaps…), rather than something where healthy psychology and common sense might be better. Ask most people working in an organisation where its real ‘value’ lies and you are likely to hear of a much more equitable distribution down the management chain rather than the current perception that the board is omnipotent and should be duly rewarded. Other key success factors often cited are a strong internal ‘culture’ with imaginative

rewards for hard work, creativity and loyalty as well as clear grievance and whistle-blowing mechanisms. Employees after all are humans with ‘work/life’ motives far beyond pure monetary desires. Might the ‘quantum status quo’ (to stretch the latin further..) we have arrived at today where board executives can regularly be paid multiples up to 100 times (not including accelerated pensions rights and other perks) that of the average employee, on the basis that ‘it’s what other companies do’ actually work as a disincentive to company success by de-motivating or encouraging needless risk in employees further down the company? An interesting study a couple of years back by MVC Associates International, a consultant in the design of leadership structures and shareholder value, based on interviews with more than a 1000 executives in the US, UK and Canada over 15 years, suggested that each ‘value-adding’ management layer should be paid 2 to 2.5 times the layer below it. The report said the pay differential should be conditional on whether the manager role was truly accountable for different and value adding planning, innovation and risk management. The report said its ‘fair pay’ system should also be based on total compensationnot just salary. Such criteria, if applied across a reasonable timeframe – say 3-5-years – could help ensure that management is genuinely rewarded for entrepreneurialism rather than just gambling with shareholders’ money. Imposing a firm-wide accountability on management incentive structures is, of course, no exact science. Mark van Clieaf, managing director of MVC and one of the report’s authors noted that companies are much more complex and global today then when Peter Drucker, the management guru, came up with the 25xCEO pay multiplier. Van Clieaf says that the largest, most successful companies in the world would still be able to justify high executive salaries, but that at least they would be ‘felt-fair’ across the whole group. The study is serious food for thought, particularly as investors now appear to be serious about challenging companies on board pay. But we need to see more such research being considered by analysts and investors as their rationale for healthy company structures and sustainable investment; just as we need to see more transparency and equity in the remuneration and behaviour of our politicians. They are two sides of the same tarnished coin.