Top Pay and Performance

Shaun Tyson, Frank Bournois

• Publisher: Routledge
• Year: 2005
• ISBN:
  9781136354748
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Top Pay is an extremely topical and contentious area and compensation and benefits is a well-defined area of interest in HR. This book investigates how the field of top pay developed? Why is there so much interest in top pay? Why governments take such an interest? Separation of ownership from control. The issues of Institutional shareholding, globalisation, comparisons between countries, equity theory and government policy are all addressed

1 Introduction

Shaun Tyson and Frank Bournois

DOI: 10.4324/9780080454894-1

The twenty-first century has commenced with unprecedented attention to corporate governance in the face of front-page scandals, public pressure and institutional insistence. Whether through diminished deference from employees or shareholder demands for more transparency and accountability, senior executives find themselves having to explain their rewards to sceptical stakeholders. At the same time, increased competition and pressures on costs have put directors under an obligation to perform against tough targets.

Underneath the public face of ‘top pay’ – where headlines from the tabloids meet column centimetres from the financial broadsheets – there is at a deeper level an organizational drama regularly played out in companies large and small, where rewards are always at the heart of the strategic dilemmas managers face. Top pay is a critical aspect of reward strategy, since the reward systems for senior executives are used to communicate the symbols of success or failure, of being one of the top team, or of not being in the top team. Rewards are the lifeblood of motivation and are the manifestation of a system through which people are motivated to perform, to change, to develop, to remain, to join or to leave the organization.

By rewards we mean more than money, and include in our definition all the methods deployed to energize those who work in and who manage the business. However, money or ‘pay’ in all its forms is representational, standing symbolically for the values of approval or disapproval, signifying status and power in most societies.

Public scrutiny and disapprobation, new corporate governance structures and movements in shareholder power therefore bring new pressures into an environment at the top of organizations where the stakes are high and are personal. High because failure or success at the top leads to major effects throughout the organization. Personal because reputation, personal wealth, relationships, lifestyle and perhaps even the sense of identity are subject to these pressures.

This book is about the fundamental issues raised by these pressures. A recurring theme we will explore is the extent to which there is convergence across Europe in the corporate governance rules and in the management approach to director-level rewards. In particular, we will examine the trends in France, Germany and the UK, and make reference to the trends elsewhere, to see what is emerging as a common management approach – a common plank in Western Capitalism’s supporting structure. The new corporate governance codes are based on transparency and accountability to shareholders. These are emergent tendencies which may be taken further. Linkages between organization strategy, performance targets and rewards are regarded as important at a time when HR strategy is designed to drive business performance. Tests for the linkages, found in the quality of incentive schemes, are therefore falling under direct scrutiny. How should director-level remuneration be decided is an underlying question which this book seeks to address.

Given the explicit and symbolically significant linkages between rewards and performance, we believe explorations on this topic are timely. To investigate the field there are two streams of data. First, consultancy reports, newspaper articles and published surveys are sources. For example, there are newspaper articles with their data sources which include corporate annual reports, information from executives and from institutional shareholders and investment analysts as well as government white papers. The second stream is academic research into director-level rewards. Here again, a variety of perspectives can be taken: there are empirical and theory building studies, as well as literature reviews and ‘think pieces’. These topics are studied at universities and business schools in a variety of courses: ethics, finance, economics, human resource management and industrial relations, for example.

Theoretical perspectives to the study of top pay

The study of top-level executive pay brings us into contact with a wide spectrum of subjects. These include the study of corporate governance, and related issues such as boardroom effectiveness and public relations; economic theories of behaviour and rational action; the study of ethics and of power; business strategy and its relationship to reward strategy, as well as practical questions about the design of reward schemes for directors. Not surprisingly, this variety leads researchers to take an eclectic approach to theory.

From the extensive research into top pay we can distinguish five main categories. We will follow these broad headings in our description: economic theory, institutional theory, corporate governance, consultancy prescriptions, and behavioural theories concerning decision-making and the use of discretionary power.

Amongst the economic theories found, agency theory is perhaps the most popular in studying rewards. At its simplest, agency theory argues that the fundamental relationship in which director-level rewards are founded is the relationship between the principal (shareholder or owner) and the agent (director or senior executive). The potential difficulties that arise in this relationship stem from the extent to which the separation of ownership from control has distorted the fiduciary responsibilities of directors, and has affected the risks and opportunism of directors. Such research has been used extensively to explain contingent rewards and executive contracts, and to explore reward alignment with stock performance (e.g. Tosi and Gomez-Mejia, 1989; Jensen and Murphy, 1990; Lippert and Moore, 1994).

