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It was Charlie Munger, Warren Buffett’s partner in quotable business aphorisms, who once quipped: “Show me the incentive and I will show you the outcome.”
So it is no surprise that, over the decades in which the consensus set in that a chief executive’s main job was to create value for their shareholders, boards began adding ever more stock to CEOs’ compensation packages. This, the refrain went, was the way to match up the interests of managers and owners.
Yet a couple of strange things have happened in the two years since the US Business Roundtable made its symbolic break with shareholder primacy.
First, the investors, with whose interests executives were supposedly so well aligned, have begun voting against CEOs’ compensation packages in ever larger numbers. Second, heedless of Munger’s mantra, executives’ incentives have remained overwhelmingly focused on shareholder outcomes, even as they have been busy professing what fine stakeholder capitalists they are.
So the way companies now pay their top officers is failing to satisfy shareholders while undermining executives’ credibility as guardians of other stakeholders’ interests.
This week, a study spanning seven European countries found an 18 per cent increase this year in shareholders dissenting over pay resolution.
In the US, too, protests over executives’ rewards have hit a record high, with once placid institutions baulking at the $230m GE gave CEO Larry Culp and the $155m Bobby Kotick took home for running Activision Blizzard.
You don’t have to be Bernie Sanders to wonder how much empathy a CEO earning nine digits has with employees and other stakeholders barely scratching a living. Yet it is still startling that three-quarters of investors now think that executive pay is simply too high, as a recent London Business School survey found.
Only 18 per cent of investors bought the familiar argument that such high pay is needed to “recruit and retain” the best executives. But what about the non-shareholders? In a controversial analysis of Business Roundtable members’ actions since signing 2019’s stakeholder pledge, two Harvard Law School academics last month found that none had yet tied directors’ compensation to stakeholders’ interests.
That seems unlikely: other studies suggest that more than one in five US companies now includes some environmental, social or governance metrics in their incentive plans, such as goals for increasing diversity or cutting carbon emissions.
But those stakeholder metrics which boards have adopted typically focus on annual bonuses and put little of the CEO’s total compensation at risk. Investors suspect that boards are simply adding complexity to already conveniently impenetrable packages.
Meanwhile, as accounting standard setters have yet to agree common definitions for most ESG measures, there is equal concern that boards are picking pet metrics and setting targets that will be hard to miss, inflating packages further.
The conditions are ripe, then, for a rethink of compensation norms, but can incentives be redesigned to produce outcomes that satisfy both shareholders and other stakeholders?
The answer lies in the economic logic that persuaded so many executives to espouse the stakeholder agenda in the first place: that, at least in the long term, doing the right thing by employees, customers and the environment builds value for shareholders.
That is making investors increasingly keen to see more CEO packages take the form of simple grants of equity, held for at least five years, says Alex Edmans, one of the authors of the LBS study.
Most environmental and social goals cannot be achieved in the time between annual bonus awards. Better, instead, to incorporate only the most relevant and clearly measured of them into longer-range stock awards, of which a significant portion will be at risk if the goals are missed.
If more stock sounds a perverse prescription for a stakeholder-driven age, it need not be if boards take two further steps.
First, directors need to ask whether they can justify the potential payouts to all of their stakeholders. It is becoming clearer that the worst excesses of C-suite pay are damaging relations with shareholders and trust in capitalism more broadly. Reining them in would not only head off clashes with investors or hostile politicians seeking to impose pay caps — it might just rebuild some trust.
Second, if boards truly believe that equity ownership is vital for focusing executives on shareholder value creation, then they should extend that logic to other employees.
As one Harvard Business School study found, businesses with widespread employee ownership “are more productive, grow faster, and are less likely to go out of business than their counterparts”.
If anything would align the interests of investors and the staff who the majority of CEOs see as the most important of their stakeholders, it is making more employees shareholders.
Given that most CEOs are already multimillionaires, boards might even reflect on what might happen if they took a chunk of the stock reserved for executives and distributed it around people for whom even a small stock payout would be a transformative incentive.