PAYnotes on CEO rewards – More does not equal better

Paydata and CIPDOur Managing Director Paul Hajduk has been working with the Chartered Institute of Personnel and Development (CIPD) as part of a team leading research into Executive Reward. The research highlighted how CEO pay in the UK’s largest organisations has reached a critical point. What’s more, without clearly correlating to personal performance or business outcomes, these executive reward structures are impacting the motivation levels of the wider workforce.

This post has input from members of the research team including Dr Almuth McDowall, lecturer in Birkbeck’s Department of Organisational Psychology, Jonny Gifford from the Chartered Institute of Personnel and Development (CIPD), Dr Zara Whysall from Lane4, and Dr Duncan Jackson from Birkbeck. It builds on the recent practitioner report Paul and colleagues produced for the Chartered Institute of Personnel and Development 

Report: The power and pitfalls of executive reward: a behavioural perspective

How can we explain the growth in CEO rewards?

In the report, we undertook a robust analysis of pay trends over the last few years. We set out to test whether the rise in CEO pay could be explained in the context of UK wealth creation. Yes, there is a widening gap between rich and poor, however the number of people in the 1 million plus earnings bracket has remained relatively stable. CEO rewards continue to grow, quite out of proportion to the rate of growth of high pay generally and also to the rather unsteady growth of the UK economy. So if the growth in CEO rewards cannot be accounted for by wealth increase per se, can it be justified in terms of increased organisational performance? Apparently not. An interesting paper reveals that organisations with particularly highly paid CEOs are unlikely to be in the top 10 percent of high performing organisations [WSJ, 2015].

Our Managing Director Paul says: “There would appear to be little to support the argument that high CEO pay growth is justified by how their role is often positioned, which is as wealth generating entrepreneurs. Yes, they may lose their job if things do not go well but they rarely lose much of their own money. We have yet so see if clawbacks built into reward arrangements will be truly effective in creating significant downside risk in CEO reward packages”.

This leads to the wider question of how organisational performance is benchmarked.

The size of the packet

Chief executive officer (CEO) pay is a serious topic which requires serious and well-informed debate. In one way or another the size and makeup of CEO rewards affects everybody – either because it can be seen as part of the trend for wealth to be increasing concentrated in the hands of the few, or because the measures that drive the package do not necessarily serve the best interests of society as a whole.

The average UK CEO wage packet is now around the £5million per annum – imagine 100,000 £50 bank notes lined up neatly in a row to get an idea of what this means in reality. We witnessed ‘fat cat Tuesday’ in the first week of January; when CEOs had earned the average UK workers’ salary in just 22 hours.

Are CEOs worth the money?

The notion of the ‘fat cat’ and unfair pay gaps has been vehemently disputed as ‘pub economics’ by the Adam Smith Institute’s director Sam Bowman. The argument runs that organisations need to be profitable to survive so they can make a contribution to a nation’s economy; and that the value of a CEO is hard to quantify in an absolute sense.

Clearly, organisations need to be effective to survive. It is also arguable that the figurehead at the top contributes the most to the long-term success of the organisation. The symbolic value of the person at the top is great, and can make or break corporate success hence CEOs should be rewarded proportionally to their input. But does proportion equate to 180 times the average workers’ salary?

What is the link between CEO rewards and organisational performance?

Most organisations benchmark CEO success against hard measures such as profitability and productivity, the bulk of research in the field also concerns itself with financial indicators. Far fewer organisations use non-financial metrics such as staff health, safety or engagement measures in their annual reporting. However, it is important to consider the human aspects of performance and their link to organisational outcomes. One US study considered the characteristic of the CEOs of US basketball teams and the link to measures as wide ranging as external team reputation, winnings and fan attendance at matches (Resick, Whitman, Weingarden and Hiller, 2009). There is a shortage of parallel evidence in a business context which considers the relationship between differentiated measures of CEO performance, and the scope of their impact on organisations such as their members, including intangible assets such as motivation and engagement.

Are our reward structures creating the wrong kind of CEOs, or are our CEOs creating the wrong kinds of rewards?

Dr Zara Whysall from Lane4 says: “Our work with a range of organisations has shown that reward practice in organisations lacks an evidence-base, CEO reward practice appears no different. People tend to overestimate the motivating force of money in particular where rewards are delayed and not immediate, and we also do not pay enough attention to non-financial rewards and the impact they have an on organisation’s culture and ethos.”

There have been several high profile instances of rather dysfunctional examples of CEO stewardship particularly in the financial sector. It is therefore important to try and understand the influence CEOs have. Research shows us that powerful CEOs are good at negotiating rewards and clever at shining the spotlight on favourable indicators [Morse et al., 2014].

Time for a change?

There is a strong case for change in executive reward practice given that the justification for the maintaining the current status quo is at best dubious. However, the research detailed in our report shows that barriers are ingrained and institutionalised. Whilst there is body of people who support change and who state openly that the UK (and the world?) needs more considered, innovative and ethical CEOs in the future, there is less consensus on how such change can be brought about.

The vision for the future

Given the lack of evidence to support the ever escalating size of senior rewards, CEO salaries should be a smaller multiple of average earnings, with smaller bonus packages, and reduced long term incentives such as performance share schemes. But is it a more pressing question that in order for change to happen we need different people at the top?

There is the argument that any capping of rewards policy changes will negatively impact organisations’ ability to recruit and retain the quality of people needed to position themselves positively in the global market place. To counter this, it is informative to compare and contrast CEO reward in the most successful mission-led businesses. When profit distribution moves from being the primary motive the CEO reward package loses, in most cases, most of the upside variable pay elements and share-based pay disappears altogether. And yet these businesses attract and retain very able leaders who are maybe motivated by things other than the size of their reward package.

A fundamental shift in leadership practice might need to accompany these reward changes. There is ample evidence that shared leadership is better than top centric leadership [Wang et al., 2014]. It is also a fact that diversity at top levels does not mirror society at large. Only radical revision of selection, talent management and reward processes and structures will change the current status quo. Our report makes distinct recommendations for how to put this into practice.

But are our recommendations radical enough, or should we start again with a blank slate? Dr Almuth McDowall says: “This has been a fascinating and complex research project which we hope will offer a rich springboard for debate. There appears a cautious consensus that change is needed, yet a certain reluctance to challenge the current status quo. 

To read our report please click here, and let us know – are our recommendations radical enough?”

The report has also featured in:

  • BBC News 
  • City AM
  • Daily Mail 
  • Daily Mirror
  • Daily Telegraph 
  • Sky News
  • The Guardian
  • The Guardian – leader comment
  • The Times
  • Yorkshire Post

References:

  • Morse, A., Nanda, V., & Seru, A. (2014). Compensation Rigging by Powerful CEOs: A Reply and Cross-Sectional Evidence. Critical Finance Review, Vol. 3 No. 1, pp. 153-190.
  • Resick, C. J., Whitman, D. S., Weingarden, S. M., & Hiller, N. J. (2009). The bright-side and the dark-side of CEO personality: examining core self-evaluations, narcissism, transformational leadership, and strategic influence. Journal of Applied Psychology, 94(6), 1365.
  • Wall Street Journal (2015) How much the best-performance and worst-performance CEOs got paid. 25th June 2015
  • Wang, D, Waldman, D. A. and Zhang, Z. (2014) A meta-analysis of shared leadership and team effectiveness. Journal of Applied Psychology, Vol. 99 No. 2, pp.181 -199