What can we learn from the UK's tougher stance on executive pay?

Following the global financial crisis of 2008/09, there has been no shortage of finger-pointing in an attempt to identify its roots. Almost every British media covered high-profile cases of banking executives seemingly being rewarded for taking excessive risks that, in many cases, led to corporate failures. More recently, senior executives of a major global construction company were criticised for allegedly prioritising their own pay over company performance, partly contributing to its eventual liquidation; and in each of the last 3 or 4 years, several other large UK companies have been criticised publicly for allowing executive excesses and/or weak governance on executive pay.

This surge of so-called “senior executive greed” has led to significant changes in the regulations, policies and practices governing executive pay globally. So, what can we learn from these changes in the context of executive pay here in the UAE? 

What is it all trying to achieve?

Firstly, it might be useful to reflect on the main underlying objectives behind these changes such as: 

• To better align executive pay with the long-term interests of owners/shareholders.
• To make the design of executive pay and incentive plans simpler and more transparent.
• To minimise the likelihood of rewarding executives for under-performance and inappropriate leadership behaviour.
• To ensure executive pay does not drift excessively out of line with other management levels and the workforce in general.
• To ensure a level of independence in the administration of executive pay.

The 4 Golden Rules for managing executive pay

1. Take a long-term view

Whilst short-term (i.e. one year) incentive plans are important, the primary expectation from senior executives is the long-term survival, sustainability and growth of the business. Incentive compensation should therefore be geared more towards long-term targets and rewards (i.e. 3-5 years), with a lower portion focused on this year’s performance. It should not be considered unusual for a CEO’s pay to be made up of 35-40% “fixed” and 60-65% “variable”, where 75% of the variable portion is achievable over a 3-5 year time-frame. Further down the senior leadership team, the ratio between fixed and variable is typically less aggressive, but the principle remains.

Where share ownership is not an option, these longer-term rewards can be geared around cash bonus deferral plans where full pay-out does not materialise until and unless long-term targets are achieved.    

2. Maintain a strong connection between strategy, performance, behaviour and reward

Target-setting is a topic for much wider discussion but, in principle, organisations should be setting senior executive performance metrics that: 

• are challenging, meaningful and simple to understand for all stakeholders;
• are fully aligned with the business strategy, culture and values;
• encourage the pursuit of the right business results and, of equal importance and often neglected, the right behaviours (e.g. avoiding a “sell at any price” mentality);
• let executives know that significant out-performance will deliver significant incremental reward over the long-term – and that mediocre performance will not.

3. Design reward plans that develop and retain your critical talent

Whilst long-term company performance is the priority, it is important that executive pay is designed not only to incentivise high-performance with the right behaviours, it needs to keep your critical senior talent engaged with the business. Reward design can play an important part in this when you build in elements of retention incentives (i.e. reward without specific performance conditions) that recognise continued loyalty. The point being that executives need to feel that incentive plans are not solely a “one-way street.”    

4. Establish impartial governance of executive pay

The establishment of a Remuneration Committee or simply having an independent executive remuneration adviser can offer a level of impartiality and “distance” from what can be a very sensitive matter that, in fairness, should not be left solely to the HR Director to administer. The HRD is often left in the potentially invidious position of advising on his/her boss’s pay. The Remuneration Committee or adviser, typically with a relationship to the business owners or the parent company board, as well as having a strong interface with the HRD, would then have advisory oversight of such things as incentive plan design, target setting, pay out decisions, base salary market alignment, etc.

In conclusion, executive pay is a high-cost item but if executives are delivering high performance then no one can begrudge them high rewards. It is also a highly sensitive topic that, if poorly managed, can create dissent, not only amongst senior executives themselves but also other management levels, the workforce in general and, worse still, external stakeholders. There is a lot we can learn from the improvements that have been achieved globally in the last 5 years and from those companies in the UAE that have been the early advocates of better governance of executive pay.

John Macdonald is the Lead Associate for Compensation & Reward at the CIPD Middle East. Having been in the region for the last 20 years, he specialises in compensation and benefits and in particular executive remuneration and providing advisory support to Boards, senior leadership teams and remuneration committees. 

We are hosting a free webinar on Executive Pay on Tuesday 29 October 2019. Led by John, the session will delve into these key points in more details and provide participants with opportunity to have the answer to their questions live. Click here to register.