The talent myth

In 1980, the average CEO in the US earned 42 times the average blue-collar worker’s pay; by 2000, that multiple had increased to 531 times the average. And this pay bubble has been by no means limited to the US, says David Bolchover in his latest book Pay Check: Are Top Earners Really Worth It? It is all down to a “talent myth” that has reigned in recent years, he tells us.

“I think there has been a huge myth around talent that has been built up to protect the interests of insiders, and that myth says that only a tiny few people possess the ability to be a senior executive of a public company or a company in the finance sector,” he says.

“And via that myth, a few have managed to secure much of the wealth that belongs to these companies. Ironically, we all ‘own’ these companies in the population at large – through our pensions, our savings, our investments. That money in my view is being taken unfairly from the pockets of the average person in the street and put in the pockets of the very few, and they don’t deserve it. There is no rational case for it.”

Lest he be written off as an extreme left commentator, Bolchover is quick to nail his ideological colours to the mast. “I come at this from the political right, by the way. I believe in capitalism, I believe in the market. The problem is, because of this distortion of the market in terms of high pay in the high end of the corporate sector and the financial world, there is a huge disincentive to entrepreneurship. And I believe in entrepreneurship, I believe in its power.

“You get young people who are business or money minded, and why not? They should be, it’s healthy for society, but they’ve now got a choice,” continues Bolchover. “They can struggle to rack their brains, push themselves to the very limit to think of a new idea, which might sell, and go through the painstaking process of trying to raise investment for that business idea, knowing that in all statistical probability they will fail. Or they can go into the corporate or financial world, try and climb their way up the greasy pole, reach the top, and become wealthy without having to take any risk, without having one original idea. That is a suppression and a subjugation of originality and creativity in society, which is a very bad thing, I believe.”

Clearly the financial crisis has drawn the public glare onto the huge salaries commanded by the few but, according to Bolchover, this phenomenon had a clear role in bringing about the crisis.

“In the finance sector, because of the huge rewards on offer and because these people have no personal risk involved in running their business, or dealing with other people’s money, they stood to gain a huge upside, and the only downside was at worst they might lose their job, which is a risk that every employee faces. That’s not much of a downside, so every rational human being in that situation is going to take the risk, and that obviously puts the whole financial system in jeopardy.

“It’s clear that it doesn’t necessarily follow that because they are highly paid that they are talented,” he says. “In fact this talent myth has been exposed by the financial

crisis. The senior executives of these huge financial companies were supposed to be highly talented. So how come they took decisions which sent the world spiralling into recession, and cost millions of people their jobs? Not so clever, it seems.”

So has anything changed now that the spotlight has been placed on executive remuneration? “Well unfortunately, not much,” he says. “We are still seeing extremely high pay, and they are digging in to protect their position. The frustrating thing is there are a lot of people in whose interest it is to protect this position, so this is going to be an extremely gradual process.”

As public anger grows, there is an inherent danger for the whole system, says Bolchover. “If anger grows, and the progress continues to be slow, democratic governments are going to be forced to take action against business, and this will hurt enterprises, businesses and growth in general. So I think there are danger signs there for us all.”

Pay for performance

Mary O’Hara is partner, HR and Reward Services, at PricewaterhouseCoopers (PwC), which recently published a review of executive compensation entitled Is Pay for Performance a Power for Good? It too found the banking crisis had undermined public confidence in incentive pay. While the report argues that pay for performance can still work if properly managed, it found that some “fresh thinking” was clearly required in the area.

“I think the banking crisis is the one that has had the most dialogue around it, but in fact it does extend beyond that – the principles that exist in the financial services sector extend equally to all other organisations,” says O’Hara. “When you focus on what’s gone wrong, I suppose it’s about this interplay between business strategy and what exactly the senior executive does in terms of delivery of that strategy, and how you reward them in such a way as to align their performance with what the company is trying to achieve.

“Usually high-performing companies have a fairly transparent, clearly articulated business strategy, which simplifies the process at one level, but it is not always simple to articulate the key goals and the key indicators as to whether or not they are achieving on performance, and finally how that performance is linked to what the executives do.

“I suppose a big failure in the current remuneration system, which has come out in the crisis, is the short-term nature of incentive plans,” says O’Hara. “So if they don’t follow the life of whatever activity is in question, then in year one you may hit a target that would trigger a bonus payment, but in year two, three or five this basically could come back to bite you. By and large, there was no mechanism to deal with that about-turn on performance. Once the bonus was paid out, that was really the end of it, and there was no reverse position for companies.

“That meant in order to achieve short-term targets – human nature being what it is – risk-taking was encouraged, no one really needed to worry about the long term. There was probably a real lack of understanding of how incentive plans work. They are very complex models where the executives themselves have a keen interest in knowing what they have to do in order to hit the triggers to get the pay out.