An equally instructive theoretical perspective draws upon the study of the corporate governance legislation, which means research into the growth of institutional arrangements to regulate the power relationships in society, including those between stakeholder groups. Different societies and different business systems can therefore be studied to see, for example, whether or not there are convergent or divergent trends in the control of top pay (Cheffins, 2003). We may regard this as an institutional theory version.

Researchers sometimes take the analytical position of examining the influence environments have over organizations, when examining the norms within decision-making for example, and when looking at transparency of reward policy as a device to put pressure on boards to conform. This gives us the opportunity, by making international comparisons, of explaining how institutions produce different organizational responses:

… it focuses on the ways that different institutional environments generate different kinds of technically efficient business recipes.

(Whitley, 1992, p. 126)

One danger from this approach might be to foster a deterministic emphasis on the rules and governance structures. Prescriptions from shareholders, such as shareholder interest groups, often see the solution to ‘fat cat’ problems in the need for more rules and structures to limit the opportunism assumed in senior management – see, for example, Clarke (1998), who sets out the competing stakeholder groups and the influence they seek, and the references to such interest groups as the Association of British Insurers (ABI), e.g. in the consultative documents (pp. 6 and 11, Rewards for Failure, DTI consultative document, June 2003).

These kinds of prescriptions serve the interests of stakeholders, lobbying on behalf of their members. However, prescriptions are also important for consultancies acting in this field. They represent a pragmatic strand in the research on top pay, producing detailed data on reward packages, surveys of rewards, of contracts and pension schemes, as well as summarizing trends (see, for example, Incomes Data Service Reports). All the major reward consultancies conduct salary surveys. There are also ‘niche’ surveys into rewards covering particular sectors such as financial services or manufacturing, and surveys into specific occupational groups such as finance directors, human resource directors or chief executive officers. The advantages to be gained from data-driven enquiries into rewards come from the fine-grained detail found in these surveys of reward practice. Disclosures, now mandatory, about reward policy and the greater transparency within annual company reports facilitate data gathering for academics and consultancies alike.

The methodologies to assess performance for all the elements within reward packages are also assuming a high degree of standardization. Long-term incentive plans (LTIPs) are very common amongst the top FTSE companies and measurements such as earnings per share (EPS) or total shareholder return (TSR) are found as target measures for LTIPs in most large businesses. EPS occurs in 40% of the FTSE 100 and TSR in 85% of FTSE 100, as the main performance measures within LTIPs. For share option criteria, the majority of FTSE 100 companies use EPS (72%), with 18% using TSR (IDS, 2003, pp. 24/25). Measurement of the expected value of incentives is now almost always done by means of the Black–Scholes formula, and the emerging common trend towards more pay at risk with proportionately less basic pay is growing, following the typical US director-level salary structure.

A common language in rewards found in Europe and North America has also spread to countries espousing the US ideal. There is a long-standing debate about whether convergence in HRM policies and practices is a result of multinational influence and the spread of consultancy techniques (for example, the Hay job evaluation scheme). Expatriates are also said to spread practices as they move from head office to local offices. The implications for reward research include the question of whether rewards at the top are closer to the style naturally adopted by the parent company, whilst at lower levels employee pay schemes are more likely to reflect local practices, labour market conditions and traditions found in the local country in question. All of these questions show the social and psychological significance of reward policies.

A well-recognized trend in board-level compensation and corporate governance research seeks to establish how boards are structured and how this influences compensation for CEOs and other members. For example, ‘insiders’ (management executives) are often contrasted with non-executive directors who may represent the wider interests of shareholders (Angbazo and Narayanan, 1997; Cosh and Hughes, 1987; Newman and Mozes, 1999). Other aspects of board structure include the problems of ‘duality’, where the roles of chairmen and CEOs are vested in the same person (Boyd, 1995), this being a more common practice in the USA than in the UK.

In most studies, behavioural changes or actions by board members are implicit within the hypotheses proposed. Some actions are thought to be universally defined, the meaning behind them unambiguous. A descriptive base is sought by such studies to explain whether and to what extent changes to the structure might impact on performance. This is defensible given a need to establish the nature of the problem.

