The Advisors' Blog

– Subodh Mishra, ISS Governance Exchange

Britain’s High Pay Centre is warning companies against the failure to link “at least half the performance pay of top executives to broad measures of success,” suggesting British businesses risk losing out to foreign rivals using such incentive models. The center, a non-partisan think tank established in the wake of the financial crisis to “monitor pay at the top of the income distribution,” said in a Jan. 14 report that executive pay packages across the largest 100 U.K. companies are “overwhelmingly” linked to short-term financial measures of corporate performance such as earnings and share price movement. As a result, the center argues, executives are “encouraged to focus on short-termism, cost cutting and the need for quick returns.”

The group notes that CEO pay has tripled to 4.8 million pounds in 10 years “without any accompanying long-term increase in share values.” “British business will erode its competitive edge even further if it doesn’t start looking beyond share prices and reward executives for their success in fundamental areas of non-financial performance,” said High Pay Centre Director Deborah Hargreaves in a Jan. 14 statement. “We’ve got to start taking a longer term view and that means persuading business that performance in areas like corporate social responsibility, employee engagement and customer satisfaction rates are the key to lasting business success.”

The report finds that total shareholder return (TSR) is used to calculate at least one element of performance-related pay at 74 of the largest 100 U.K. companies, with 96 companies using either TSR or earnings per-share (EPS), or a combination of both to determine performance for their chief executives’ long-term incentive plan. Most companies, the center argues, pay little or no regard to the long-term benefits of non-financial performance across areas like employee engagement, corporate social responsibility and customer satisfaction.

In addition to calling on businesses to link at least half of chief executives’ performance related pay to non-financial yardsticks, the High Pay Centre said it is seeking the introduction of mandatory reporting on social and environmental performance and a new tax and procurement incentives “to encourage companies to focus on wider measures of performance.”

The group also wants requirements for pension fund trustees, investment managers and commercial pension providers to take into account the social/environmental impact of their investments on beneficiaries and for employee representation on company boards “to challenge decisions based on short-term financial considerations that may jeopardise the company in the long-term.”

The High Pay Centre says longer-term institutional shareholders like the Association of British Insurers “support broader measures” of executive performance and says leading businesses like BP, Barclays and HSBC, who have suffered reputational damage, “have gone further than others to link top pay to non-financial measures of success.”