“Someone on a remuneration committee, an investor in the company, needs to be asking: do we know the downside to this model? Have we looked at different scenarios depending on different outcomes? Is the payout excessive? Is it so unrealistic that the goals cannot be achieved? Is there an adequate motivation factor in it?”

Like Bolchover, O’Hara too says there is a risk now of over-regulation as a reaction. “One of the real dangers is that we could swing wildly the other way,” she says. “Companies do have to take risk to grow and expand, that’s an inherent part of business and fostering an entrepreneurial spirit. There is a risk that if we swing to the other extreme, there would be no motivation for anyone to do anything other than maintain this status quo. 

“So if you look at the concept of risk, it’s really about being able to quantify and measure that risk, not about eliminating it. It’s about saying, do we know what the parameters are that we’re working within?

“One of the key things that has happened in recent years is people got bonuses sometimes not out of any real influence over the business, but out of pure luck. They were in the right place at the right time. Now, the question is can you split the skill and the luck? And can you actually ensure that what you are rewarding is actually the skill element?”

It can be done, says O’Hara. “It comes back to taking the business strategy first of all, articulating that and what is it that you need your executives to do, in order to achieve that strategy and to what extent can they influence that.” 

Shareholder scrutiny

With all the dialogue around remuneration over the past 18 months, O’Hara says shareholders and investors have become better educated and better placed to ask the right questions. “One of the things that emerged in the PwC report is that the level of investors that vote against remuneration packages for executives has gone up, but it’s not so great that they can overturn the executive compensation plan.

“This will impact remuneration committees to some extent in that they will be expected to better communicate a rationale before putting forward an executive incentive plan to shareholders, and anticipate the type of questions that are going to arise. That has probably changed. However, I don’t think we’re likely to see high executive pay thrown out the window because, in reality, to attract the right type of talent, executive pay still plays a big part.

“Without a doubt remuneration has become a more contentious issue, so it’s important to have a more rigorous approach. It isn’t a tick-the-box exercise at the end of the day, it’s something that needs to be looked at carefully so that any challenge is anticipated and dealt with,” she adds.

It will mean greater challenges for remuneration committees, says O’Hara. “In certain businesses like financial services the regulatory body is going to force greater scrutiny on them. We’ve seen that in the UK where guidelines have been issued, and you either comply with those guidelines or you must explain why you’re not complying. It always takes a little longer for these things to filter down to the Irish market, but I think we are going to see the same kind of thing here.”

Other unregulated organisations will be looking more closely at this area, says O’Hara, taking the best-practice principles that will emerge. “So, for example, there is a strong movement toward the concept of measuring performance over the life of an activity, looking at the degree of risk that may come into play at a later time, and not paying out everything in the first year.

“That leads companies onto this concept of, for example, deferral of bonuses where you hold some of it back, and you only pay it out when you can actually see how the lifecycle pans out. Those sort of best-practice principles will start to cascade down in an Irish context. It may start at HQ in the US and then filter down to the subsidiaries here in Ireland.

“As for indigenous Irish companies and Irish-headquartered companies, they are probably going to be looking around and saying ‘we need to make sure we can attract and retain the best people, but at the same time we need to make sure we take on these best principles’.

“One concern would be that there has been an awful lot of dialogue around this, but I’m not sure anyone wants to be the first one out of the track. Do you want to be the first one to cut back or be seen to to be the one to cut back on executive pay? Could that mean you’re going to lose some of your best people to your competitors?

“There will be a need for remuneration committees to be well versed on how things work. You certainly can’t comment on the reward policy if you don’t really understand the business, what drives the business. If you don’t understand that then how do you know what motivates the people who drive the business forward?”

Bolchover concedes that financial incentive remains a strong ‘self-evident’ motivation for senior executives, however the issue he says is the sheer level of remunerations some of the ‘top tier’ executives receive. “CEOs and investment bankers are not paid huge amounts of money in order to motivate them, they are paid it so as to compete in this so-called ‘war for talent’. This whole phenomenon of chief executive pay has spiralled in the last 30 years – you have to ask are the CEOs of today more motivated than CEOs of 30/40 years ago?

“And there are a significant number of non-financial incentives to perform well as a CEO: for instance the opportunity to make an impact, the status involved is high, the respect from peers.

He cites the former CEO of Shell, Jeroen van der Veer, who said: “If I had been paid 50pc more, I would not have done it better. If I had been paid 50pc less, I would not have done it worse.”

Pictured: Jeroen van der Veer, former chief executive at Shell, who said: “If I had been paid 50pc more, I would not have done it better. If I had been paid 50pc less, I would not have done it worse.”[Image: Chris Ratcliffe/Rex Features

This article first appeared in Irish Director magazine