Bryan Innes, Senior Client Partner – Towry
Sally Claridge, Compensation and Benefits Manager – Oxford Instruments plc
Diana Crisp, HR Manager – Imperial Innovations
Sheila Edmund, Interim Reward Consultant
David Ellis, Head of Reward – KPMG
Gordon Clark, Partner – Kepler Associates
Jane Williams, Interim Reward Director – People Innovations Ltd
Sharon Williams, Director of HR – Bright Horizons
The remuneration culture for executives is more important today than it ever has been. Never before has top-tier reward been so directly linked to brand and reputation, as well as the ethical and corporate social responsibility credentials of a business, its workforce, partners, brand, product and services.
Attitudes to reward have changed irrevocably and organisations are held to strict account by the so-called “shareholder spring”, the media and the wider public. This is not about soundbites or paying lip-service to good practice, it is about a deep and comprehensive strategy that rings sonorous culture change and actively promotes ethical and responsible behaviour, balanced with remuneration management that is fair, equitable and above all about achievement. There is also a strong case for finance education in the workplace as well as managing the wealth of top executives to ensure that wealth achieves optimised financial objectives.
What lessons have been learnt from the reward culture that contributed to the economic downturn and what are the key challenges to rebuilding reputations and trust?
Gordon Clark: To say the reward culture was the key contributor to the economic downturn, exaggerates its role. It had a role, but it was not the primary cause. It is human nature for people to want to perform well, and be rewarded. The key challenges to rebuilding reputation and trust are; better communication, understanding the views of other stakeholders, better governance, independent committees and advisers, and executives who are paid, and seen to be paid, fairly for their contribution.
Bryan Innes: How do you reward your senior executives in today’s climate? Is it purely financial or are there more innovative ways? What do individuals really value and what price is there on financial wellbeing? Executives don’t have the time, desire or expertise to focus on their own affairs, given the pressures on business. Focusing on financial reward can be very pointed when a more rounded approach may be more appropriate. Paying a bonus when the company is making a loss could be viewed as fundamentally and morally wrong, however a business (private) has the right to pay what they think is appropriate. The question I would ask is, could employers do more to help individuals personally achieve their life goals and financial objectives?
David Ellis: Pay can drive behaviour, encourage people to sell, but questions as to the risk profile of the product being sold, who is an appropriate buyer and whether the transaction is appropriately risk managed should never be governed by an incentive plan. That is the role of external regulation and internal governance framework, which businesses are subject to. That is what needs fixing. Changes in how people are paid will follow regulation and governance, but cannot take its place.
Jane Williams: Reward strategy has to take into account a much wider group of stakeholders including the general public and shareholders. The overall level of accountability is rising considerably, especially as those in front line services, are facing job and salary cuts. This has to be balanced when looking at executive remuneration and in consideration of rewarding people who run large businesses with huge responsibilities – it is a fine balance.
Sheila Edmund: I would say there’s definitely change with regards to focus on more strategic measures, so if anything, it’s leading to greater complexity. At least there is greater business alignment and we’ve moved from the measures, such as just relative TSR, to those really driving the business. That has got to be good because it’s more aligned with the business and shareholders’ agenda. Where there’s a mismatch is between the design of plans for the Chief Executive Team and the different set of reward plans lower in the organisation. I believe that the whole organisation needs to be aligned. However, a challenge is the complexity and probably less than 30 percent of senior leaders really understand their plans. So fundamentally are they really motivated by these? Also the issue of longer deferrals, are you really motivated by something being paid in three years time? I think that is also illustrated further down the organisation where we’ve looked at pay and engagement and people have said just “make it simpler”. I think complexity and granularity of measures is a big challenge for effective employee communications.
Has it got better or worse? Is it unnecessarily – or purposefully by design, over complex?
Sheila Edmund: In some ways it’s got better, people have a very clear understanding of what the organisation is focused on, and there’s a lot more communication around it. However, it’s got worse in terms of trying to break it down too much and can potentially create conflicts between different parts of the organisation. I can think of a situation where one area of the business has been negatively impacted by bonus measures on working capital in another part of the business. So there can be unintended consequences and you need to be careful to consider whether plans will drive the right behaviours across the whole business.
Katie Kenny: Recent commentary from shareholder bodies has placed significant focus on evolving and simplifying executive pay. The Kay Report suggested that long-term incentives should be paid solely in shares that don’t vest until executives retire, an interesting way of looking at pay. Other models are valid and should be explored, but I don’t think that the current pay model is necessarily broken, but it could be better.
