THE NEW JanuaryCLOSED 2013 SHOP: PAIDWHO’S TO DECIDING PERFORM?ON PAY? WHATTHE MAKE DO WE UP WANT OF REMUNERA OUR BUSINESSTION COMMITTEES LEADERS TO ACHIEVE? High Pay Centre Paid to Perform: What do we want About the High Pay Centre Contents our business leaders to achieve?

The High Pay Centre is an The High Pay Centre is resolutely independent non-party think tank independent and strictly non- 4 Foreword established to monitor pay at the partisan. It is increasingly clear that top of the income distribution and there has been a policy and market 5 Executive Summary set out a road map towards better failure in relation to pay at the top business and economic success. of companies and the structures 8 Introduction of business over a period of years We aim to produce high quality under all governments. It is now 9 Turning a fast buck: current measures of executive performance research and develop a greater essential to persuade all parties that understanding of top rewards, there is a better way. 11
.OT
ALL
THEY
SEEM
ÚNANCIAL
YARDSTICKS
CAN
BE
MISLEADING company accountability and business performance. We will The High Pay Centre is grateful to its 14 It’s not just about money: workers are important too communicate evidence for change supporters and would like to thank to policymakers, companies and the Polden and Puckham foundation 18 In it for the long-haul? How existing gauges of performance other interested parties to build a for funding this work. discourage long-term thinking consensus for business renewal. @highpaycentre 25
7HAT
ELSE
DO
COMPANIES
DO
3UCCESS
IS
ABOUT
MORE
THAN
PROÚT
www.highpaycentre.org 29 Conclusions and recommendations

2 3 High Pay Centre Paid to Perform: What do we want Foreword Executive summary our business leaders to achieve? 0ROÚT
WITHOUT
PURPOSE
IS
A
RECIPE
FOR
DISASTER
!S
AN
INDUSTRY

AND
INDEED
)
WOULD
SAY
AS
A
GLOBAL
SOCIETY

n&INANCIAL
INCENTIVES
HAVE
ONLY
A
WE
HAVE
BECOME
WRAPPED
IN
OUR
OWN
RHETORIC
LIMITED
ROLE
TO
PLAY
IN
THE
CREATION
Britain’s business leaders have been Broader performance 7E
NEED
TO
LEARN
HOW
TO
BE
COMFORTABLE
WITH
OF
SUCCESSFUL
BUSINESSES o criticised for taking a short-term measures ARTICULATING
PURPOSE
AND
REJECT
THE
IDEA
THAT
MONEY
IS
approach to the companies they run THE
ONLY
EFFECTIVE
MEASURE
OF
ALL
THINGS
OR
THAT
THE
FREE
says the Local Authority Pension and failing to develop a strategy for The broader factors that affect MARKET
IS
THE
ONLY
SORTING
MECHANISMm
1 Fund Forum in a recent report.3 An a long-term sustainable future. The company performance include: INmUENTIALSHAREHOLDERBODY THE,OCAL lNANCIALCRISISHASPUTAFOCUSON %LISABETH-URDOCHWASCHIEmY Authority Pension Fund is looking the issue of short-termism. But chief > Employees - Motivating, referring to the media in her Edinburgh at how a company’s focus can be executives are given incentives to developing and retaining several speech, but her sentiments capture shifted to take more account of its CHASESHORT TERMPROlTSBECAUSE thousand staff, and engaging them a key debate about our economic employees and customers. their pay is overwhelmingly linked in a common purpose is one of system. The round of soul-searching TOlNANCIALMEASURESOFCOMPANY the most challenging tasks for a PROMPTEDBYTHElNANCIALCRISISHAS If chief executives are to create performance such as earnings per company executive and is critical to seen an increasing number of people more sustainable businesses, their share (EPS) and total shareholder the company’s long-term success. questioning the way our companies incentives need to change. While the return (TSR). > Customer satisfaction - ARERUN!FOCUSONSHORT TERMPROlTSTO High Pay Centre is sceptical about the Companies with a reputation for the exclusion of other objectives is felt effectiveness of performance-related Existing performance poor quality or poor service are by many to have led British business pay in general, if it is to remain part of measures unlikely to thrive in the long-term and particularly our banks, on a roller- the corporate landscape, it should be > Trust/reputation - Brands such coaster ride - in some cases - towards made to work better. Executives’ pay Our analysis of the annual reports as BP, News International and destruction. should be determined by more than of the FTSE 1005 companies found a number of banks have been JUSTSHORT TERMlNANCIALOUTCOMES that CEO performance is mainly tarnished by reputational issues. However, what are business This report is an attempt to look MEASUREDAGAINSTlNANCIALOUTCOMES > Innovation and productivity leaders supposed to do? For years at existing measures of company CRUDElNANCIALPERFORMANCE shareholders have been telling them performance, at why they are not the > Total Shareholder Return (TSR) measures fail to differentiate that they must align themselves with full answer to long-term viability and was the most popular measure, between companies that increase the owners of the company. This has what can be done instead. used to calculate at least one SHAREPRICEANDPROlTABILITYBY meant tying executive pay packages element of performance-related pay building brands and developing to returns for company shareholders. If executives see that their own by 74 out of 100 companies. their product, and those that do so lNANCIALFUTUREISMORECLOSELYTIEDTO > 96 companies used either EPS by cutting costs. The focus almost wholly on short-term running companies sustainably, their or TSR or a combination of both, MEASURESOFlNANCIALPERFORMANCE behaviour could be a lot different. to determine performance for Shareholder value has incentivised many executives to their chief executive’s Long-Term go for broke. They stand to make a Leading shareholders in the Incentive Plan (LTIP). Shareholders have called for chief LOTOFMONEYFROMPRIORITISINGPROlTS Association of British Insurers have > Only seven companies used executives’ pay to be linked to and share price, usually measured by recently called on companies to NON lNANCIALMEASURESFOR company performance in order to investors in quarterly increments. Chief consider ways of rewarding directors calculating their LTIP. In each case, better align the interests of managers 1 Elisabeth Murdoch, chairman and CEO of executives’ average pay packages that are not just based on measures NON lNANCIALFACTORSACCOUNTEDFOR with the owners of the company. Shine, in the James have trebled in the past 10 years from OFlNANCIALPERFORMANCE4 The debate less than 50% of the pay awarded. MacTaggart memorial £1.5million to £4.8million, but the FTSE needs to go further. Executives should 4HEFOCUSONSHORT TERMlNANCIAL lecture, Edinburgh 23 Aug 2012 100 index of share prices is almost be given incentives to look at other (OWEVER lNANCIALPERFORMANCE measures can encourage 2 Figures from Manifest/ back where it started the decade.2 factors creating success. This would measures can be misleading and executives to increase the share MM&K 3 Local Authority Pen- NOTJUSTBENElTTHOSEEXECUTIVES  fail to capture fully the way the PRICEANDPROlTSBYCUTTINGCOSTS sion Fund Forum report: There is now a growing movement but their employees, customers and company is operating. and investment, or by speculative People and Investment Value, 29 Nov 2012 among shareholders, economists and indeed, wider society as a whole. mergers and acquisitions and share 4 http://www.guardian. critics of the current system to look buybacks. However, this can have 5 Companies in the co.uk/business/2012/ for more sustainable ways of running Deborah Hargreaves, founding adverse long-term consequences FTSE 100 stock market nov/26/curb-executive- index in November pay-advise-insurers? companies. director of the High Pay Centre for companies. For example, BP 2012 4 5 High Pay Centre Paid to Perform: What do we want our business leaders to achieve?

