Disrupting CEO Pay

The former CEO of the Investment Association, the trade body that represents UK investment managers, has made a disruptive proposal on CEO pay.

Decades of technocratic effort by corporate governance experts has had unintended effects. Pay levels have “gone through the stratosphere” with “ever more complex” arrangements.

Daniel Godfrey’s proposal is simple and radical: a salary-only model, incorporating shares. Such a system would:

1. Align incentives with sustainable, long-term wealth creation, reversing the short-termism of the current model. The focus would be on the value of shares in seven years, the earliest when they can be sold, so getting CEO attention on customers, environment, communities and suppliers, not to mention R&D and innovation.

2. Focus the current CEO on his or her successor’s success. Today’s CEOs are incentivized to pump up the stock value and leave their successor with the consequences.  BP, GE, Tesco are just some of the companies where celebrity CEOs have shown good timing, leaving ahead of share price collapse.

3. Put responsibility for performance management back on to boards rather than pay formulas negotiated between remuneration consultants and investors. Shareholders would say to boards: “we trust you to work out how much it is worth to the company to get the right person, to identify someone who fits the bill and to calculate how much they need to pay to get and keep them.”

4. Today few CEOs actually know how much in total they will get because the formulae are so complex. Over time, a salary-only system removes uncertainty and provides the basis for a reduction in absolute levels of pay and inequality too.

In return, boards would explain their thinking to shareholders. They would no longer be able to say: “If the CEO doesn’t perform, he/she won’t get paid”. Not only is this a low trust way to start a relationship, but “they don’t get paid” often doesn’t happen.

The above would, together, hugely improve corporate and investor reputation. So what are the push backs?

Performance, remuneration and corporate governance specialists would need to do a very different job. Their skills are definitely needed but should be re-oriented to fully supporting long-horizon corporate success (which includes meeting key short-term objectives) by actively monitoring issues such as return on capital over 5 year, innovation and future value. Endlessly fiddling with share price focused pay formulae simply hasn’t worked!

Of course, “bad” CEOs may on occasion get more than they deserve. But this happens today: global investors have probably paid $15 bn in underserved performance pay to CEOs just in the USA Shareholders need to accept recruitment mistakes will happen, but repeated mistakes would be a cause for resignations from the nomination committee that finalises senior appointments and for these directors to known for having poor judgement. This would quickly improve performance.

Others say a great idea but how on earth can we get from the dysfunctional system that we have today to this elegantly clean system?  Why, for example, should CEOs agree whilst the City – investment bankers, fund managers – have the potential to earn (much) more for seemingly doing (much) less? There are more fund managers at Blackrock earning over £10m p.a. than there are FTSE CEO’s! CEOs would simply move to escape this restriction! Wouldn’t CEOs just move country?

The likelihood of all these CEOs getting jobs in the USA is very slim and there are plenty of better suited candidates from outside the UK to take their place. As with any deep culture change – eg voting rights for women, abolition of slavery – the solution won’t come from technocrats and insiders. Nor can there be a complete solution one country at a time but any country can trigger change for the good, or for the bad as we now see in the USA. Fundamentally, this proposal depends on non-insiders making it happen. Might citizens, #OccpuyWallStreet and the Tea Party, put aside their differences and agree on this one issue? Or could political leaders eg Theresa May see the electoral value of not just talking but also acting decisively?

If this Godfrey’s proposal triggers investors to, finally, get their act together and make their technocratic approach do what they have been talking about for so long, that’s great. But I won’t be holding my breath and that’s why I am backing this innovative proposal. Moderates and progressives can also tear up rule books!

A shorter version of this article originally appeared in IPE, April 2017.