The FINANCIAL — CEO and senior executive compensation is the subject of ongoing discussion in the press and beyond, fuelled by periodic disclosures of salary and bonus figures. Professor Thomas Noe says most criticism of pay levels and how they relate to performance are unfounded.
‘The sometimes sensationalist reporting of high salaries is damaging and misses the point. There is a lot of misunderstanding about reward and the important part it plays in shaping senior executive behaviour – even among academics. Compensation should not be structured in isolation from the other components of the manager/board relationship. Relying on a naive model of CEO being a sort of super-worker who requires high-powered incentives to motivate effort is misguided.’Professor Noe calls for a review of the structure of reward packages, which could allow companies to reduce the cost of remuneration without reducing the value of the package for individuals.
‘Companies need to reward senior employees in the most efficient way, that is, one which achieves the goals the company identifies – such as motivating and directing executives’ efforts – for the least cost’ says Professor Noe. ‘Changes in the reward package to executives can generate value for firms both through attracting talent at lower cost to the company and through improving the alignment between corporate and executive goals. I would encourage firms to rely less on conventional design and more on tailoring reward packages to their overall business model.’
‘Many of the reward practices which are now commonplace arose in response to past tax, accounting or regulatory requirements which have long since been superseded, yet the reward practices have remained in place. In other cases, such as with options, they came to prominence as a result of a government initiative – in this case, to encourage entrepreneurial behaviour among boards. There is no evidence that they do encourage this sort of behaviour, and yet they continue to be widely used, often without a company having any insight into the behaviour they actually encourage. In most circumstances, options are not an effective motivator and are expensive: there are more effective and cheaper alternatives.’
The debate around the efficacy of options continues. What is clear is that the valuation of those options is often hard to determine, particularly where stocks are understood to be overvalued. Whilst bonuses have been much criticised, Professor Noe argues that well- conceived performance-related bonuses are a cost effective and logical motivator. ‘Bonuses which rise at a decreasing percentage rate as targets are met, encourage executives to maintain effort beyond a certain point, which can be significant for an organisation. Although the percentage gain decreases as goals are reached, the actual sums of money gained are increasing for the individual and continue to motivate’.
In response to the issue of ever rising pay packages Professor Noe comments: ‘The market sets the rate for CEO and senior executive reward levels, so there is little that an individual company can do to keep down the sums here without risking a reduction in its ability to attract and retain the right people. Companies can however reduce the “wasted” pounds or dollars in current packages, represented by those elements which do not effectively motivate staff, which do not encourage the right strategic decisions, nor induce efforts and which they do not value. More efficient alternatives exist.’
Professor Noe concludes: ‘It is time to review rewards for senior executives. We should beware just following past pay practices we have inherited. We have a strong tendency to do what we have always done, and what our competitors do, and that is not necessarily productive for anyone. The goal is to encourage CEOs and boards to do the right thing strategically for the benefit of the organisation, to take a sufficiently long term view, and to manage risk. Reward can be a powerful means of encouraging particular behaviours, if it is managed well.’
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