attempted to cut costs on its US PERFORMANCEMEASURESSHOULDREmECT commercial pension providers drilling rigs, but ended up with a the interests of society as a whole. should be required to take into $100 billion bill in the aftermath of account the social/environmental the Deepwater Horizon disaster. Recommendations: impact of their investments ICI and GEC prioritised speculative ON
BENEÚCIARIES
A revised acquisitions over the development In order to promote a broader lDUCIARYDUTYSHOULDRECOGNISE of their core business in the late DElNITIONOFCOMPANYPERFORMANCE that the interests of pension fund 1990s and now no longer exist. and encourage chief executives BENElCIARIESAREBOUNDWITHTHOSE to run their companies on a more of society as a whole. The average length of shareholding sustainable basis, we make the 5 Employee representatives in the UK is seven months, while following recommendations: should be elected to company the timeframe over which chief boards - Employees on boards executives’ so-called ‘Long-Term’ 1 .ON ÚNANCIAL
PERFORMANCE
would advocate a much broader Incentive Plans are measured is measures should constitute DElNITIONOFCOMPANYSUCCESS AND usually three years. It can take at least 50% of performance- challenge decisions based on short- much longer than this to build related executive pay - measures TERMlNANCIALCONSIDERATIONSTHAT a successful brand, develop such as employee engagement; may jeopardise the company in the a compelling new product or customer satisfaction; and social/ long-term. SIGNIlCANTLYINCREASETHESKILLS environmental performance and capacity base of a company are critical to understanding a Together, these policies would workforce. company’s long-term success and represent a genuine shift away its net impact on society. from the approach to business Social and environmental 2 Reporting on social and THATCAUSEDTHElNANCIALCRISIS performance environmental performance They would ensure that company should be mandatory - this should performance is judged in terms of 3IMILARLY NARROWlNANCIAL INCLUDESPECIlCINDICATORSSUCH a company’s value to society as performance measures do not as tax paid in the UK; employee a whole, rather than to a narrow gauge the wider impact that turnover; company pay differential; constituency of shareholders.s companies have on society as or emissions levels. This data could a whole. Big companies have a be used to calculate performance- profound effect on the individual related pay. wellbeing of their employees and 3 Government should use tax customers who depend on them and procurement incentives to for their income and development encourage companies to focus on opportunities, or vital products wider measures of performance - such as food, fuel and transport. Preferential tax rates would promote compliance with environmental and On a broader level, companies social reporting requirements. The have a critical role to play in society Social Value Act could also be used through their investment in staff to ensure that compliant companies training, research and development were favoured in Government and their contribution to tax procurement decisions REVENUES"USINESSALSOBENElTS 4 Pension fund trustees, from government investment in investment managers and infrastructure and public services. There are therefore both practical and moral reasons why company 6 7 High Pay Centre Paid to Perform: What do we want Introduction Turning a fast buck: current measures of our business executive performance leaders to achieve?

l3HORT TERMISM
IN
BUSINESS
MAY
BE
CHARACTERISED
BOTH
AS
A
TENDENCY
Our analysis of the annual reports NON lNANCIALPERFORMANCEATALL TO
UNDER INVESTMENT
WHETHER
IN
PHYSICAL
ASSETS
OR
IN
INTANGIBLES
of the FTSE 100 companies9, found in their remuneration report. A SUCH
AS
PRODUCT
DEVELOPMENT
EMPLOYEE
SKILLS
AND
REPUTATION
WITH
that CEOs are overwhelmingly FURTHERREFERREDTOUNSPECIlC CUSTOMERS
AND
AS
HYPERACTIVE
BEHAVIOUR
BY
EXECUTIVES
WHOSE
measured against their companies’ @PERSONALOBJECTIVESOR@NON lNANCIAL CORPORATE
STRATEGY
FOCUSES
ON
RESTRUCTURING
ÚNANCIAL
RE ENGINEERING
lNANCIALPERFORMANCE performance’ with no reference to > Every CEO pay package was QUANTIlABLEWAYSINWHICHTHESECOULD OR
MERGERS
AND
ACQUISITIONS
AT
THE
EXPENSE
OF
DEVELOPING
THE
6 predominantly calculated using be measured, FUNDAMENTAL
OPERATIONAL
CAPABILITIES
OF
THE
BUSINESSm
lNANCIALPERFORMANCEMEASURES  > Only 38 companies committed to based on the company value and assessing CEO performance in ways Business in Britain has been The Bank of England’s Andrew PROlTASRECORDEDINTHEIRlNANCIAL THATCOULDMEASURENON lNANCIAL criticised for its short-term approach. Haldane echoes this refrain: statements, or in terms of their share factors. Common metrics included: Policymakers and economists have price and payment for shareholders. Health and Safety record questioned why British business l4HE
SHORT TERMISM
PROBLEM
IS
> Total Shareholder Return (TSR) 10 Environmental impact leaders struggle to build long-term, ESPECIALLY
ACUTE
IN
THE
ÚNANCIAL
was the most popular measure, used Customer satisfaction sustainable companies. However, SECTOR
WHERE
JOB
TENURES
AND
by 74 companies to calculate at least Employee Engagement this should come as no surprise to PERFORMANCE
TARGETS
HAVE
TENDED
some part of their CEO’s pay. > These are sometimes included Earnings-per-Share (EPS)11 was ALONGSIDEOTHERNON lNANCIAL anyone who has read a company TO
BE
SHORT
ESPECIALLY
FOR
#%/S

> remuneration report. Most top the second most popular, used by 64 measures under broad headings executives are incentivised to make 0RE CRISIS
THIS
ENCOURAGED
companies. such as ‘strategic objectives.’ The SHORT TERMlNANCIALREWARDSFOR UNHEALTHY
RENT SEEKING
AND
RISK > A majority of companies used PRECISEWEIGHTINGOFTHENON lNANCIAL their shareholders since this is how TAKING
GAMBLING
ON
ONE
MORE
TSR and EPS when calculating Long element, and therefore the incentive they achieve their own maximum BIG
BONUS

4HIS
GAVE
RISE
TO
ALL
Term Incentive Plans (LTIPs) which for the executive to deliver non- earning potential. THE
WRONG
INCENTIVES
IF
THE
AIM
usually pay out after three years. LTIPs lNANCIALOBJECTIVES IS INMANYCASES  WAS
TO
GENERATE
LONG RUN
VALUE
often form the largest proportion of an uncertain. The most widely-used measures FOR
CUSTOMERS
AND
INVESTORSm
8
executive pay package, with a value of > 4HENON lNANCIALPERFORMANCE for calculating performance-related up to 700% of a CEO’s basic salary.12 measures are generally used to executive pay are connected to In addition to promoting short- > 96 companies aligned their LTIP, calculate annual bonuses. The non- COMPANYSHAREPRICE ORPROlTABILITY termism, and encouraging risky at least in part, with either TSR and/ lNANCIALELEMENTUSUALLYRELATESTOLESS 6 John Kay, the Kay This is measured over a period of up speculation at the expense of or EPS. 37 companies used only than half the total bonus award. Annual Review of UK Equity Markets and long-term TOTHREEORVERYOCCASIONALLYlVE  genuine improvements to innovation TSR and/or EPS to calculate their bonuses account for up to 200% of a decision-making, De- years and is a comparatively short- ANDPRODUCTIVITY NARROWlNANCIAL LTIP CEO’s salary.13 This is a much smaller partment for Business Innovation and Skills, term and narrow view of company performance measures also ignore > /THERlNANCIALMEASURESUSED AT proportion of performance-related pay 2012, p10 performance. A number of leading the wider impact of companies LEASTINPART BYASIGNIlCANTNUMBEROF than that covered by LTIPs. 7 Kay Review, p63 commentators have suggested on their employees, customers, companies included Only 7 companies mentioned 8 Andrew Haldane, > A Leaf being turned, that the use of these measures and surrounding communities and #ASHmOW  NON lNANCIALPERFORMANCEMEASURES Executive Director, incentives are damaging to UK society as a whole. It is important VARIATIONSONPROlTOREARNINGS in their LTIP – in each case the non- 9 FTSE 100 companies Financial Stability, and in Nov 2012. Most member of the Financial businesses and contributed towards to understand what company variations on return on capital, or lNANCIALMEASURESACCOUNTEDFOR companies use more Policy Committee, Bank THERECENTlNANCIALCRISIS&OR executives are currently paid to return on equity, a much smaller element of the LTIP than one performance of England; speech to measure ‘Occupy Economics’ example, the Kay review of Equity deliver, and the consequences of lNANCIALMEASURESRELATINGTOA than that linked to EPS, TSR or other 10 TSR is the increase in October 29 2012 Markets concludes that: this for wider society. This paper SPECIlCBUSINESSPRIORITY SUCHAS lNANCIALMETRICS the value of the share analyses the current system, looks market share or growth in sales for The companies with the largest price plus dividends > 11%03ISTHEPROlTPER l7E
BELIEVE
THE
LESSON
OF
RECENT
ÚNANCIAL
CRISES
IS
at why it encourages short-term particular markets or products. PROPORTIONOFNON lNANCIALMEASURES outstanding share THAT
THE
CULTURAL
CHANGES
WE
SEEK
CAN
BE
ACHIEVED
behaviour on the part of leading > The measures used largely relate linked to the CEO’s LTIP were 12 High Pay Centre, It’s how you pay it: Making ONLY
BY
CHANGING
THE
STRUCTURE
OF
THE
INDUSTRY
AND
executives and recommends a TOTHElGURESRECORDEDONCORPORATE those that had undergone recent sense of the complicat- 7 series of policy changes that would lNANCIALSTATEMENTS RATHERTHANHOW reputational damage such as BP, ed world of executive THE
INCENTIVES
OF
THOSE
WHO
WORK
IN
ITm
pay, High Pay Centre, prompt them to behave in a longer- THESElGURESWEREACHIEVED Barclays and HSBC. 2011 term, more sustainable way. > 24 companies did not mention 13 ibid 8 9 High Pay Centre Paid to Perform: What do we want Not all they seem: financial yardsticks our business can be misleading leaders to achieve?

