It’s Performance, Not Pay
By Philip Whiteley
High rewards for senior executives have caused outrage, particularly in the banking sector, large parts of which have been bailed out by western taxpayers in the past few years. Income inequality is now a major political issue, being highlighted by, among others, François Hollande and Barack Obama in their campaigns for the French and US Presidencies, as this FT article illustrates [paywall].
There is a natural tendency to focus on the sheer amount being paid, but of more significance are the justifications given and the beliefs that guide these. Defenders of high pay argue that they are justifiable if it motivates executives to stronger performance. Given that there have been some significant failures at corporations run by very highly paid executives in recent years, these considerations prompt major questions:
- What constitutes good performance?
- What constitutes fair reward for exceptional performance?
- Should these principles extend throughout the organization?
The approach that has been dominant in the past couple of decades is that shareholders ‘own’ the company (not strictly true, but that has been the assumption) and that senior executives can only be expected to perform well if they are highly remunerated with schemes that are ‘aligned’ with share prices.
This approach is called ‘agency theory’. One problem with it is that people are only seen as an asset to be highly rewarded at the very top of the organisation. At lower levels, pay is seen as a cost to be minimised. There is even a completely different theory relating to pay at lower levels in the hierarchy. This is the idea that pay is a ‘hygiene’ factor – capable of de-motivating if it is too low, but not capable of prompting higher performance.
So the corporate orthodoxy in recent years is that pay for junior staff cannot motivate better performance – but that at senior levels it is the only thing that motivates!
Not only are these beliefs unproven, but if there is a tendency, it is likely to be in the opposite direction: that is, the link between pay and motivation is stronger at lower income levels. If a pay rise means providing a decent home, good food and better holidays, it is transformational for a family’s living standards. By contrast, a huge pay rise for those who are already well off has no real impact on living standards and is mostly to do with status. As such, it is likely that high reward can contribute to irrational exuberance and excessive risk-taking, as well as good performance.
The dominant theories around pay have not been based on empirical evidence. Such studies as do exist indicate that attributes of effective leadership include the ability to hire and retain the best skills, maintain high employee engagement, and be responsive and nimble as an organization. This evidence has been around for years – notable researchers are Jeffrey Pfeffer, Mark Huselid and Laurie Bassi – but evidence has not yet been the dominant influence in corporate strategy-making or the setting of executive pay.
One matter that has been striking about some corporate failures in the past decade, for example Arthur Andersen, the Royal Bank of Scotland and UK furniture retailer MFI, is that in most of their activities these organizations performed well, staffed by people of integrity providing good service to thousands of customers. They were brought low by excessive risk-taking or misjudgement by a relatively small number of senior managers.
This dynamic illustrates the risk in paying large sums tied to short-term indicators, but also the importance of attracting and retaining the best leaders as the decisions they make are so important. Everyone who has lost their job at these firms would have been happy to see higher pay at the top if it had ensured organizational sustainability. The current controversy is more about performance, than it is about pay.
The lessons are that greater rewards for the executive and alignment with shareholders do not guarantee good performance, and may encourage high risk taking; but that greater equality in pay does not necessarily help the worker. The need is for much deeper knowledge on the actual contributions made, throughout the organization, and about the risks as well as the potential gains of high executive pay.
Philip Whiteley is a renowned author and journalist in the UK, specializing in the working environment and business performance. He argues that management requires a conceptual shift, recognizing human activity and skills as the source of all assets, rather than just an item on the balance sheet. His book “Meet the New Boss” was shortlisted for the 2010/2011 Chartered Management Institute Management Book of the Year Award, Digital Book category. Philip’s most recent book, “New Normal, Radical Shift “explores the theory underlying recent approaches to corporate governance, and where they may have gone wrong. For an online excerpt click here.