The tide is turning on high pay

Written by: Luke Hildyard on 18 February, 2013
Filed under Economy

The Pensions Invesment and Research Consultants (PIRC), an adviser to pension funds responsible for a combined £2 trillion worth of investment, have announced that they will be advising clients to vote ‘no’ to all new Long-Term Incentive Plans (LTIP’s) introduced for company executives (see the attached press release from PIRC).

This represents a significant shift in thinking around executive pay. LTIP’s are generally the largest component of an executive pay package, with a value of up to 700% of basic salary. They are typically three years in length, and usually measured against the company share price. So, for example, a CEO  offered an LTIP in 2013 would not be able to access the money until 2016. The precise value of the award would depend on the share price meeting a minimum threshold in 2016, and would increase in proportion to the amount by which that threshold were exceeded  As LTIP’s are the largest component of executive pay, but dependent on the company share price three years into the future, this makes it very difficult to calculate the total value of an executive pay package.

Some would say that this is entirely intentional, making it easier for companies to deflect criticism of gross pay awards, on the grounds that the amounts being reported are not necessarily accurate.

In addition to being overly complex, LTIP’s have been criticised because, in the words of PIRC Managing Director Alan Macdougall, “they are not long-term and they do not incentivise”. As the HPC report ‘Paid to Perform‘ pointed out, over a three year timescale it is much easier for a company to drive up profits and share price by cutting costs and investment, rather than working hard to build up the great brand or product, highly motivated workforce and loyal base of satisfied customers that will enable it to survive in the long-term.

Equally, research from PricewaterhouseCooper’s and the Sky Future Leader’s survey suggests that recognition and a sense of working for a great company are more important drivers of executive motivation than the size of their pay package, while deferring the award for three years only reduces its value on the ‘a bird in the hand is worth two in the bush’ principle. Much of the academic research on the psychology of incentives concludes that financial incentives ‘crowd out’ the intrinsic motivation of people to do an excellent job. Performance-related pay only improves performance for simple tasks for which the individual lacks intrinsic motivation – it is quite ill-suited to the complex role of managing a major corporation, or the educated, competitive individuals in executive positions.

As such, PIRC have a robust and credible business case for adopting their position on LTIP’s. As James Moore at the Independent notes “over the long term Pirc has been on the right side of most of the arguments about (corporate) governance”. Their intervention is therefore a significant moment, and will lend great momentum to the effort to reform executive pay.

This article first appeared on the Big Pay Debate.