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Keep CEO pay packages simple, say experts

By Jessica Tasman-Jones

This article is brought to you by Agenda, an FT Specialist publication that focuses on corporate boards

Chief executives with complex pay packages deliver poorer results and share-price performance than those whose pay is kept simple, says a study of 1,300 US companies.

Researchers say that poorer-performing bosses have too many measures to focus on, and some of those conflict.

“We found that contracts were getting more complex over time,” says Mary Ellen Carter, a professor of accounting at Boston College Carroll School of Management, and co-author of the report. “Probably our most interesting finding is that when you look at future performance, companies that had unusually complex contracts had worse performance.”

The study could help boards to concentrate on keeping pay packages simple, the researchers say.

UK executive pay is less complex than before the 2007 financial crisis but more complicated than in the early 1990s, says Tom Gosling, executive fellow at London Business School.

Ocado, the grocery technology group, faced criticism from investors this year. Its complex CEO package was said to create a “costly administrative burden [when compared with] typical incentive arrangements”.

Long-term incentive plans with lots of targets have driven complexity, experts say. These proliferated as companies sought to better align executive pay with strategy and share-price performance.

Three decades ago, most executives received a salary, final salary pension, bonus and share options, says Gosling. The bonus was usually based on just one measure, such as profit.

But the rise of variable pay, which depends on executive performance, has complicated matters. It accounted for a third of total pay in the 1990s but represents three-quarters today, says Gosling.

With more at stake, a payout that relies on one simple profit measurement became untenable, he says. This led to a rise in multiple performance measures in incentive plans.

Most companies aim to avoid complexity but want to align pay with strategy, performance and governance requirements, says Einar Lindh, director for reward and employment at PwC.

“Satisfying these various criteria can inevitably result in pay structures that are more complex than originally intended,” he says.

Complex pay structures are “discouraged” by the Investment Association, which represents the UK asset management industry. Shareholders prefer simple and understandable remuneration structures, it says.

Complexity is a key part of remuneration analysis at Royal London Asset Management, which manages £159bn on behalf of investors.

“If an experienced analyst is still struggling to understand a proposal after an hour, then there is something very wrong,” says Sophie Johnson, corporate governance manager at the group..

Some UK companies have found ways to simplify pay, and many FTSE 100 companies have stopped multiple incentive plans, says Lindh. Businesses now typically offer an annual bonus with deferral and a single, long-term incentive.

Many companies award shares to executives with no performance conditions, he says. These are known as restricted share schemes. The share price, rather than multiple performance metrics, is meant to be the motivation. BT, Burberry and Weir Group are among companies that have adopted such a structure.

Pay structures need to be simple so they still motivate executives, says Lindh.

“Simplicity is achieved through minimising the number of incentives used, prioritising so that only key measurement criteria are assessed, and providing clarity on how any supplementary features operate, for example underpins or clawback criteria,” he says.

Companies may not be able to please all stakeholders, says Blair Jones, managing director at Semler Brossy, a remuneration consultancy.

“Boards always worry about whether the compensation programme is too complex to achieve the motivational impact you'd like. They get lots of input from stakeholders. As they try to respond, the risk is that they end up with something that looks like a retread tyre,” Jones says.

It is critical that boards and management talk about a company’s priorities. The result may be that some strategic goals are kept out of executive packages, even as companies strive to attain those goals, says Jones.

This article is based on a piece written by Neanda Salvaterra for Agenda.

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