Linking executive pay to just hard financial targets may only encourage more bad behaviour

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The push to stop the introduction of so-called soft targets for CEOs and their senior executives may have the unintended consequence of creating a culture where it’s okay to do anything to get that bonus.

Shareholders have been pushing back against soft targets being linked to senior executive bonuses.

The thinking is that shareholders want revenue and dividends — a good return for their equity invested in the company — and that’s how the chief executive and the team should be measured.

And the other major factor is a sense that CEOs and their acolytes somehow game the system anyway, conspiring to create easy targets so they can collect millions from a blue chip range of short and long term bonuses not available to the average worker or shareholder.

Last year there were more than 100 strikes, some as high as 84%, against remuneration reports at company AGMs.

And companies, seeing the mood change among shareholders, have been backing away from introducing targets for customer satisfaction and other no-financial measures of success.

The Commonwealth Bank in November had its senior executive pay plans knocked back by shareholders at its AGM, the first such strike for a major bank. If it happens a second time, the board of directors will be spilled.

The bank at the last moment withdrew more proposed non-financial measures to CEO Ian Narev’s bonus targets due to be presented to the bank’s annual meeting.

Narev was paid $12.3 million in 2016. Just $2.65 million of that was base pay, the rest being short and long term incentives. Total statutory remuneration for Narev and his 11 senior executives for the 2016 financial year was $44.8 million.

Shareholders are not happy

And there’s more activism ahead. The Australian Shareholders’ Association says it will continue its focus on improving remuneration disclosure in 2017.

Its latest voting guidelines encourage companies to include a table of actual remuneration in their reports and voluntarily disclose a ratio of the CEO’s actual pay as against average weekly earnings.

The tendency to categorise non-financial measures as “soft” has devalued their importance, according to the latest AMP Capital Corporate Governance Report.

“Incentives linked solely to financial metrics risk fuelling negative culture and conduct,” the report says.

“Companies would therefore do well to carefully consider which non-financial performance measures to introduce, how they can be adequately measured and monitored, and how these measures can be transparently explained to shareholders.

“The clearer the link to long-term value creation and the more clearly targets can be measured and articulated, the more likely it is that shareholders will support the pay structure.”

Karin Halliday, AMP Capital’s senior corporate governance manager, says culture is important in a company.

Culture

Company culture can be described as “the way we do things around here” and its impact on company success or failure indicates its importance.

“Companies need to focus on creating a culture that attracts the best employees and creates an environment that enables employees to contribute their best,” she says.

“While it can be difficult to articulate aspects of a good culture, it is very clear when things go wrong.

“For example, merging a company with a culture that is focussed on ‘exceptional customer service’ with a company focussed on ‘lowest-cost’ will send conflicting messages to employees about the way things should be done.”

And she believes both financial and non-financial measures should be applied.

“Total reliance on financial performance measures can be harmful if they discourage executives from focusing on the strategic goals linked to building and enhancing the capability required for long-term value creation,” she says.

“Over the long term, non-financials will impact financial outcomes.

“The timing is just less clear. For example, profit growth attained at the expense of customer satisfaction is not sustainable nor is profit growth achieved by underpaying workers or neglecting legal responsibilities.

“Given the impact factors such as employee engagement or workplace diversity or culture can have on company value, there will be times when it makes sense to link executive bonuses to such measures.

“At the end of the day, executives focus on what gets rewarded. If one’s pay, wealth and reputation depend on how successfully certain things are done, it is natural that this is where attention will be directed.”

A question of trust

Trust is needed, especially when performance measures are subjective.

AMP Capital’s Corporate Governance Report: “Shareholders need to believe that boards will do their best to apply hurdles in a fair and acceptable manner. Companies need to get better at describing why particular focus areas are important relative to others and how they will generate future shareholder value.”

Elizabeth Proust, chair of the AICD (Australian Institute of Company Directors), believes that directors have a role to play in the national conversation around inequality and fairness.

“We recognise the importance of building trust and building confidence for our employees and shareholders; but we need to be creative and consistent in the way we listen to, and respond to other stakeholders in a way that builds and strengthens trust,” she told this year’s Australian Governance Summit.

She believes business has never been more unpopular in the eyes of the community and governments have never been less trusted.

The GFC, globalisation and technological change have come in tsunami-like waves, weakening and breaking down trust.

“People are uncertain about their futures … unsure whether their jobs will exist in 10 years’ time, much less the ones their children aspire to in 20 years’ time,” she says

She says there are excessive and unreasonable practices that do deserve a strike.

The role of directors

“Do we need more corporate embarrassments, or front page stories, or examples of irresponsible decision making to know that there are issues within organisations that need to be addressed?” she says.

“That we need to reflect on the systems we as directors put in place and whether they’re achieving the good governance we strive for.”

She says boards need to argue for and champion the value of non-financial targets in remuneration reports.

“One area in particular where there seems to have been a breakdown in communication and engagement is the topic of so-called soft targets,” she says.

“However, just because a board sets and remunerates on non-financial targets does not mean they are rewarding a CEO just for doing their job.

“The diversity of your work force, your culture, and customer satisfaction are all areas which it is entirely appropriate for boards to recognise and remunerate.

“The question is on the extent to which the target is stretched, not on whether the target is solely financial or not.”

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