Our research clearly demonstrates to calculate EPS, TSR and many Financial Performance measures lDEPRECIATION
OF
ÚXED
ASSETS
THATNON lNANCIALPERFORMANCE OFTHEOTHERlNANCIALMETRICSALSO are well-established as a DEPENDS
ON
AN
ASSUMPTION
OF
measures form only a minor proportion aligned with executive pay packages. conventional means of judging HOW
LONG
THE
ASSET
WILL
LAST
AND
of the performance-related pay Furthermore, they are focused on company performance. Measuring ON
ITS
RESIDUAL
VALUE

)N
THE
packages awarded to FTSE 100 doing so over a relatively short time ACOMPANYSlNANCESWOULDAPPEAR CASE
OF
PENSION
LIABILITIES
THE
CEOs. Executives are far more heavily period of, at most, the three years over to be a reliable way of assessing ASSUMPTIONS
ON
LIABILITIES
FOR
incentivised to prioritise performance which ‘Long-Term’ Incentive Plans its success, and shareholders ASMEASUREDBYlNANCIALSUCCESS  measure performance, and some are understandably keen to know ÚNAL
SALARY
SCHEMES
DEPEND
ON
primarily TSR and EPS. annual bonuses are deferred.s how much money a company is THE
ASSUMPTIONS
WHICH
INCLUDE
making for them. However, there are RETURNS
FROM
INVESTMENTS
AND
The culture of Britain’s large PROBLEMSWITHlNANCIALMEASURES THE
LONGEVITY
OF
PENSIONERS
BOTH
companies is currently geared towards because they can be less objective OVER
MANY
YEARS

&OR
LENDING
delivering the increase in share price, THANTHEYAPPEAR)TISALSODIFlCULT INSTITUTIONS
PROVISIONS
FOR
BAD
DIVIDENDPAYMENTSANDPROlTSUSED to discern whether the measures DEBTS
DEPEND
ON
THE
ACCURACY
employed are an accurate gauge of OF
MODELS
OF
FUTURE
BEHAVIOUR
OF
a company’s overall performance. BORROWERS

!CCOUNTS
THEREFORE
PROVIDE
PRECISE
INDICATORS
OF
Financial performance measures are either accountancy-based or PERFORMANCE
ONLY
IN
AS
MUCH
AS
market-based. Accountancy-based THEY
APPLY
PRECISE
RULES
TO
A
SET
measures are calculated by using OF
UNCERTAIN
EVENTSm

 the company’s accounts – common examples used by FTSE 100 So if a company has misjudged the companies include variations on EPS value of its assets, for example, or (earnings per share) or ROCE (return the ability of its debtors to maintain on capital employed) which are REPAYMENTS THEIRPROlTSMAYPROVE BASEDONTHEPROlTSRECORDEDINTHE illusory. Box 1 provides an example accounts and/or assets and liabilities. of why the inherent uncertainties Market-based measures, such as CONTAINEDINCOMPANYlNANCIAL Total Shareholder Return (TSR), relate statements limit their value as a to the company’s price on the stock guide to company performance. market. Elements of both mechanisms can be highly subjective.

!CCOUNTANCY BASED
ÚNANCIAL
measures

Andrew Likierman of London Business School notes that company accounts are ‘inevitably based on a series of assumptions 14 Andrew Likierman, 14 Measuring Company about the future.’ Likierman Success - Paper pre- highlights the depreciation of sented at Performance Measurement Associa- assets, the cost of pension liabilities tion Conference, Lon- and debt repayments as three don Business School, April 2006 major uncertainties inherent to 15 ibid accountancy-based measurements. 10 11 High Pay Centre Paid to Perform: What do we want our business leaders to achieve?

lNANCIALSTATEMENTS WHICHAREBOTH Box 1: Banking off-balance sheet SUBJECTIVE ANDBASEDONlGURES Box 2: Apple and Blackberry prepared internally by company The recent banking crisis provides a famous example directors. However, they are still Writing in October 2012, US academic Aswath Damodaran compared the of how accountancy-based performance measures potentially misleading. increase in value of Research in Motion (makers of the Blackberry phone) can be misleading. A number of major banks became to the decline of Apple. Damodaran notes that the Apple share price heavily exposed to sub-prime mortgages in the &IRSTLY SHAREPRICESREmECTMARKET tumbled because of a small glitch in the map application on the iPhone USA, with their loans recorded off-balance sheet expectations. This relates to 5. But because Apple has been so constantly successful for such a long through part-independent subsidiaries, or Structured what will happen in future, and period of time, this was taken as a sign by the market that the company Investment Vehicles, in order to avoid regulations so is of little value as a gauge was not infallible, and could make a bigger mistake in future. on capital reserves. When sub-prime mortgage of past performance. Box 2 customers defaulted in higher numbers than provides an example of how hype By contrast, RIM had been subject to ‘unremittingly negative’ news stories, expected, some banks were unable to meet their own and expectations can override and therefore the revelation that the company’s quarterly losses amounted debt obligations and were ultimately dependent on a performance as a determinant- of to ‘only’ $235 million was seen as positive. It was not enough to wipe them government bail-out for their survival. share price.16 out completely, so the company might have a chance to rebound, making it a potential bargain in the eyes of some investors looking to purchase stock As the massive write-downs undertaken by the Secondly, market judgements at the bottom of the market. crisis-hit banks demonstrated, the assets recorded are sometimes wrong. As with by banks had been grossly overstated, meaning that accountancy-based measures, )N
BOTH
INSTANCES
THE
ÛUCTUATIONS
IN
THE
MARKET
VALUE
OF
THE
COMPANY
WAS
SO
WERE
THEIR
PROÚTS
4HOUGH
THEIR
EXPOSURE
MIGHT
the 2007 banking crisis provides a almost the complete opposite of a reward for excellent past performance. have been more obvious were it not for the Structured salutary lesson of how inaccurate Investment Vehicles, the fact that the banks, with full they can be. The markets KNOWLEDGE
OF
THEIR
ÚNANCIAL
POSITION
AS
DOCUMENTED
completely failed to recognise the in their accounts, were willing to issue the loans at all, inherently unstable business models value investment by their own )TISCLEARTHATTHEPREVAILINGlNANCIAL demonstrates that judgements made on the basis of established by leading banks. objective judgement, but what measures used to evaluate business CORPORATE
ÚNANCIAL
STATEMENTS
CAN
BE
CATASTROPHICALLY
Former Chairman of City Regulator, the average opinion of best value performance and determine ÛAWED

4HIS
INCLUDES
ASSESSMENTS
OF
EXECUTIVE
the Financial Services Authority, will be. Replicated en masse, executive pay can be an unreliable performance using measures based on data Lord Adair Turner notes that these attempts to second guess guide to a company’s success. CONTAINED
WITHIN
THESE
ÚNANCIAL
STATEMENTS
0RIOR
TO
consensus create what Turner calls In order to better understand the the crash, neither the EPS nor the ROCE of the worst lTHE
MARKETS
COLLECTIVE
a herd mentality, and John Kay weaknesses of these measures, it AFÛICTED
BANKS
WOULD
HAVE
REÛECTED
THEIR
VULNERABILITY VIEW
WAS
THAT
RISKS
TO
BANK
refers to as ‘the lemming standard.’18 is vital to identify the critical factors CREDITWORTHINESS
HAD
FALLEN
In their efforts to replicate what each shaping performance that are not STEADILY
BETWEEN

AND
other is doing, investors create rapid necessarily captured by company -ARKET BASED
ÚNANCIAL

REACHING
A
HISTORIC
LOW
IN
investment trends, often followed accounts or market judgements. s measures by a subsequent collapse when the THE
EARLY
SUMMER
OF

THE
initial judgement proves incorrect. The share-price movements which VERY
EVE
OF
THE
WORST
ÚNANCIAL
dictate market-based performance CRISIS
IN

YEARSc
"ANK
EQUITY
PRICES
PROVIDED
NO
FOREWARNING
OF
16 Aswath Damodaran, measures such as TSR, can also 17 Winning (losing) by be an unreliable indicator of IMPENDING
DISASTERm
losing (winning): The company performance. power of expectations via http://aswathda- John Maynard Keynes famously 17 Adair Turner, Eco- modaran.blogspot. Market movements at least highlighted the psychology nomics after the Crisis: co.uk/2012/10/ Objectives and Means, winning-losing-by- represent a view from outside of markets as a potential risk MIT Press, 2012, p53 losing-winning-power. the company – the value of a factor in causing market failure. 18 Economics after the html, 9 October 2012, company as judged by external Participants attempt to identify Crisis p43 and Kay accessed 17 October Review of UK Equity 2012 investors, as opposed to company not what constitutes the best Markets p63 12 13 High Pay Centre Paid to Perform: What do we want It’s not just about money: our business workers are important too leaders to achieve?

