Wednesday, 15 March 2017

Rolls Royce in the News Again: The Age-Old Dilemma of Executive Compensation

On the 10th February in Financial Regulation Matters, the focus was on the poor performance of Rolls Royce and the difficulties it was facing, mostly stemming from allegations of bribery and corruption around the world. In today’s post, the focus will be on the associated story making the headlines today, and that is that Warren East, CEO of Rolls Royce, is being awarded a bonus of £916,000 despite the mire that Rolls Royce finds itself in, something which the Institute of Directors suggests will not ‘sit well with investors’. However, is the answer really to reduce the financial incentive structures because of poor performance? This post will pose this question, and look at the arguments for and against this issue which is central to the idea of big business in the modern world.

Mr East’s bonus of just under £1 million comes at a time when the renowned engine manufacturer’s profits fell almost 50% in the past year, and also comes on the back of 700 middle-management job cuts and a freeze on salary increases for 8,000 managers and executives. Although Mr East’s bonus represents only half of what he should have received, the figure is bound to generate negative headlines when contrasted to the plight of the company recently. However, rather than bow to this pressure, the company’s remuneration panel is instead seeking to increase Mr East’s total achievable bonus package to 250% of his salary, up from 180%. This seems at odds with what would rationally be expected when we look at the recent performance of the company, but there are other considerations at play.

The remuneration panel are hoping to increase the bonus package for the CEO because the increase forms part of a concerted plan to ‘attract and attain’ high quality staff. This divergence, between the obvious responses to the poor performance being not to reward those involved, as opposed to increasing the pay of those involved in order to ‘attain’ them, is a key divergence in this field, and is arguably dependent upon viewpoint. Renowned Professors of Finance, like Professor Lucian A. Bebchuk of Harvard University, have argued that this pay structure provides for ‘considerable upside rewards for good performance but few downside penalties for poor CEO performance’, although this is countered by other experts in the field, like Professor Murphy, who has suggested that regulating executive compensation excessively can result in reduced incentives to create value, reduce competitiveness, and arguably just result in the increase in fixed compensation. The divergence can be seen in real life examples from the world of business, because whilst WPP CEO Sir Martin Sorrell has been awarded £41.5 million and Shell CEO Ben van Beurden €8.59 million, Yahoo CEO Marissa Meyer has agreed with her company to waive her 2016 bonus, totalling $2 million, because of poor performance.

Ultimately, it may come down to institutional preference, or indeed the firm’s aptitude to deal with internal and external pressures, but arguably it relates to something which was discussed in yesterday’s post in Financial Regulation Matters, and that is ‘perception’. A firm’s position within its market will usually define its reticence – if it is secure, it will proceed as it sees fit, and if it is not, then external pressures will naturally have more of an effect. If we take Rolls Royce and Yahoo as examples, then we know that Rolls-Royce are renowned in their field, and have a reputation for excellence that precedes them – it is easier to brush off the type of negative publicity it is currently experiencing as a ‘phase’; Yahoo simply do not have this luxury. Even landmark deals, like that made between Yahoo and Firefox in 2015, have very little impact upon its market position in relation to the tech giant that is Google; therefore, when the company is experiencing negative press, like when one billion accounts were hacked in the biggest data breach in history, there is little the company can do but react to the criticism. However, there is a larger issue and that is how this reward for failure is perceived more generally, simply because at almost every other level, the same phenomenon does not exist – it is not something the public can relate to. Whilst the argument may be had that the remuneration panels should have no regard for public perception, the change in environment recently, with populist movements affecting all walks of life, is a warning to be aired to the remuneration panels of these large and highly visible companies: excessive pay for those involved in socially-impactful failures may be extremely damaging for the health of any company. Whilst bribery and corruption around the world may not register with voters in western countries, it provides a warning for firms like PSA who have recently completed the takeover of Vauxhall/Opel – as was discussed in a recent post - which brings them directly into the focus of the general public; the remuneration panel of firms like PSA must surely take note of developments in this regard… the future may depend upon it. 

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