As has been noted, board structures may be different in the USA from the UK and other European countries, and in the UK, corporate governance changes backed by shareholder groups and given the force of law have been introduced, in the form of The Directors’ Remuneration Report Regulations 2002 (SI No. 1986). The Higgs report (2003), also in the UK, proposed a description for the roles of the board, and that half of the members should be independent non-executives. It also recommended a separation of the CEO and chairman roles and described the roles of the non-executive directors. The earlier regulations had already prescribed that the remunerations committee of the board should consist of non-executive directors. Higgs also comments on the differences between the changes to corporate governance in the UK compared to the US. US changes have focused, according to Higgs, on corporate malpractice (following Enron), whereas the motivation for change in the UK had been the poor stock market performance of companies (P12, 1.11), which sparked a debate about ‘rewards for failure’ (see, for example, the DTI consultative document, with that title, June 2003).

There is evidence on how changes to boards and the extent of managerial discretion are also important. For example, Werner and Tosi (1995) reported that firms with higher levels of managerial discretion paid compensation premiums, in higher salaries and bonus, but that changes in pay were not related to changes in firm performance. Similarly Core et al. (1999) show how CEOs earn greater compensation when governance structures are less effective, and that weaker governance structures are associated with poor performing firms.

CEO turnover and changes to board membership can also affect how a company is regarded by the investment community, depending upon the board’s prior performance (Kesner and Dalton, 1994). Fox and Opong (1999) found that although there are short-term effects from these changes, reputations are recovered over time.

In our study of director-level pay we must remember that their behaviour is unlikely to be substantially different from the behaviour of staff in their companies. Much of what can be said about decision-making and motivation will be the same for all employees, since these issues are rooted in the human condition.

Board members are reluctant to terminate or financially punish poor performing CEOs, for the same reasons supervisors are reluctant to punish subordinates – they personally bear a disproportionately large share of the non-pecuniary costs, but receive essentially none of the pecuniary benefits.

(Baker et al., 1988, p. 614)

Nevertheless, the study of pay at the top is worthy of special attention, because directors have power to influence their own rewards and to affect the performance of their firms, probably to a greater extent than other employees, at lower levels. They can also manipulate information. In their study of corporate presidents’ letters, contained in the annual reports to shareholders, Abrahamson and Park (1994, p. 1329) found evidence of concealment:

Results were consistent with the claims that accountants and certain types of shareholders and directors prompt officers to reveal negative outcomes, whereas others promote concealment. We also found evidence for the claim that some concealment and its toleration by outside directors may be intentional.

This fascination with the internal working of boards and those at the top should not prevent us from taking the strategic context into account. Corporate strategies are linked to reward, as argued earlier, and the objectives which trigger variable pay through long-term incentive schemes and bonuses are most likely to be those that reflect desires for corporate success, however defined, for those at the top.

We will discuss later in this chapter the question of whether the new ideas on business and human resource strategy offer a further alternative for the student of rewards to explore, to give us new insights in the field by showing the strategic context where reward policies and practices are used.

The theoretical background to the study of this area is diverse. To see how reward policies and practices may be studied and to take general conclusions from our book means we travel a path through a variety of theories. Merchant et al. (2003) argue that research in the field has become hindered because of the tendency to focus on one theoretical perspective. They suggest organizational incentive schemes are a good example of a system that contains a multiplicity of interdependent elements which can only be researched by using a range of theoretical disciplines – including accounting and economics, but also sociological, anthropological and philosophical ideas and models. In this book, we have sought to offer a number of different lenses through which to observe rewards at the top.

One of those lenses is the institutional and cu...

Table of contents

• Cover Page
• Half Title Page
• Title Page
• Copyright Page
• Table of Contents
• Contributors
• Acknowledgements
• 1 Introduction
• 2 ‘Fat cat’ pay
• 3 Shareholders’ attitude to directors’ pay
• 4 Accountability, transparency and performance: comparing annual report disclosures on CEO pay across Europe
• 5 Director performance standards and rewards in France
• 6 Developments in top-level compensation in Germany
• 7 Designing reward packages
• 8 Equity incentives
• 9 Remuneration committees
• 10 Human resource strategy and top-level pay
• Bibliography
• Index