!SHASBEENSHOWN THElNANCIAL The sheer logistical challenge with social media become a larger safeguard and strengthen social performance measures most of managing tens of thousands part of the market, there will be a and environmental performance, prevalently used amongst large of employees, channelling their corresponding growth in the power and other areas that affect trust in companies can be dictated by productivity appropriately, and of consumer activism. A business the business. BP for example, had factors beyond the companies’ forging a coherent corporate that has pro-actively improved built its branding campaign around control, and often fail to gauge identity that binds them to the performance in this respect is the ‘Beyond Petroleum’ slogan performance correctly. company is one of the foremost clearly more resilient to a changing and green credentials for many challenges for any business leader. social/technological environment, years, but in the aftermath of the Financial performance measures Their success or otherwise in this but this is not necessarily Gulf of Mexico oil spill it is doubtful are simplistic, and do not explain respect is clearly crucial to the REmECTEDBYEXISTINGMEASURESOF that environmental leadership is HOWPROlTSWEREACHIEVEDnONA company’s long-term prospects. performance. something that consumers readily yearly-basis, or even over the three associate with BP. year periods covered by ‘long-term’ Customer satisfaction Trust and Responsibility INCENTIVEPLANS0ROlTANDSHARE There are a number of obvious ways price increases can be driven Equally, customer satisfaction Customer service is also linked to in which low levels of trust could by cost-cutting or speculation as is clearly a vital measure of wider issues of trust and reputation. have an impact on businesses: much as genuine improvements to company success – it is hugely Again, these are clearly vital to for example, loss of customers, products and services. important in determining whether business’ long-term interests. The or a lack of willingness from other revenues have been generated in News of the World is a prominent key stakeholders (eg suppliers, In order to understand whether a a sustainable way. Companies with example of a business damaged distributers or advertisers) to business leader has implemented a a reputation for poor quality/poor irreparably by reputational issues. engage with the company. long-term, sustainable strategy for service are unlikely to thrive in the A number of other companies have success, it is important to examine long-term, particularly in an inter- undergone similar scandals – the It is also likely that a company with critical underlying factors such connected age when it is becoming banking sector more or less in its a poor public reputation would be as human capital and employee increasingly easy for poor consumer entirety; BP over the Deepwater less desirable to work for. The Sky engagement; customer satisfaction; experience to be disseminated via Horizon disaster; businesses such Future Leaders Survey, involving trust and reputation; Corporate Social the internet. as Vodafone and Starbucks, relating graduate trainees, high-potential Responsibility; or levels of research, to tax avoidance; Primark, part of middle managers and MBA development and innovation Research for Oracle in the USA the Associated British Foods Group, students, found that found that: because of the use of child labour > 79% of survey respondents cite Human Capital > 89% of consumers had switched in its supply chain; and the ‘big six’ the vision and values of a company to a competitor after experiencing energy companies which have seen as an important factor when looking The academic evidence poor customer service; their businesses heavily criticised at a potential employer; DEMONSTRATINGTHEBENElTSTO > 86% said they would pay more for over sharply rising energy prices. > The top 5 factors for judging 19 High Pay Commis- businesses of improved employee an improved customer experience; quality of business were: 1) quality of sion, Cheques with ENGAGEMENTISSTRIKING4HElNAL > 26% have posted negative The Edelman Trust Barometer notes product 2) customer service 3) values Balances: why tackling high pay is in the report of the High Pay Commission comments about a company that just 38% of UK citizens ‘trust and ethics 4) reputation as good national interest, 2011, CITESMULTIPLESTUDIESCONlRMING on a social networking site after business to do what is right.’21 This EMPLOYER lNANCIALTRACKRECORD 21 Edelman Trust, Edel- p29 that highly engaged employees experiencing poor customer service.20 ISTHElFTHLOWESTOFTHECOUNTRIES 34% see ‘creating social and man Trust Barom- 20 Oracle, 2011 Custom- > eter 2012, via http:// 22 er Experience Impact generate substantial cost savings surveyed. Only 30% judge CEOs environmental value through edelmaneditions. Report: Getting to the for businesses in terms of reduced A number of companies have TOBECREDIBLElGURES23 business’ as a key career goal com/2012/01/trust- Heart of the Consumer barometer-2012/ and Brand Relation- staff turnover, sickness absence UNDERGONESIGNIlCANTREPUTATIONAL versus 35% for ‘quickly increasing accessed 18 October ship, 2012 via http:// and accidents at work, while also damage after comparatively minor Though trust and reputation can salary or bonus.’ 24 2012 www.oracle.com/us/ 22 ibid products/applications/ increasing revenue through heightened complaints went viral via email and/ take a long time to build, they 23 ibid cust-exp-impact-report- productivity and greater commitment or social media. As internet-usage can be lost much more quickly, It is often argued that a failure to pay 24 Sky, The Sustainable epss-1560493.pdf to corporate goals leading to improved increases in developing economies making it vitally important that executives the astronomical salaries Generation: Sky Future accessed 18 October Leaders Survey, 2011, 19 2012 customer advocacy. and generations who have grown up executives are incentivised to that have become commonplace p6-7 14 15 High Pay Centre Paid to Perform: What do we want 25 Financial Times, It’s our business plain for all to see, ESG leaders to achieve? research works, Octo- ber 21 2012 via http:// www.ft.com/cms/s/0/ b22c49c8-06e8-11e2- 92ef-00144feabdc0. will lead to a failure to attract and economic and cultural traditions as the difference between ‘value So revenue growth is clearly a html#axzz2Cn0oCUhU 30 accessed October 25 retain talent. This evidence suggests increases, a clear social mission creation’ and ‘value extraction.’ preferable way for companies to 2012 that the ability to demonstrate can facilitate the vital relationships "UTTHElNANCIALPERFORMANCE IMPROVEPROlTABILITY BUTCRUDE 26 Rosabeth Moss Kanter, How Great strong social values and an ethical with local regulators and opinion measures currently used by UK accountancy-based performance Companies think business model will be at least as leaders necessary to secure a real companies make no allowance measures such as EPS or ROCE fail differently in Harvard important in future. competitive advantage.28 FORHOWPROlTABILITYORSHAREPRICE to differentiate between the two. Business Review, 1 November 2011, increases are achieved. 27 ibid )NTHELONG TERM THEBENElTSOFA Both in the developed world and in Equally, share price can be 28 ibid 29 Ha Joon Chang, 23 responsible business that builds emerging economies, poor social While cost-cutting is sometimes manipulated by stock buybacks, Things they don’t tell higher levels of trust could pay off performance by an individual JUSTIlED PROlTSARISINGFROMA whereby the company invests its you about Capitalism, Allen Lane, London , lNANCIALLY!REVIEWFOR$EUTSCHE company can shape attitudes brilliant product innovation or brand OWNPROlTSINSHARES INORDERTO 2010, p19 Bank in June 2012 estimated that: towards entire industries and the development are more likely to be drive their market value upwards. very concept of business. For sustained in the long-term. This then increases a company’s TSR lACADEMIC
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 regulation of the UK media business and attachment to the company, product that sells millions. in response to the illegal activities and a higher risk of accidents. Writing in the Harvard Business of News International employees Extending the life-cycle of dated Clearly, performance measures that Review, Rosabeth Moss Kanter could change the sector profoundly. equipment again increases the risk distinguish between ‘value creation’ ARGUESTHATlRMSSHOULDCONCEIVE Despite this, very few companies of accidents, production failure or and ‘value extraction’ are needed to of themselves as ‘enduring social link their chief executive’s pay the loss of competitive advantage remedy this.s institutions’, with the interests of package to responsible business to rival companies with more wider society given at least an practices. Those that have done so sophisticated technology. equal weighting to economic or are generally companies that have lNANCIALCONSIDERATIONSINSTRATEGIC already suffered a major corporate decision-making. crisis, such as BP and HSBC, suggesting that businesses see lTHE
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 Innovation Kanter argues that, in addition to the value added through stakeholder "USINESSESCANIMPROVElNANCIAL engagement, improved Corporate performance by growing revenue Social Performance also creates or by cutting expenditure. Leading greater resilience and enhances economist Ha Joon Chang the prospect of growth in an observes that it is far easier to increasingly globalised economy.27 achieve the latter through cost- 30 Mariana Mazzucato, Re-Balancing What? As emerging markets develop, cutting measures, than the former 2EFORMINGlNANCEFOR and the volume of business through innovation and product creative destruction not 29 destructive creation, done by Western companies in development. Fellow economist Policy Network, 2012, unfamiliar countries with different Mariana Mazzucato describes this p4 16 17 High Pay Centre Paid to Perform: What do we want In it for the long-haul? How existing gauges of our business performance discourage long-term thinking leaders to achieve?

