Paradigm shift needed in executive remuneration - 12 March 2010

The depressed operating environment, despite recent signs of
recovery, continues to cast the spotlight sharply on executive
remuneration as CEOs will continue to take home huge pay packages while
their organisations may still struggle to provide shareholder return. In
the difficult operating conditions that businesses will encounter for
the foreseeable future, how are executives to be rewarded so that
indispensable talent is motivated and retained?


“We need a paradigm shift for the future as far as the design,
implementation and communication of executive performance and reward is
concerned. Until the economic downturn, there were many public instances
of apparently ‘unseemly wealth creation’, fuelled more as a result of
economic performance than any company performance, and generally too
much reward for mediocrity,” says Nick Icely of Deloitte Consulting,
speaking at a conference at the University of Pretoria’s Gordon
Institute of Business Science (GIBS).

“These were most apparent
in the financial sector, and it now appears sometimes that the easiest
scapegoat for the recent economic crisis is those excessive bonuses
earned by executives and transactors in financial institutions. However,
the blame for the recession surely cannot be placed solely on the
shoulders of financial institutions. It must be shared by governments
and political parties which made promises to their electorates;
treasuries which printed money and tacitly encouraged credit;
over-confident consumers who extended themselves; demanding shareholders
who required positive growth in earnings and returns on equity on a
quarterly basis; actuaries who dreamt up ever more complicated financial
structures, barely understood by those that adopted them; as well as
the most often quoted culprits, greedy executives and self-serving
remuneration consultants! Capitalism as a whole and the demand for and
supply of credit in general must stand accused”, believes Icely.

The
recent trauma has not just been an equity devaluation phenomenon but is
also an investment and earnings growth issue to be faced for a long
time to come. Shareholders will rightly become even more observant and
critical of executive pay, and will expect executives to compensate
through company performance for the absence of positive economic
factors.

“Executives may begin to realise that a share-based
nest egg for retirement, or even for loyalty, is not an entitlement but a
privilege that has to be earned through performance,” comments Icely.
In South Africa, executives outside the finance sector are generally
targeted to earn approximately 45% of their income from guaranteed pay,
with the remainder being variable - a proportion Icely believes is
suitable to ensure that executives work toward attaining their goals as
set out in the company strategy.

“With the implementation of
King III, annual reports will move from reporting the bare minimum to a
fuller disclosure of executive performance and reward criteria,” he
says. “This will expose companies to greater potential criticism, but
may actually allow them to defend themselves more capably against
uninformed criticism.

What constitutes company
performance?

There is a need for both shareholders and
society to dictate to companies what is expected of executives. The
ultimate performance that a company can give is a return to
shareholders, i.e. the dividends they receive and an increase in share
price. Other stakeholders may be looking to companies to make more of a
societal impact, through transformation, upliftment, and skills
development.

In this new environment, companies should review
their remuneration practices in order to optimise both shareholder and
the more general stakeholder value. They must not base their incentive
schemes on vehicles that are sensitive to the economy but rather on ones
that address company comparative performance in what may be an
increasingly difficult economy.

“Comparative performance need
not be in relation to a direct competitor, but rather at other
investments that shareholders could have made. For example, look at the
shareholder return over a three-year period to establish whether what
the shareholders have received is greater than what they could have got
from a balanced portfolio of alternative investments,” recommends Icely.


In addition, South Africans must decide if executives are to be
rewarded purely on financial measures, or in a more holistic manner
which addresses the sustainability of business performance through
skills development and retention, CSI and the environment, amongst
others.

In future, both individual performance and company
performance should be rewarded. The Board and Remuneration Committee can
set a view of what is a good performance in the country’s economic
socio-economic climate and make the award of bonuses, and the award and
vesting of shares contingent upon delivering that performance.

“Executives
should be rewarded for sustained performance and not opportunistic
behaviour,” says Icely.

“There is no one ideal product. What is
needed is a hybrid approach that in the combination of its elements
addresses the required attributes of shareholder return, sustainable
company performance and retention of key talent.

“King III is a
general framework and set of guidelines, not a blueprint or prescription
for design. Compliance with the remuneration guidelines of King III
will be a cinch for any responsible company that truly wishes to align
executive pay with shareholder value, but the design challenge will
remain,” concludes Icely.

http://www.leader.co.za/article.aspx?s=2&f=1&a=1861