Has excessive compensation finally had its day?
Article written by Professor Alexander Pepper, Professor of Management Practice in the Department of Management at LSE and former Associate of PricewaterhouseCoopers. He is currently writing a book on business ethics, inequality and executive compensation.
In 1999, New Labor chief strategist Peter Mandelson told the City: “We are extremely relaxed that people get very rich as long as they pay their taxes.
For many, this symbolized an era of excessive executive compensation.
Over the next 15 years, top wages at Britain’s biggest companies would increase rapidly – by around 11% each year on average – while the wages of all employees would increase by only 2.5%.
Big companies have behaved as if they were in an arms race.
The government, rather than taking a public stand, viewed executive compensation as a private matter to be managed by institutional investors and other shareholders.
But institutional investors showed little interest in changing the status quo – after all, the amounts in question were relatively small in the context of their multi-billion dollar investment portfolios.
Fast forward, however, to 2020 and the compensation of CEOs among the UK’s Top 100 had initially stagnated and then declined – by more than 15% from its highest point in 2014.
Two events in particular marked the change. In 2017, one of the UK’s biggest stock market investors, Norges Bank Investment Management (NBIM), which manages the Norwegian sovereign wealth fund, publicly criticized the over-inflated CEO salaries and proposed a new way to pay those in the Mountain peak.
“A substantial proportion of total annual compensation should be provided in the form of shares blocked for at least five years and preferably ten years, regardless of resignation or retirement,” says the fund’s position paper. “Requiring the CEO to invest a significant portion of his compensation in company stock is a straightforward and transparent way to align the CEO’s interests with those of shareholders and society at large. “
A year later, The Weir Group replaced its long-term incentive plan with a restricted stock plan of lesser value. Other leading companies, including BT Group and Burberry, followed suit and gave their top executives restricted stock, rather than another pay raise.
In 2019, BlackRock, the world’s largest asset manager, issued a declaration urging shareholders of state-owned enterprises to moderate excess compensation. Meanwhile, institutional investors had begun to view excessive executive pay as a serious “reputation problem”.
So, has the excessive inflation of executive salaries finally had its day?
Increasingly, large UK companies are replacing long-term, high-leverage incentive plans with less generous longer-term restricted stock plans, like those of The Weir Group and in line with NBIM’s recommendations.
It is also true that the massive government financial support to businesses provided during the pandemic made the overinflated executive salaries even more distasteful to investors and the public.
Interestingly, my research shows that senior executives are certainly not, for the most part, the unethical selfish people popular culture likes to pass off; instead, they were simply the lucky beneficiaries of a system that had gotten out of hand.
When, in the fall of 2016, with my co-researchers Susanne Burri and Daniela Lup, I asked 1,100 senior executives around the world – that they are all among the top 10% paid in their country – if they would be happy to be paid less, the majority replied that they would, provided that those with the same seniority as them in other companies, too.
Research shows that top executives fall into four “tribes”: relationship egalitarians for whom fairness is most important; welfare liberals who are prepared to see differential rates of pay as long as the poorest are taken care of; the meritocrats who believe that those who work the hardest or are the most capable should, within reason, be better paid, and the free traders who have ultimate faith in the way the markets work. Very few appear to be “in preparation”.
In the recent past, companies have all too easily accepted the premise that if they pay too much for a leader they will get someone really good, while if they pay an average rate they will get someone mediocre. If this premise has really changed, there is real reason to believe that executive salary inflation in the UK has had its day.
Either way, it seems clear that executive compensation is undergoing a paradigm shift, albeit in its early stages.
We have to wait and see if investor activism on executive compensation will survive the pandemic; if interest wanes, we could see a return to the era of excessive executive compensation that Peter Mandelson so memorably heralded. Either way, he would probably say something very different about maximum pay these days.