It is possible to argue, that assets to companies. But these l2EMUNERATION
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This has reduced the level of if research and innovation – assets are built up over many years, TO
ACHIEVE
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engagement between shareholders or employee engagement; and are not something even the THE
REWARD
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WITH
THE
and companies, meaning that social responsibility; customer most gifted CEO can deliver to a CREATION
OF
SHAREHOLDER
VALUEm
33
shareholders are likely to use ‘exit’ satisfaction; or trust – are so lXED SHORT TERMTIMEFRAME (ie selling their shares and investing important to a company’s long- BAE Systems elsewhere) rather than ‘voice’ (voting term sustainable future, then this Shareholder value and in AGMs and engaging with the WILLEVENTUALLYBEREmECTEDINITS short-termism However, the interests of shareholders company management) as a tool for lNANCIALPERFORMANCE4HEREFORE  in UK companies have become more increasing the value of their investments.35 replacing/complementing existing It is unlikely that businesses can be and more focused on the short term. performance criteria with non- persuaded to measure performance Shares are traded with increasing Technological changes have lNANCIALMEASURESWOULDBE on a more sustainable, long-term frequency, meaning that their owners exacerbated this trend, with pointless. CEOs are already basis without challenging the focus are concerned with returns over a computers and mobile devices incentivised to embed these non- on shareholders and asking in period of months rather than years, making it much easier to keep lNANCIALINDICATORSINBUSINESS whose interests a company is run. and business leaders are expected to track of markets and arrange respond accordingly. 36 STRATEGIESBYlNANCIALPERFORMANCE It is well –documented that most transactions. Fair Pensions, 33 BAE Systems plc, measures. In theory, this would lead UK businesses see their primary the campaign for responsible BAE Systems Annual TOIMPROVEDlNANCIALPERFORMANCE objective as being to maximise Over the past two decades, there investment, also claim that the mis- Report 2011, 81 34 Kay Review, p31 and the CEO will be rewarded. the returns they generate for has been a growth in investors, who INTERPRETATIONOFINVESTORSlDUCIARY 35 Ibid shareholders. This explains the operate internationally and are not duty combined with short-term 36 John Kay, the Kay Review of UK Equity In practice, however, the timeframe particular incentives currently used always interested in working closely performance measurements in the Markets and long-term of CEO pay packages means in most executive pay packages, with the UK companies in which they investment chain has increased the decision-making: Inter- invest, unlike some UK-based long- im Report¸ Department that a focus on sustainable, long- and is explicitly noted in the frequency of trading. for Business Innovation term growth may go unrewarded. remuneration reports of the FTSE term funds. and Skills, 2012, p10 Annual bonuses still account for 100 companies: ASIGNIlCANTPROPORTIONOFMANY executives’ pay packages, so l)T
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from a renewed focus on social 31 Anglo-American plc, SHAREHOLDER
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 Annual Report 2011, responsibility would take longer p104 to be realised. Public perceptions British Sky Broadcasting 32 British Sky Broadcast- ing plc, Annual Report of the brand, or the skillset of the 2011, p49 workforce are crucial (if intangible) 18 19 High Pay Centre Paid to Perform: What do we want our business leaders to achieve?

Cost-cutting customers taking their business to research and development were rival companies. operating in sectors such as the l4HE
IDEA
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major companies who have been While cost-cutting measures can industry, where the scope for ENSURE
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damaged by short-term thinking. SOMETIMESIMPROVETHEEFlCIENCY innovations relating to new forms FUND
MANAGERS
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FOR
THEIR
PERFORMANCE
of a business, this can often involve of medicine or sustainable energy 45 CONTRIBUTES
TO
A
FOCUS
ON
QUARTERLY
RESULTS
AND
The Deepwater Horizon disaster, a trade-off with productive capacity generation is considerable. estimated to have cost BP around or resilience, as BP found out. It is PRESSURE
FOR
SHORT TERM
OUTPERFORMANCEm
37 $100 billion, demonstrates the perils clearly not in the long-term interests US economist William Lazonick OFAlXATIONWITHSHORT TERMRETURNS39 of the company for executives to be provides an example from the US Fair Pensions argue that investment The inquiry into the disaster heavily biased towards cost-cutting of how damaging this failure to fund trustees do not adequately concluded that BP introduced a by the terms of their pay packages. invest can be. He calculates that focus on long-term considerations, number of cost-cutting measures the money spent by General Motors such as employee engagement or that increased risks on the offshore Share buybacks on share buyback between 1986 social responsibility, because of rig. “Whether purposeful or not, and 2002 would have covered the an erroneous belief that they are many of the decisions that BP, Critics of shareholder value cost of the $35 billion bail-out the compelled to maximise returns in Halliburton and Transocean made have highlighted in particular, company received from the US the short-term. that increased the risks of the the pernicious effects of share government to stave off bankruptcy Macondo blow-out clearly saved buyback. The proportion of in 2009.46 As such, the pay packages of the THOSECOMPANIESSIGNIlCANT company spending dedicated fund managers commissioned by time and (money),”40 according to buying their own shares has As with cost-cutting measures, trustees to manage their investment to the Congressional report into INCREASEDSIGNIlCANTLYINRECENT executives are biased towards are also attached to short-term the disaster. When the disaster years, while spending on Research practices such as share buyback performance – the returns they occurred, the damage far exceeded and Development has undergone a because their pay packages generate on a quarterly basis the initial savings made by BP.41 corresponding decline. are attached to company share compared to other fund managers. prices. The share price can be 37 Fair Pensions, The They are therefore incentivised It is easy to see how the logic of FTSE 100 companies spent $46 driven upwards by using the Enlightened Sharehold- 43 er: Clarifying Investors to improve their performance by shareholder value could incentivise billion on share buybacks in 2006. company resources controlled by Fiduciary Duties, 2012, frequently trading stocks that companies to reduce staff numbers; 4HElGUREHADDECREASEDTOABOUT the executives to purchase more p6 they expect to rise or fall sharply, 38 Professor Prem Sikka, extend the lifetime of company $22 billion by 2009 as a result of shares. These resources could Empowering Sharehold- rather than investing in companies equipment; reduce customer budget contractions stemming in many cases be used more ers won’t Revolutionise that they believe will deliver more Corporate Culture, support facilities; or cut spending FROMTHElNANCIALCRISIS BUTTHIS productively to invest in areas 19 January 2012 via SIGNIlCANTRETURNSINTHELONG TERM on ‘unproductive’ (in the short still remains double the estimated such as staff training, research and http://leap-lrc.blogspot. term) research and development $10 billion spent annually on share development or upgrading facilities co.uk/2012/01/empow- ering-shareholders- All this means that the average processes. buyback in the late 1990s. Over the and equipment. wont.html accessed 13 length of shareholding in the UK is same period, business investment October 2012 now just seven months, down from 39 Lynn Stout, The But these ‘savings’ may prove costly as a proportion of GDP has fallen When executive pay packages Shareholder Value TWOYEARSINTHESANDlVE to the business in the long-term. from around 12 per cent to 9 per are linked to metrics that can be 43 Institute for Chartered Myth, 2012, p2 years in the 1960s.38 Therefore, for A smaller, overworked employee cent, lower than in France, Germany manipulated through actions that Accountants of Scot- 40 Guardian, BP cost- land, Corporate Share cutting blamed for company executives, delivering base is likely to be less productive or the USA. are potentially contrary to the Repurchases: The Per- ‘avoidable’ Deepwater shareholder value increasingly and more prone to mistakes, company’s long-term interests, ceptions and Practices Horizon Spill, 6 January of UK Financial Manag- 2011 via http://www. means short-term returns to enable with less emotional attachment While there is no point in investing there is a clear need for changes. ers and Corporate guardian.co.uk/envi- AQUICKPROlTWHENSHARESARESOLD to the company as a result of job for investment’s sake, Mariana Investors, 2009, p1 ronment/2011/jan/06/ on in a few months’ time. 44 Ibid p1-3 bp-oil-spill-deepwater- insecurity. Older equipment could Mazzucato (looking at global 45 Rebalancing What?, horizon lead to faulty production processes lGURES SHOWSTHATMANYOF p5 41 Shareholder Value or costly health and safety incidents. the companies that claimed 46 23 Things they don’t myth, p2 tell you about capital- 42 Ibid, p3 Poor customer service may result in they had no opportunities for ism, p20 20 21 High Pay Centre Paid to Perform: What do we want our business leaders to achieve?