Jane Williams: Responsibility, accountability and transparency is the way to rebuild trust.
Diana Crisp: Simplicity is key and a transparent performance management process where a few core goals that drive the right behaviours, are cascaded and aligned across the organisation. Reward strategy must link to business strategy, and the more complexity introduced, the greater the potential to exploit loopholes, manipulate ratings and mask underperformance.
Sally Claridge: We’re currently working on a project to refine and simplify our bonus schemes, due to employees not understanding them completely. We are making the communications a lot clearer, introducing more long-term plans and additional bonuses.
Sharon William: I think we do overcomplicate a lot of things, where actually taking a less-ismore approach, is much more effective. I can’t see how you can have a reward strategy without linking it into the business strategy, so there are two aspects for me, one is around wellbeing, the financial wellbeing – so educating people, not just execs, but across the organisation. Most people need some form of financial wellbeing, whether it’s how to do their budgeting and how to save for the future. A lot of this is about education and awareness, and we need to align bonus plans, long-term incentive plans and remuneration, to the business strategy.
Gordon Clark: Everybody’s against complexity for its own sake, so we need to understand the root causes and sources of complexity in order to simplify incentives, without reducing their effectiveness.
Sheila Edmund: It’s trying to meet the business drivers with what shareholders want, including making all the long-term incentives performance-related. Fundamentally, managers also have a belief that if they pay for something it will have the right focus. There is a tendency to want to just add more and more measures. In my last organisation we had to adopt a “one in one out” approach to requests, to address the proliferation and complexity of measures.
What do you think is driving this complexity, committee design, everybody adding bits over time?
Gordon Clark: Nobody deliberately introduces complexity without a good reason. But if the people designing an incentive focus on optimising every detail, they may fail to optimise the whole.
David Ellis: Pay will be complex, it’s a complex world. The issue is not complexity, but that people understand what they are being paid and why. Pay will not be simple, but it should be simple to understand. Most employers accept that they do not expect their executives to open their drawer and check the rules of their LTIP before they take a business decision.
Jane Williams: As an interim, you go into one business and it’s clear which measure is driving behaviours. Go to another business and you find that people don’t know which financial measures to use.
Gordon Clark: Different company cultures need different measurement and pay systems, because the way they create value differs. Operating profit may be a good measure of performance for a retailer, but not for measuring, say, the progress of a five year project of a natural resources company. Complexity is in the eye of the beholder, and the complexity that matters most is complexity in the eye of the executive being incentivised. On the other hand, simplicity cannot be the overriding objective for incentive design, as there is usually a trade-off with alignment and line-of-sight.
Katie Kenny: Conversely, too much simplicity can have unintended consequences. Focusing on just one metric may drive the wrong behaviour, which could be detrimental to the long term sustainability of the business. A test of complexity is, can your executives explain their remuneration package to you from memory? If not then it is probably not driving the behaviours an organisation wants.
Sheila Edmund: I think a lot of this is obviously cultural and relates to the history of the organisation, and what works in one organisation doesn’t necessarily work in another. It’s interesting when you look across the bonus plans of different organisations, the variation clearly reflect the ethos of the organisation and the context in which it operates. The other thing that’s really interesting is whether it is paying for something, or the impact of more attention. Better communications drives focus and changes behaviours.
Bryan Innes: At the end of the day, if the employees understand it, surely that’s the most important thing because if that encourages the right behaviours then the business is going to benefit.
Sharon Williams: I’d agree, I think if people can tell you what the remuneration strategy is then it doesn’t matter whether it’s complex or simple does it really, as long as they know what it is and how it impacts them, that would be the acid test for me.
Jane Williams: One huge complexity is pensions, which for many Executive Directors is a cash supplement, paid every month and almost indistinguishable from salary. In other places you’ve still got the complexity of managing the values in defined benefit schemes, in addition to equity, other benefits, bonus and salary, so the complete suite is complex.
What are the key considerations in setting policies and procedures as well as dealing with reward and remuneration in senior executive employment contracts?
Katie Kenny: Exit packages are clearly a very sensitive area. Remuneration Committees need to think about what is a fair result for shareholders, the executive and other stakeholders. They need to consider the external perception of any decisions made.
David Ellis: Vince Cable’s new executive pay regulations mean businesses will have to be more explicit about how they deal with executive terminations. The focus is on not rewarding for failure, but this will give rise to an unintended consequence. The treatment of executive termination will be determined by the agreed policy which will take the place of any negotiation, in effect, a form of liquidated damages.
