Fishburn Hedges

24.09.2009

With the banks heading back to black, Fred Goodwin’s pension not yet a distant memory and the G20 summit in Pittsburgh this week considering a global framework to curb bonuses, the controversy of undeserved and short-term City bonuses is back in the headlines and chat rooms.

Here, Alan Leaman, CEO of Management Consultancies Association, explores the communications issues around risk and reward and suggests a way forward that might help restore wider public confidence in how pay is structured and decided.

The outrage over bank bonuses reached near hysterical levels this year, and is part of a wider phenomenon of public disenchantment and distrust, which takes in MPs’ expenses and much else besides.

The media feeds off hostile public opinion. In turn, it hardens that opinion and makes it even more difficult to influence, or even to engage. And much of the public’s anger is justified.

Let’s be honest: there have been plenty of examples of appallingly bad practice in recent years. Not just in the banks, either. Many of our largest corporations indulged themselves on what they call executive remuneration while the economic times were good. There are numerous stories of plain and simple greed.

Bonuses came to play a larger role in this story than we could ever have imagined. A decade ago, bonuses typically represented roughly 20% of the basic salary of Britain’s senior executives. Today the figure has risen to around 100%. Some of this was the result of inflated profits in parts of the financial services sector.

But, even there, the philosophy of “I eat what I kill” was often based on illusion – in this case, that bankers shoulder all the financial risk and that customers, shareholders and society more generally make no contribution and have little at stake. For many people, the growth in the role of bonuses has unbalanced the total pay package.

And it was made worse by the way in which bonuses frequently became much easier to earn, even if performance was humdrum or average. With the economy in recession, unemployment rising and many organisations in financial trouble, these packages are under far greater scrutiny, from the media, customers, employees and investors.

We’re also discovering how little public understanding or consensus there is about the morality and economics of pay. The result? Communicators are certainly busy, but few people are prepared to listen. The fury of recent months means that it has been almost impossible to hold a rational and constructive discussion about pay.

Bad practice in investment banks and elsewhere is infecting the atmosphere around performance-related pay wherever it is used. ‘Bonus’ has become a dirty word. There is a real risk that the idea of variable pay will be forced into retreat- at severe cost to our economy and public services as well as to business performance – at a time when we probably need it more than ever.

This crisis has shown us that our previous arrangements were built on fragile foundations. But, to echo the Obama administration, we shouldn’t waste a crisis. There is an opportunity, too. Let’s use this crisis to put pay – particularly variable pay - on a firmer footing.

The situation requires a healthy public debate which scrutinises not just where pay went wrong, but also what is worth saving and putting right. For public trust in our institutions to be restored, we need to ensure a better and shared understanding of the principles on which pay should be based in the twenty-first century.

At the Management Consultancies Association we would like a new, independent Commission to look at this. It should bring together employers, investors and relevant experts from management consultancy and beyond. The Commission should be asked both to identify and explain the principles on which pay packages should be based in the twenty-first century.

These should be principles that encourage and foster economic success; but also ones that command the support and understanding of a wider public constituency. Get this right and we could build greater consent across society for the pay arrangements we will need in order to prosper in the future.

It will also help us to spread the practice of variable pay in one part of the economy where it is urgently needed to help improve performance – the public sector. What are the principles on which pay should now be based?

First, it is clear that we need to restate the argument that pay can be related to performance. Why should someone earn a large salary regardless of the amount of effort they put in or the results of their work? And why should organisations deny themselves the flexibility that variable pay gives them as they seek to control their costs? But these performance measures should be aligned with the long-term interests of companies and shareholders.

Short-term imperatives can disrupt organisations and distort their priorities. Remuneration committees and managers must explain why their chosen measures are right.

Management consultants tell me that there is often a very weak relationship between businesses’ strategic aims and their planned incentive structures. Equally, variable pay must enable the pain to be shared in the bad times, just as much as it shares the fruits of success in the good. Variable pay should not be just a one-way street. The current crisis has given a huge boost to support for regulation throughout our economy.

Therein lies another danger. Without a commission or a similar effort of this sort, and informed public debate on the issues, calls for regulation of pay are likely to grow stronger, and government and politics will get more and more involved. That would only store up further problems for the future.