Speculation and acquisition There are similar examples from 4HOUGH(ALDANEREFERSSPECIlCALLY l7HAT
WAS
MADE
VERY
CLEAR
TO
the recent banking crisis. Andrew to the banking sector and the metric US
WAS
THAT
SHAREHOLDER
PRIMACY
The dominance of shareholder Haldane attributes the pursuit of ‘return on equity’, the same problems WAS
THE
INTENDED
OUTCOME
q
VALUEANDSHORT TERMlNANCIAL high returns on equity incentivised could apply to any company run on AND
THIS
WAS
THE
UNEQUIVOCAL
performance measures also in bank managers’ pay packages the basis of short-term shareholder UNDERSTANDING
OF
ALL
THE
as a critical cause of the crisis. As value maximisation, and other encourage risk-taking and INTERVIEWEESm

 increased-levels of debt, as Haldane puts it: lNANCIALMETRICSTHATCANBE companies seek to grow quickly manipulated by risky takeovers and via takeover deals and speculation, l)NVESTORS
SHORTEN
THEIR
HORIZONS
debt-fuelled growth. The Kay Review suggests that rather than slower improvements to 4HEY
SET
2/%
RETURN
ON
EQUITY
Britain ‘is the most open market for the underlying business model. TARGETS
FOR
MANAGEMENT
TO
BOOST
Again, this demonstrates a clear need acquisitions of any large country.’ 51 THEIR
SHORT TERM
STAKE

4HESE
to measure CEO performance using Kay cites the claims of the Chairman The Kay Review cites GEC and TARGETS
IN
TURN
ENCOURAGE
SHORT metrics that are more reliable indicators of Cadbury that they did not believe of long-term, sustainable growth it possible to reject a high bid for ICI, the UK’s two largest industrial TERM
RISK
TAKING
BEHAVIOUR
4HAT
companies at the beginning of the the company, even if they thought BENEÚTS
THE
SHORT TERM
INVESTOR
1990s, as examples of companies Shareholders’ paradise that it was not in the interests of whose focus shifted away from AT
THE
EXPENSE
OF
THE
LONG TERM
the company, because they were GENERATING
INCENTIVES
TO
FURTHER
47 Kay Review, p18 developing their core business and Though ‘shareholder value’ compelled to accept what was an 48 Andrew Haldane, instead became pre-occupied with SHORTEN
HORIZONSm

 maximisation is most readily attractive offer for shareholders. 52 Wincott Annual Memo- rial Lecture, London, 24 acquisitions designed to deliver associated with neo-liberal October 2012 IMMEDIATElNANCIALRETURNS Haldane suggests that short-term economics as pioneered in the USA, The British government has focused INVESTORSBENElTFROMAMORE it is arguably more entrenched in the on strengthening shareholder l)N
THE
S
)#)
RESPONDED
TO
STOCK
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volatile economy, where company corporate culture of the UK. power as a means of tackling PRESSURES
BY
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share prices rise and fall rapidly. unpopular business practices such AND
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OF
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ACQUISITION
DESIGNED
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RE ESTABLISH
THE
company’s long-term prosperity, law at Cornell university, describes regulations will give shareholders because they generate returns from the UK as a ‘shareholders paradise’ a binding vote on executive pay COMPANY
AS
A
SPECIALITY
CHEMICAL
BUSINESS
4HE
sudden changes in market value. even when compared with plans every three years. However, STRATEGY
WAS
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COMPANY
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Sharper and more frequent changes America. In the UK the primacy of shareholders’ say on pay is likely ACQUIRED
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give them the opportunity for larger shareholder interests over all other to favour pay packages that SEEN
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RESULTED
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as a legal principle.49 As has been increases and short-term returns, COMPETITIVE
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shareholder interests, then the duty as a reason for ignoring social #%/
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likelihood of excessive risk-taking responsibility issues. This entrenchment of shareholder EXECUTIVE
TEAM
PLANNED
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REPOSITION
THE
COMPANY
is increased. Examples of the kind value maximisation in the UK raises envisaged by Haldane include Similarly, the ACCA report into the a number of questions relating 49 The Shareholder IN
GROWING
MARKETS
BY
AN
AGGRESSIVE
PROGRAMME
RBS’s series of debt-funded Company Law Review interviewed to company performance – if Value Myth, p56 OF
ACQUISITIONS
AND
DISPOSALS
!S
AT
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50 David Collison, Stuart acquisitions in the early 2000s, a number of individuals who had shareholders’ focus is so short-term, Cross, John Ferguson, PROGRAMME
WAS
NOT
SUCCESSFUL
4HE
SHARE
PRICE
or Northern Rock’s programme of participated in the review, and what alternative business objectives David Power and Lorna Stephenson, Share- COLLAPSED
AND
AFTER
A
MAJOR
DEBT
FOR
EQUITY
SWAP
borrowing to increase the number concluded that the review and the would better sustain the UK economy holder Primacy in UK THE
COMPANY
WAS
BROKEN
UPm
47 of mortgages they offered. Both subsequent 2006 Companies Act in the long run? In whose interests Corporate Law: An Exploration of the Ra- organisations had to be rescued were intended to further entrench should businesses be run, and tionale and Evidence, DURINGTHElNANCIALCRISIS shareholder value. how could executive performance ACCA, 2005, p5 MEASURESREmECTTHIS s 51 Kay Review, p58 52 Kay Review: Interim Report, p13 22 23 High Pay Centre Paid to Perform: What do we want What else do companies do? our business Success is about more than profit leaders to achieve?

l)TmS
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TO
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businesses to the UK as a whole, enhancing products or services. UK as a whole, it therefore makes it is necessary to study what would )TmS
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 customer service does not make This provides the practical wellbeing business sense on a long-term basis, JUSTIlCATIONFORSOCIETYSSTAKEIN By the same logic, the individual and also has a short term impact company performance. But there For example, 24 million people work companies that make up the on consumer wellbeing. If we want is also a moral case. Society as a in the private sector across the UK, economy as a whole should also BUSINESSESTOBEOFPRACTICALBENElTTO whole bears the cost of a number of with over half of them working for consider their value beyond narrow society, then performance measures the negative externalities generated large companies. lNANCIALMEASURES3OMANYPEOPLE relating to customer satisfaction by companies. The business spend such a large part of their lives must be given greater prominence, sector accounted for 31% of UK As such, a huge number of people’s working for large companies that the particularly in relation to executive pay. Greenhouse Gas emissions in 2010 day-to-day lives are shaped by contribution of those companies to (the most recent year for which companies: their standards of living individual wellbeing is critical. Yet Broader impact END USERlGURESAREAVAILABLE 55 are dictated by what their employer this information cannot be captured Excessive levels of executive pay pays, and how they are treated USINGTHElNANCIALPERFORMANCE On a macro level, the UK’s economic awarded by large companies by colleagues and management; measures currently in place across prosperity as a whole depends on increase inequality and thereby their future prospects are shaped most of the FTSE 100. factors such as the skill level of the MAKEASIGNIlCANTCONTRIBUTIONTO by employment and training workforce; or the spending power the myriad of social problems - opportunities. Customer care of consumers. These are, in part, including poor public health, low contingent on the levels of training, levels of trust and a higher prison There has been a huge interest in Many of the arguments used to employment and remuneration offered population – that occur in more ‘wellbeing’ as a measure of national advocate performance measures by individual companies. unequal countries. prosperity in recent years, with a THATREmECTEMPLOYEEINTERESTSCAN growing number of mainstream also be made in relation to customer Private sector funding for R&D and the Practices such as tax avoidance; politicians taking an interest in satisfaction. capacity for companies to innovate reductions in staff costs and training ways of evaluating quality of life contributes to the UK’s economic budgets; or the use of cheaper but BEYONDNARROWlNANCIALMEASURES Companies play a key role developing dynamism and potential for future environmentally damaging business In France, Nicolas Sarkozy and delivering many of the most GROWTH4HE+AY2EVIEWIDENTIlESTHE processes can all lead to increased, commissioned leading economists essential and life-enhancing products decline of business investment as a SHORT TERMPROlTABILITYANDHIGHER Joseph Stiglitz and Amartya Sen to and services available today. proportion of GDP, relative to France, returns to shareholders, but create 54 Kay Review, p15 55 53 Department for Guardian, David look at ways of measuring national 4HEREFORE THEYEXERTAMAJORINmUENCE Germany and the USA, as a future costs elsewhere that must be Cameron aims to make Energy and Climate 54 happiness the new wellbeing. UK commentators such on the wellbeing of their customer strategic economic threat. borne by the population as a whole Change, UK Emissions GDP, 14 November as Adair Turner and Robert and base, as well as their employees through avoidable public spending Statistics via http://www. 2010 via http://www. decc.gov.uk/en/content/ guardian.co.uk/poli- Edward Skidelsky have argued that Business also makes a vital funded by general taxation. cms/statistics/climate_ tics/2010/nov/14/david- GDP does not properly measure 4HEUSEOFlNANCIALPERFORMANCE contribution to UK tax revenues. The Thus, it is entirely possible that stats/gg_emissions/ cameron-wellbeing- uk_emissions/uk_emis- inquiry accessed 13 our success as a society. David measures suggests the successful 5+SPUBLICSPENDINGDElCITBALLOONED a business could be performing sions.aspx accessed 1 October 2012 Cameron stated in 2010 that: delivery of products or services is ININTHEAFTERMATHOFTHElNANCIAL successfully according to the November 2012 24 25 High Pay Centre Paid to Perform: What do we want Conclusions and our business Recommendations leaders to achieve?