Why is it so hard to get rid of people without incurring huge expense? Is it ambiguity and too much goodwill in contracts, for some?
Gordon Clark: There’s a perception that companies and remuneration committees are throwing money at departing executives like confetti, but payment in lieu of notice is largely bringing forward a future expense, and pro rata bonuses for periods worked are also amounts that have already been earned.
Sheila Edmund: There’s also the challenge that they’re not allowed to work for anybody else for a defined period within their contract. Restrictive contracts of 12 months, not working for a competitor, means you’ve probably got to make it financially feasible. If an organisation wants somebody to leave, then the end result is going to be that you need to pay them to leave. The bigger issue is around when people are getting big pay offs, when actually they haven’t performed, that doesn’t feel right.
Jane Williams: Why pay people to leave if they are good performers? Surely they are leaving because they wish to leave, unless there has been a fall out. In these circumstances you may consider their performance, honour their contract and it could be individual negotiation. When I begin an assignment, I check dates, signatures, the clauses around mitigation and restrictive trading so that it is clear to both parties what will happen in the event of a termination.
Katie Kenny: Notice periods have moved from 24 months to a norm of 12 months or less. Liquidated damages payments now often are limited to salary and benefits. I think companies should monitor contract provisions compared to market practice and look to update these where possible. Shareholders have to recognise that changing existing service contracts is not always easy and there may be costs.
Jane Williams: Executive Directors can be in an invidious position as stewards of the Board’s policy. Their contracts have to be reviewed from every point of organisational view because as Execs, they could be exiting people from their companies, so they have to review what is fair and right.
Katie Kenny: The new BIS regulations are due later this year and I do think, in the area of contracts and share plan leaver provisions, more transparency will be a good thing.
David Ellis: There are not as many people as we would like out there in the world who can work with the same vitality and vigour when they are serving their notice as when they are not, whatever the period of notice.
Jane Williams: Would they pay the full 12 month salary? With mitigation in place plus the knowledge that they are moving potentially to another employer, you would pay month by month.
Gordon Clark: If both parties agree to give six months’ notice, employers have to keep to the contract, while employees do not have to work with the same level of application during their notice period?
Sharon Williams: Every case is different and it’s more of a negotiation in relation to whatever the situation is. We have six months for some executives and we would have negotiated on both sides that it’s three months. I agree with you, once somebody has decided they are going, there isnt much point in hanging around very long for them or the company.
What are the key issues to consider in changing a reward culture to one that works to the advantage of the business and encourages performance and achievement across the organisation?
Jane Williams: That is the question! Beginning with assessment of the prevailing internal culture, where it works for the business and where does it not work, or any bias towards a particular stakeholder group. It usually involves a check and balance across the organisation to see if the needs are common, and working with union groups can be particularly difficult.
David Ellis: I think it is absolutely right that businesses create reward frameworks with the outcome that when the business does well then the people in the business do well also.
Jane Williams: Isn’t ethical pay about the distribution of reward? You consider the profit figure as an example with an ethical outcome in mind, then compare the balance of distribution.
Sheila Edmund: Yes, from an employee point of view, it’s about fairness internally and fairness externally and also how managers communicate how that aligns with the organisation. It has more to do with aligning with the delivery of the business strategy, and the ethics of the business and that you’re paying for the right things and the right actions in the market. One of the biggest challenges with regards to reward strategy is actually what works in some businesses might look very different in another. In the Pharma sector, there’s been constraint in pay growth in the mature markets and so this employee population probably won’t feel their pay is fair versus the rapid growth and investment in pay in the developing economies. I think that’s why it’s very difficult to actually answer a question like this when you’re talking about organisations working in the global marketplace.
Gordon Clark: One of the original BIS proposals, since dropped, was the ratio of CEO pay to average employee pay. I suspect it was dropped due to the recognition that job markets are diverse and segmented, and averaging different rates across a diverse mix and across different geographies would not have been very meaningful.
Katie Kenny: Fairness is a value judgment and means different things to different people. I have observed that the perception of unfairness around pay is not always actually a pay issue at all. Sometimes it reflects culture and people feeling undervalued.
David Ellis: As much as corporate social responsibility is hugely important, businesses need to be more responsible about how they make their money, not how they spend it.
What measures must be put in place to ensure executives are educated, informed and understand the actions required to achieve their financial objectives?
