Executive remuneration and Corporate Social Responsibility
By Mallen Baker: Posted 4 May 2003
It seems that there has been something of a minor revolution in what shareholders are prepared to accept from business management. In particular, the protests about perceived excessive levels of executive remuneration have swept the recent round of AGMs like the corporate equivalent of SARS.
What are the rules here? Is this the last bastion of corporate greed, or is there simply no response to demands made in this area that would constitute a body of best practice within the terms of corporate social responsibility?
The arguments are straightforward. Senior directors earn absurdly more than the other workers in their business. Sure, they work hard - but not that hard. Their value has been defined purely by what the market will bear - and because remuneration committees are peopled by other company directors who have an interest in the market norm being constantly raised, so the salaries and benefits just spiral upwards.
Every now and then, you will hear a beleaguered director complain about the intense scrutiny, perhaps arguing that nobody gives the equivalent attention to the amount that rock stars earn - people who don't work so hard, and who don't support businesses who employ thousands of other livelihoods.
Of course, it is a false comparison. Rock starts earn only in proportion to the number of people willing to buy their records. Their salary isn't set by a committee of their chums without reference to their success or popularity.
The real fuel for the complaints of the last few months has been the apparent lack of a link between success and reward. Some of these executives seem to be granted great fat pay-offs, even if during their tenure the stock price has plummeted to depths never imagined. "We don't mind rewarding success" some people say, "but not failure". Interestingly, this principle didn't stop considerably controversy over the package awarded to Jack Welch, seen by many as one of the most successful senior managers ever. This does seem to raise the question whether the issue of success or failure is really at the heart of this controversy, or whether it is simply the feeling that the sums now involved are just disproportionate to any measure of what one person's contribution can be worth.
So within all that, we have a few issues:
1. How much is it decent for the successful senior executive to earn? Should there be a formula, such as a percentage of the average wage in the business, or reference to a going market rate? If a senior executive is removed by whatever process, they may often find that they won't work again, at least not at that level. Should that level of risk be recognised within the remuneration, or not?
2. How should the market standards be set? Clearly, the perception today is that the current system of remuneration committees has simply served to constantly drive up expectations - and all senior directors would obviously aspire to be in the top quartile on the pay scale. Is there an alternative mechanism that could be acceptable to business that would reward excellence whilst restraining the upward spiral?
3. How should success be measured? It's all very well to focus on the share price, but the general approach to running a quality business should be on putting in place the fundamentals for sustainable and responsible wealth creation, retaining staff and building trust. There are times when, with the best will in the world, share price will fall because the market is unsettled for other reasons. So long as the business fundamentals are strong, those who are with the company for the long term should not suffer. So measuring success and failure should not be so quick a process.
By and large, the business-led movement for corporate social responsibility has avoided all this like the plague. You do not persuade senior business leaders to take CSR seriously whilst leading with demands - that many perceive to be driven purely by envy - for them to receive substantially less benefits. And although I tend to believe that most aspects of CSR are best developed by the businesses - responding to the expectations of their stakeholders whilst preserving the processes that make the business successful - there is a strong argument that this is one of those areas that could never be taken forward on a business-led basis.
The trouble is, it isn't easy to envisage what alternative routes there might be that would work. Many of the groups who make the most noise about executive remuneration project a general anti-business stance - they clearly do not value the work that the CEO does, and frankly are not quick to differentiate between a good one and a bad one.
Likewise, public legislators are probably the very worst people to wade into this territory. The record of knee-jerk legislation drafted in response to an outcry has not been good.
Logically, the people best placed to hold the business leaders to account, as you might expect, are the shareholders. The problem is that the shareholders have been disconnected from the fundamentals of the business for so long, they have only themselves to blame if they now find aspects of the businesses not to their liking.
For decades, owning shares in companies has become a game of chance - a way to make money quickly from assets and processes that you briefly own, but take no responsibility for. The fact of ownership without the responsibility of ownership is exactly what has created businesses that have been able to thrive financially without an eye to some of the fundamentals of risk and sustainability - leading to problems later.
Since executive leaders aren't held to account by shareholders on how they establish the fundamentals for sustainable wealth creation, it shouldn't be surprising that there are no mechanisms for aligning remuneration according to these goals. Perhaps the way forward would be for remuneration committees - in addition to business peers, to have representation from other reasonable, pro-business stakeholders whose role would be to measure the CEO's success against criteria set for sustainable wealth creation - measured in terms such as employee retention, public trust, as well as financial performance.
Of course, business leaders won't voluntarily go down this road - it's just a little bit too close to the extreme view that directors should be responsible to all stakeholders, not just shareholders. That isn't a practical way of running a business. But since the shareholders currently fail to look beyond the short term to what constitutes real successful performance, what other way would there be?