prevailing performance measures in ‘silicon fen’ around the University Business leaders are encouraged Therefore, we believe that overall used across the FTSE 100, yet still of Cambridge, funded, in part, with TOINCREASEPROlTSOVERTHESHORT performance-related-pay, which have an overall damaging effect on public money, demonstrates the term with a focus on returns for can be around 900% of base society. Measures that record the importance of government support shareholders. The executive salary, should form a much smaller environmental and socio-economic for industry. Research carried out at pay packages that are attached proportion of total pay packages. impact of our biggest companies the University, and its liberal attitude TONARROWlNANCIALMETRICS are clearly vital to understanding towards its intellectual property, have like Earnings per Share or Total If performance-related pay is to their overall value. If these measures been crucial to the development of a Shareholder Return, are a direct result continue, it should be much less determined the size of executive thriving business cluster. of the view that ultimately shareholders complex, with one performance- pay packages, then it is likely that are the only constituency that matters related plan as part of the package, the improvement of society as a This funding for R&D is in addition to a business. judged against a small number of whole would be a much higher to the more general infrastructure, MEASURESTHATARECLEARLYDElNED priority for UK businesses. provided or guaranteed by the In many cases, these pay packages ANDQUANTIlABLE!TLEASTOF government, that enables businesses have incentivised decisions that the performance-related element In addition to covering these on- to thrive – roads and public transport have not turned out well for the should be attached to the underlying going costs resulting from the networks, schools and universities, company in the long-term, even NON lNANCIALMEASURESOFCOMPANY negative externalities produced by publicly-funded healthcare, the INlNANCIALTERMS LETALONETHE performance, that give a true picture large companies, society also plays rule of law and a stable economy environmental and social damage of an executive’s achievements, a key role in generating business in that maintains steady growth in that can result from a disregard for RATHERTHANTHEHEADLINElNANCIAL THElRSTPLACE-ARIANA-AZZUCATO consumption. business’s wider responsibilities. lGURES4HISCOULDBEENSHRINEDBY highlights the important but the Financial Reporting Council in the understated role that state funding While certain narratives depict This model needs to be fairer and UK’s corporate governance code. played in the development of wealth-creation as the work of more sustainable. Companies should technologies vital to recent growth in individual entrepreneurs or intrepid widen their objectives beyond Many mainstream shareholders are key business sectors. She asks: companies, the truth is far more the narrow focus on shareholders starting to recognise that short- complex. Government may derive TOREmECTTHEINTERESTSOFALLTHE TERMlNANCIALPERFORMANCEISNOT (OW
MANY
PEOPLE
KNOW
THAT
THE
ALGORITHM
THAT
its resources from individual stakeholders who are affected by the only measure of company LED
TO
'OOGLEmS
SUCCESS
WAS
FUNDED
BY
A
PUBLIC
households or companies, but it also the company’s activities and who success. They have suggested that SECTOR
.ATIONAL
3CIENCE
&OUNDATION
GRANT
/R
THAT
generates wealth on their behalf as an contribute to its success. Executive measures such as employee and MOLECULAR
ANTIBODIES
WHICH
PROVIDED
THE
FOUNDATION
aggregator, co-ordinator and investor PAYPACKAGESSHOULDREmECTASIMILAR customer relations, or corporate FOR
BIOTECHNOLOGY
BEFORE
VENTURE
CAPITAL
MOVED
INTO
on a scale that is vital to collective balance of interests. social performance should have prosperity yet impossible for private a much greater weighting in THE
SECTOR
WERE
DISCOVERED
IN
PUBLIC
-EDICAL
2ESEARCH
judging a company’s success.
 individuals or organisations to achieve Recommendation 1: #OUNCIL
-2#
LABS
IN
THE
5+
in isolation. At least 50% of executives’ The Association of British Insurers Mazzucato’s paper notes that the performance-related pay recently called for more non- state plays a more prominent role Therefore, Government should be packages should be tied to lNANCIALMEASURESINEXECUTIVE in R&D in the US, where it accounts seen as a key stakeholder in business NON ÚNANCIAL
METRICS
SUCH
pay packages.58 Paul Polman, the for 57% of basic R&D funding. Even performance, not only because of as employee engagement; Unilever CEO has said that in the UK however, the Government the impact of businesses on wider customer satisfaction provides 32 per cent of R&D society, but also because businesses and; corporate social and
l7E
NEED
NEW
BUSINESS
MODELS
funding,57 compared to 44 per depend on publicly funded research environmental performance c
THAT
TAKE
INTO
ACCOUNT
NOT
JUST
cent provided by businesses. The and infrastructure. So company THE
ECONOMIC
BUT
THE
SUSTAINABLE
58 Guardian, Curb ex- objectives and executive performance The High Pay Centre remains ecutive pay rises, insur- contribution of government-funded AND
EQUITABLE
PARTS
OF
GROWTHm ers tell top companies, 56 Mariana Mazzucato, research to sectors such as health MEASURESSHOULDREmECTTHEPUBLIC sceptical of performance-related 26 November 2012 via The Entrepreneurial and pharmaceuticals; or defence interest, as well as the interest of their pay – the academic evidence !TTACHINGNON lNANCIALPERFORMANCE http://www.guardian. State, Demos, 2012, co.uk/business/2012/ p19 ANDAEROSPACEISSIGNIlCANT4HE shareholders.s looking at whether or not it actually measures to executive pay nov/26/curb-executive- 57 Ibid p51 growth of technology businesses improves performance is mixed. packages would not be a pay-advise-insurers 26 27 High Pay Centre Paid to Perform: What do we want our business leaders to achieve?

complicated process – many MEASURETHATGIVESADElNITIVE in top pay packages. Putting narrative of business prospects, companies undertake independent overall verdict of the company. This standardised, readily comparable plus a more detailed ‘Annual audits of their employee and is debatable – it could be argued NON lNANCIALDATAINTHEPUBLIC Directors Statement’ featuring customer engagement. THATCERTAINNON lNANCIALMEASURES domain would create pressure on SPECIlC COMPARABLE QUANTITATIVE like brand perception or customer companies to prioritise performance information. Companies such as BT Group (for satisfaction, for example, provide in these areas. It would also enable customer satisfaction) and Centrica a more fundamental gauge of them to use this data to measure The Strategic Report could require (for employee engagement) already sustainable success than earnings executive performance. companies to provide qualitative FACTORNON lNANCIALPERFORMANCE or share price. A comprehensive information describing their into their executive pay packages. environmental or social balance A model for implementation of relationships with employees; Currently, they only account for a sheet such as that pioneered by mandatory reporting already customers; suppliers/partners; small proportion of their total pay Puma records a company’s value to exists in France, where the New and society. This should cover package, but there is no reason why society as a whole more accurately. Economic Regulations (NRE) past performance and forthcoming this could not and should not be have mandated social and challenges in these areas with increased, provided remuneration Perhaps as importantly, it is clear environmental reporting for listed particular reference to public trust; committees who set pay, exert that the charge of subjectivity is at companies since 2001. Prescribed brand development; long-term vigilance to prevent executives from least as applicable to the prevailing quantitative performance measures business strategy; de-carbonisation using them as a means to secure lNANCIALMEASURESCURRENTLYUSED relate to employee relations and and sustainability; and compliance HIGHPAYPACKAGESWHENlNANCIAL to calculate executive pay, and that environmental impact. Companies with relevant business or performance has been poor. indicators such as EPS and TSR are also compelled to include environmental legislation. REmECTAVERYNARROWCONCEPTIONOF qualitative narrative reporting on The primary argument against these company success. areas such as employment policies; The Annual Directors’ Statement measures is that they are subjective, environment management; human SHOULDMANDATESPECIlC and do not provide a single Pay attached to stakeholder rights; and community relations. QUANTITATIVENON lNANCIALDATAIN ‘bottom line’ indicator of company/ interests would also establish This mirrors the two tier reporting order to validate the information on executive performance, nor is there a clear principle that company structure envisaged by the coalition stakeholder value outlined in the ASINGLENON lNANCIALPERFORMANCE executives have a responsibility government for the UK. Strategic Report. to all those who contribute to a company’s wealth and are affected Research by Elise Perrault Crawford This should include the following 0UMA
PROÚTS 59 Elise Perrault by its actions. Executives would be and Cynthia Clark Williams; and CRITERIA REmECTINGREQUIREMENTSTHAT Crawford and Cynthia rewarded for leading companies by Mary-Lou Egan et al found currently exist in France, or have Clark Williams, Should 0UMA
HAVE
DEVELOPED
AN
ENVIRONMENTAL
PROÚT
AND
that make a net contribution to that though compliance with the been advocated by campaigners for corporate social report- loss account, designed to calculate their resource ing be voluntary or society, rather than ones that extract NRE was not universal, mandatory socially responsible business: mandatory? Evidence use and Greenhouse Gas emissions from their value from it. REPORTINGHADSIGNIlCANTLY > Staff turnover and Staff absences from the banking entire supply chain. Puma CEO Jochen Zeit said sector in France and improved disclosure of social and > Pay differential between highest the United States in he believed that the audit would ultimately be to the Recommendation 2: environmental performance; and paid employee and the median Corporate Governance, company’s commercial advantage: Vol 10, No. 4, 2010, Companies should be required made sustainable development > Working days lost to injuries p512-526; and Mary to report on employee a more integral part of French sustained in the workplace, and Lou Egan, Fabrice ‘I think there is no way around it for businesses that engagement; customer companies’ business models.58 deaths in the workplace (if applicable) Mauléon, Dominique have long term view and that believe in building Wolff and Marc Bendick satisfaction; and social and > Consumption of water, energy, Jr, France’s Mandatory brand equity long term rather than quarter-by- environmental performance These requirements could be raw materials/natural resources; and “Triple Bottom Line” Reporting: Promoting quarter. I believe that regulation will also kick in implemented as part of the new use of land throughout supply chain AND
ENVIRONMENTAL
PROÚT
AND
LOSS
WILL
BECOME
A
Sustainable Develop- Stronger requirements on the framework on narrative reporting > Emissions of wastes into ment through Informa- standard because it’s such a powerful idea that you DISCLOSUREOFNON lNANCIALREPORTING that the Government is developing. air, water, and land, including tional Regulation in The can’t ignore it. I believe that either way, push or pull, International Journal of would support the use of non- This involves a ‘strategic report,’ Greenhouse Gas emissions, Environmental, Cultural, it’s going to happen.’ lNANCIALPERFORMANCEMEASURES providing an over-arching throughout the supply chain Economic and Social Sustainability, Volume 5, No. 5, 2009, p27-47 28 29 High Pay Centre Paid to Perform: What do we want our business leaders to achieve?