Sheila Edmund: In the Pharma sector, I believe that most organisations do pay for some personal financial planning at senior levels and general education for most employees on long term savings. I’m not sure that people always make the most of this opportunity and I wonder about whether more education needs to be done at an earlier career level. It is surprising how people just don’t seem to understand the value that the organisation has invested in shares and share options. In the USA, there seems to be better financial understanding and planning, so this should be more of a focus for the UK in future because of some of the pension changes. The personal circumstance of people and where they come from seems to make quite a big difference as to whether they really focus on these opportunities.
Jane Williams: Wrong decisions can cost people money without their knowledge. Personal financial planning with independent advisors is the right way ahead, to help with their own personal decision-making, and in respect of the consequences of financial decisions, on behalf of others.
Sheila Edmund: My organisation has always made broader financial education available, and there’s probably a need for more focus on managing debt versus investment planning, depending on your career stage and population needs. At the senior levels we have improved online long-term incentive communications which I think again is perhaps what a lot of organisations do. There is definitely still work to be done on improving LTI communications and the perceived value of these awards.
Diana Crisp: Companies are pretty good at fulfilling their obligation to provide solid advice on benefits, particularly for specific things like pensions and LTIPs. Less effort is paid to general financial welfare, as many employers assume that their senior executives have their own independent financial advisors, and that the associated costs should be borne by the individual.
Katie Kenny: I think that the change in pension structure has played an increasing part in the need to be more financially savvy, with more companies offering defined contribution pensions and restrictions on tax relief, executives must plan their wealth creation more carefully.
Bryan Innes: Top people are usually too busy to look at their affairs, they tend to do piecemeal planning and, over the years, this becomes quite horrific in terms of strategy, often there isn’t one! If you ask people “what is the business strategy”, they’ll tell you where the business is going in one-to-five years. However, when you turn the questions to them personally, they have not given it any thought. Financial wellbeing education is around ensuring that they benefit from bespoke planning so they can make informed decisions.
It would seem to make sense to build a culture of personal responsibility, better financial planning education, but there’s a cost of course.
Bryan Innes: Financial education across the workplace involves getting personal advice to them. Independent advice doesn’t necessarily mean the right advice. The right advice for most is to pay off debt and this can really only be given if the advice is personalised and charged on a time spent basis that is independent of a product being sold. In our experience the level of advice is not what it should be. As a result plans are rarely coordinated and ill-informed decisions are made. Senior executives need to be dealt with by an experienced advisory firm and one that is not paid via products, but one that is transparent and charges fees on the time spent with that individual.
What has the RDR (Retail Distribution Review) achieved? Do regulations need to be tighter, and is there greater transparency on advisory fees?
Bryan Innes: The majority of advisers are still remunerated by third-parties, which by virtue means that products need to be sold. RDR has brought improvements in terms of getting people to be better qualified, but it has not fully addressed advice charging. As I have mentioned, post RDR has seen companies change from commission to fee-based. Now fee-based, you’d think, that’s fine, it’s fees, but the fee is going to be three percent. Take this example, you agree to invest £100,000 with the adviser fee then being £3,000 (three percent). However, prior to investing you elect to increase this to £200,000, the fee then becomes £6,000 (three percent). Why the increase and how can you justify the increase? All they’ve done is just changed the name, so RDR has not been a solution. What will be a solution is a charge for time spent in advice.
Gordon Clark: Government and regulators need to tread carefully, because introducing rigid rules around the structure of remuneration has a tendency to lead to unintended consequences. The direction seems to be giving shareholders more power to influence remuneration decisions, but in doing this we need to be careful not to undermine the role of remuneration committees who have more visibility of all the factors.
Better guidance in making wealth work harder, nobody could argue with that ethic?
Bryan Innes: What you’re aiming to do is ensure that each individual has a bespoke strategic plan for them, one which is separate to the business. A strategic plan for them that looks at what’s important in their lives, and ultimately will lead them to managing their finances to achieve their objectives. They then have a bespoke plan which is not product linked, it’s detailed to them, and the company sponsors it. This has numerous benefits to the employer. Reward is not solely pointed to remuneration with the benefit of providing this to individuals will far outweigh the cost of the advice. Many executives will have their own and they would take the plan to their advisor to discuss and manage going forward.
Sharon Williams: We have identified five wellbeing drivers and financial is one of them, and our top exec team have a wellbeing plan which includes support and advice, both internally or externally.
Jane Williams: I know of companies that provide financial advisory services with free access for specific employees, a choice of advisors that run seminars followed by personal meetings. It is a remote, “hands off” approach, respecting the individual and simply making the service available.
