There is considerable controversy over levels of executive pay. There are a multitude of stakeholders or would be stakeholders pugnaciously striving for influence. Remuneration committees are supposed to control executive remuneration. However, as the MM&K recent survey shows, FTSE CEO Remuneration increased, on average, by 10% in 2012. Why are shareholders allowing this to happen?
Balance of power argument
I had a fascinating discussion with the executive pay guru Cliff Weight on the subject of the balance of power argument (although the discussion below is entirely mine) when looking at executive pay.
The Executive’s power
Most of the time the executives hold the balance of power because:
- Changes in executive board members, unless well managed, tends to lead to a fall in share price
- Changes in senior management generally signals a failure of strategy or strategic uncertainties – which lead to a fall in share price
- A lack of good succession planning by the Board so there is no immediate, obvious internal or external replacement.
- A shortage of good candidates with the relevant experience and willingness to take high profile roles. This tends to mean organisations can be without a CEO or Finance Director for six to nine months; which leads to a fall in share price.
No Board or Remuneration Committee wants to be seen to be acting in a way that damages shareholder returns.
The Stephen Hester debacle
A good example of how NOT to carry out changes in senior management is shown by the apparent decision of the UK Treasury to replace Stephen Hester, the CEO of RBS. The announcement seemed to take the markets by surprise – leading at one point to a 7% drop in RBS share price. Further, the lack of any successor or allegedly any succession planning by HM Treasury means there is something of a leadership vacuum in RBS (even with their excellent senior management team) that causes great uncertainty to both investors and employees. This, just at the point when RBS had turned around and had a clear and compelling vision of its mission and future.
The Shareholder’s power
Shareholders have limited power over executives; they have the upper hand mainly when:
- There are downside earnings surprises
- Takeover or mergers are under discussion
- There is a strategy dislocation – a disruptive technology or social trend; look at Smartphones impact on the traditional phone manufactures
- The market loses confidence in the management of an organisation
These tend to be seminal points in an organisation’s existence that hopefully do not occur too often.
Important issues for Remuneration Committees and Executive management
Both parties to pay discussions need to think about the balance of power issues and how they influence the reward dynamic. Strategy needs to be owned and driven by the entire executive team; hopefully mitigating the effect of the departure of any executive.
Good management of shareholder relations and open communication will help reduce any share price “shocks” when changes do take place. Good financial PR will again mitigate both the shock and share price impact.
The paradox of succession planning
One of the potential failings of Boards when considering the balance of power argument is succession planning. In an ideal world a replacement for the CEO would have been identified and prepared for the new role well in advance of the change. Unfortunately there is a paradox here. A CEO could perceive that work by the Board to identify her successor was a signal of their imminent departure. As invariably such issues leak, so the market would view it in much the same way. Dammed if you do and dammed if you don’t. There is also the issue that the heir apparent may become impatient with the wait and either go elsewhere or worse actively seek to undermine the existing CEO with the Board.
There is no easy or obvious answer to the succession paradox; but clearly it is an issue that must be taken on board in the balance of power debates.
The balance of power approach is a useful framework to view trends in executive pay. I can see no immediate answer to how or even if, the balance of power should be more equally distributed. Like any good explanatory framework, the balance of power debate asks more questions than it answers.