> Investment in Environmental their impact on society initiate a constituents generate a substantial !REVISEDlDUCIARYDUTYWOULDEMBED Management dialogue with their wider community amount of business from the public THEUSEOFNON lNANCIALPERFORMANCE > Investment in Research and of stakeholders that can lead to sector – service providers; the measures along the investment Development, and staff training improved social and environmental defence industries; construction chain, thereby encouraging their use > Tax paid in the UK outcomes. They should be subject ANDENGINEERINGlRMSORENERGY throughout the economy. It would > Fines paid to Governments for to lower rates of taxation than those companies. also allow pension fund trustees to business or environmental violations companies that refuse to consider take a longer-term perspective, on the environmental and social costs )FREPORTINGONNON lNANCIAL the basis that longer-term investment These would not represent an of their actions and therefore impose measures increased their likelihood is more socially/environmentally onerous set of requirements. a higher cost on society as a whole of winning government contracts, responsible. This would reduce the There is a clear public interest in THISWOULDREPRESENTASIGNIlCANT need to benchmark fund-managers knowing the impact that individual The Social Value Act which comes incentive to comply with the reporting on a quarterly basis in a way that companies have in these areas, and into effect in January 2013 also requirements that we propose. encourages frenetic trading activity the measures cited are universally provides a framework within which measured solely by short-term share applicable across sectors. It is also the government’s huge procurement Recommendation 4: Pension price movements, rather than the in the interests of companies and budget could be used to further fund trustees, investment wider impact of investment decisions. their shareholders to collate this promote social and environmental managers and commercial information and maintain it in order reporting. Government is currently pension providers should Recommendation 5: to analyse potential threats to the required to achieve best value when take into account social and Employees should have a brand or customer/employee loyalty. awarding contracts for public service environmental concerns when company-wide advisory vote works. The Act recommends that making investment decisions on executive pay packages, and Recommendation 3: Tax rates ‘best value’ should be understood non-executive representation and government procurement in terms of the social, environmental In addition to encouraging the on company boards criteria should be used to and economic outcomes arising USEOFSPECIlCNON lNANCIAL ENCOURAGE
NON ÚNANCIAL
from a contract award, not just the performance measures, It is vital that a wider range of disclosure cost of the service provided. So, government could create a stakeholder interests are included for example, an organisation that business climate that facilitates the in corporate governance structures, Compliance with the New Economic undertakes to pay the living wage or ADOPTIONOFNON lNANCIALBUSINESS to combat the obsession with Regulations in France has been provide apprenticeships or run the objectives more generally. shareholder value and ensure impressive, but not universal. If, service on a carbon neutral basis as that a company’s performance is like France, the UK chooses not part of their offer may be considered Incorporating social and understood in terms of its value to to enforce mandatory reporting better value than a competitor environmental concerns into society as a whole. We argue that through judicial means, there are a bidding for the contract at lower cost. investment decisions is a key part of employees are the stakeholder number of other levers open to the this. Investors currently argue that community best suited to this role. Government in order to encourage Disclosure on employee they are legally obliged to maximise full disclosure. engagement; customer satisfaction; returns, even when the wider Employees have arguably a much and social and environmental CONSEQUENCESFORTHEBENElCIARIES greater stake in a company’s Corporation Tax is the most obvious performance are vital to achieving are negative – for example, sustained success than shareholders, incentive. It would be relatively social value – companies willing to dangerous climate change arising because their livelihoods depend on simple to introduce a reduced tax engage in these areas are likely to from investment in energy intensive it and their risk is not spread among rate for companies that commit to have a much more positive impact businesses; the economic damage other investments. reporting against all the indicators on their communities, and should concentrated in geographic areas that we describe above. therefore be favoured by contract- resulting from a ruthless cost-cutter Therefore, they have far more awarding public bodies. This would shutting down a major employer; or to lose if the company fails. As 4HISWOULDREmECTACLEARAND hugely increase the importance that the damage done more generally by company employees invariably understandable principle of COMPANIESATTACHTONON lNANCIAL market volatility resulting from short- live in the community in which fairness. Companies that disclose performance. Many of the FTSE 100 term trading. the company is situated, they 30 31 High Pay Centre Paid to Perform: What do we want our business leaders to achieve?

are also likely to be concerned and effectively executive pay encouraged excessive risk-taking; with reputational issues arising incentives. But they fail to measure and a mis-guided understanding of from poor social or environmental THEBENElTOFCOMPANIESTOSOCIETY business objectives. performance. So they represent a beyond a narrow constituency of closely-aligned and feasible proxy shareholders. A revised conception of what for the interests of wider society in constitutes good company company performance. Many of the coalition government’s performance supported by the reforms to corporate governance policy changes proposed in this For example, employee rely entirely on shareholders as paper would go some way to representatives concerned with a agents of reform. Proposals to ADDRESSINGTHESESTRUCTURALmAWSs company’s long-term sustainability address the market failure on would have an interest in executive pay rely on a binding challenging short-termist practices shareholder vote on pay, while the such as stock buyback, or cuts new narrative reporting regulations in research or staff development are intended budgets. They would be unlikely to accept inequitable executive pay lTO
PROVIDE
THE
INFORMATION
packages that are many times what SHAREHOLDERS
NEED
TO
UNDERSTAND
they themselves earn. HOW
THE
COMPANIES
THEY
INVEST
IN
ARE
BEING
RUNm

 Employee representation already works successfully in Germany, But the changing nature of which is home to 32 Fortune 500 share-ownership, with a higher companies across industries proportion of international investors; including the manufacturing, short-term traders; and diverse AUTOMOBILE ENERGYANDlNANCIAL portfolios means that shareholders services sectors amongst others. cannot always be relied upon This suggests that the fear of to take a long-term interest in employees on boards is unfounded, the sustainability of individual and that the policy could be equally companies, or their impact on effective in developing a longer-term wider society. OUTLOOKANDBROADERDElNITIONOF company success in the UK. The measures that we propose to address this should not be seen Conclusion as an additional regulatory burden on companies, but as a package The central argument of this report of stability mechanisms designed ISTHATNARROWlNANCIALPERFORMANCE to help them develop a long-term, 60 Department for Business, Innovation measures do not encourage sustainable focus. Though well- and Skills, The Future sensible long-term stewardship of intentioned, constant talk of ‘red of Narrative Report- a company, nor do they accurately tape’ creates the impression that the ing: the Government Response via http:// portray its past performance or major corporate disasters of the past www.bis.gov.uk/assets/ future prospects. two decades – ICI, GEC, BP, RBS, BISCore/business-law/ docs/F/12-588-future-of- Northern Rock, Lloyds/HBOS – were narrative-reporting-gov- Businesses focus on earnings per CAUSEDBYSTImINGREGULATION RATHER ernment-response.pdf accessed 13 October share and total shareholder return than weak corporate governance; 2012 to gauge company performance poorly-structured incentives that 32 33 Design | Rachel Gannon