David Ellis: I think there are plenty of employers out there who could rationalise quite clearly why they might provide financial advice for their staff. Whether their staff wishes to utilise it is a very different question. You can offer financial planning to people all the time – but there is a point in their life when they decide to take notice of it.
Sheila Edmund: I think there are some organisations doing this and trying to target employees to engage them with the financial planning opportunities, as part of their benefits package, and to improve their employee value proposition. For example trying to target new graduates and other new employees who were probably in greater need of early financial planning. This is an interesting approach because there has been an assumption that because people can’t always afford to invest or they are not interested, rather than the service is there to help them improve their financial position more quickly. This area is likely to become even more important, so I think it’s quite interesting, as a philosophy and employee value proposition differentiator.
Bryan Innes: Unless there’s a particular event you don’t wake up in the morning and say “let’s do some financial planning”! So there needs to be an understanding as to what financial wellbeing means. It’s not just a matter of putting money into a pension and choosing a fund, it’s a much wider piece than that. Making it available to them and providing the platform for informed decisions highlighting what it will look like and possibly introducing to a smaller number, those benefitting are able to tell colleagues the value they received.
Should financial planning be aligned with career planning? Culturally, people don’t like talking about their finances.
Sheila Edmund: I think there’s a good point about people not wanting to admit they’re inept or unprepared in their personal finances. I certainly don’t think that they want to talk if they are more junior in the organisation about debt and I think that’s another issue which actually impacts on productivity, which is why it’s of interest to organisations and why I think financial wellbeing is really critical. Fundamentally, organisations are concerned that people will have enough funds to retire on and be able to leave when they want. So I think there is much more of a motivator to encourage people to take responsibility early and being able to assess the likely outcomes of investments and make decisions earlier.
Sharon Williams: It’s the culture you create within the organisation and the leadership team needs to be role models. If they aren’t getting the value of financial wellbeing, how do can you expect the rest of the organisation to get it either?
David Ellis: A key consideration is, do your senior people have enough money to leave? From a succession perspective this is really important.
Gordon Clark: The reason has shifted from needing to maintain a certain standard of living during retirement to being a benchmark of self-worth.
Bryan Innes: A perfect example was end of last quarter, I was brought into a professional law firm to look after the managing partner and we did the planning, which was all about bringing context to the wealth being generated and looking at what income/capital would be required. Got an email on the first week in January on the back of our work and he is now retiring from the firm. He is in a better place and fortunately it was beneficial for the firm too. The business and indeed individuals need to have a strategic plan.
So the business case is, it helps with succession planning, managing a finite point for people to work to, exit planning.
Sheila Edmund: When we are trying to attract senior people to the organisation, candidates often don’t know what they’re previous longterm incentives are worth, and it is the first time they really understand the value. Most have a clear understanding of short-term incentives and other benefits. Good financial planning makes them engage with the organisation more, but it won’t stop some people leaving or negotiating a buy out of their long-term incentives.
Katie Kenny: I think flexible benefits is a great advantage because it does allow all employees to pick and choose what works for them.
David Ellis: We will see changes over the next year or so in the context of how senior people are paid. There will be changes which go to the root of, for example, performance conditions applying to long term incentives and bonus plans. I don’t think we will see changes going to the root of quantum per se. The change will influence “why” something is paid rather than “how much” is paid. I think that is not a bad place to be.
Katie Kenny: There will be an evolution in some areas of pay, the fundamentals will stay broadly the same because it does work reasonably well. If we are to avoid further regulation, companies and shareholders need to be more willing to enter into constructive effective debate on pay. Companies need to be open to shareholders feedback and shareholders need to be open minded too and consider proposals on a case-by-case basis.
Jane Williams: Agreed, the executive debate will run, but the structure of reward won’t alter greatly. The context around it, whether it’s the shareholder influence, whether it’s Government influence, whether you are looking at things holistically across the organisation and society, will impact on the development of reward.
Sheila Edmund: I think we need to consider, particularly employees as a specific shareholder group, how their future interests might impact the future direction. I do think that there’s an educational piece there and we shouldn’t forget them as a specific group. They’re probably a target group we need to engage with the subjects, and to make sure that they are clear what executives are paid for what they do, to drive the success of the organisation for their long-term wealth and wellbeing as well.
Sharon Williams: We must continue to focus on financial wellbeing across the organisation and focus on education and awareness and tailor to the individual needs of the group.
Bryan Innes: Whilst we’ve got a lot of tools at our disposal, it’s important that we direct them into the right areas and I certainly feel that looking at the element of reward, from education up to financial wellbeing, it’s certainly an area that we need to continue to be active in.
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