The current debate about regulating remuneration is heated. Most corporates recognise the sensitivity of the issue. We argue a better understanding of the link between remuneration and risk in any organisation is critical to effective risk management. Importantly, done well, it provides genuine competitive edge.
Sandra Quinn, Managing Director, Quinnity Limited
The appetite for EU and government restrictions on executive pay and bonuses seems to be accelerating. On 23rd January 2012 the UK Government announced legislation to give shareholders more say in company remuneration. On 30th January 2012, EU Commissioner Michel Barnier warned of EU legislation before the end of 2012 on pay and bonuses in banks. First, it was banks but now firms in other sectors are coming under pressure in the UK to reduce bonuses. It seems that wise Boards and executives across a range of sectors and not just in the UK would do well to consider what started in banking now means for them.
They should ask themselves what it is they are not doing which is drawing the threat of legislation and requirements ever closer to them.
Behaviour needs to change in boardrooms and companies across the country, and no amount of government micromanagement can do it alone.
– Vince Cable, UK Secretary of State, Department for Business Innovation & Skills, 24 January 2012
And from the asset-owners’ perspective, how can shareholders exert potential new power over executive remuneration to safeguard their interests? Particularly where the best paid person in a large PLC may earn thirty times more than the 150th best paid person. What many fail to recognise is that in today’s business, the more senior people are not necessarily those commanding the bigger packages. And the people who set risk appetite and take the big decisions on risks are not necessarily the same people who execute the decisions, do the trades and earn the biggest money.
Regulatory focus has been on who sets the risk appetite and performs the control functions. Public focus is on senior executives and their packages – packages perceived as big but which may be less than the people who work for them. These lists of roles and people do not all align.
So companies, Boards, and shareholders have to find a way of navigating and evaluating today’s increasingly complex remuneration packages in the context of the risk and management structure of a firm.
In doing this, Boards and investors should want to assess the risk profile of the firm in considering its performance and the appropriateness of remuneration.
Logically it has to be more than about the financials. It has to be about the current and latent key risks the organisation carries because that’s where the hidden impact on financials is sitting. And that should cover the numbers, processes, compliance, people, conduct and reputation. All of which are inextricably linked. See the cultures and decision making which gave rise to Payment Protection Insurance misselling in the UK which is estimated to cost £9bn in remediation and subprime lending whose cost across the world cannot be estimated. In other sectors, look at Enron and BP Deepwater Horizon.
So where should management start? A good place is to have a tough look at how you evaluate risk and individual contributions to risk in relation to pay. Ask yourself if your decision making and the criteria you use really would stand up to external scrutiny. Chances are it won’t. So how will you make it stand up and give it integrity? How strong is the challenge from your Remuneration Committee? How much are you in the business of getting things past them instead of enabling them to make you look in the places you don’t want to look?
And how do shareholders enter into this equation? In many firms, the internal dialogue about remuneration is in practice a clamour of multiple voices, most claiming special expertise or interest. So shareholders often find themselves negotiating a slalom of specialists claiming ‘benchmarking to the market’ as the standard basis for reward decisions, even when risks of comparability and retention are less than clear.
So firms should think seriously about the discipline and justifiability of their reward judgments. These judgments should be capable of critical scrutiny from Remuneration Committees and shareholders and where necessary be prepared to change. If they aren’t, then management should ask themselves why that is. In any event, they will need to ensure that shareholders can see and judge how and why decisions are made.
Corporations are people, my friend.
– Mitt Romney, US Republican presidential candidate, 11 August 2011
This means a recalibration of decision making, encouraging tougher challenge, providing better management information and analysis which links the full range of known and latent risk to reward, from credit, market and liquidity through operational to people, cultural and reputational risk. This means HR, Risk, Compliance and Investor Relations functions will need to work together in a way they haven’t before.
Inevitably a lot of busy firms are going to groan with this prospect. While potentially painful, it could be good management and business to value your full spectrum of risk and performance and then relate remuneration to it in a way you can articulate with your Board and shareholders beyond simple earnings per share. Even getting it halfway right must be good for the company. But it will take preparation and not just waiting for the legislators to force you. But that is where your competitive advantage is.
Guest Contributor
Sandra Quinn is a consultant providing advice and support to businesses on how to manage their people, conduct, HR and business change risks. A former regulator, she has delivered multiple organisational changes, set up and run a government body as CEO and was most recently Lloyds Banking Group’s People Risk Director.
For further details on this edition of Overture please contact Sandra Quinn at sandraquinn@quinnity.co.uk or visit www.quinnity.co.uk
Fidelio Partners can be contacted on info@fideliopartners.com