Executive Compensation – It’s Complicated

Over the past few months, the team at Livingston James has seen a sharp increase in enquiries around executive compensation from our clients. Remco, CFO’s, and other board members are contacting us to benchmark salaries to ensure they are being paid or are paying “market rate”.  Our response is always the same: it is not that straight forward, especially now in the current VUCA environment.  In fact, all things considered, working out a package that motivates and attracts the best can be pretty complicated.

As the market bounced back from the pandemic, we saw many organisations caught in a bidding war for the best talent.  From niche tech professionals through to senior executives, many private organisations pushed salaries upwards to attract the best people.  Even with the market cooling, we don’t expect this to change too much in 2023.  Organisations are either looking to hold on to the best talent or seek new leaders to drive the change required through these uncertain times.  PWC’s recent analysis backs this up with exec salaries in the FTSE 100 now back at pre pandemic levels.

So, does this just mean we keep going in this direction and take someone’s current package, add on some for inflation and an LTIP to ensure they onboard and become successful?  Our advice is “absolutely not”.  There are many points to consider.

I recently attended an event held by London School of Economics, centred around Professor Sandy Pepper’s book – If You’re So Ethical Why Are You So Highly Paid? I highly recommend anyone to download the book where Pepper argues that “the ‘soaraway’ inflation in executive pay is the result of a market failure that has led remuneration committees to become trapped in a prisoner’s dilemma where they feel they must recommend over-the-odds payments in the vain hope of obtaining or retaining superior talent”.  From his research, he believes that “senior executives are not in the main the greedy ethical egoists of popular culture”, but in fact the system is broken.

I mentioned LTIPs above, always a popular choice to be added to executive’s pay.  Pepper’s research shows LTIPs are generally not efficient; they are often not effective in meeting their objectives, i.e., motivating senior executives, and instead have assisted in increasing executive salaries – not good news for shareholders.

Scotland’s very own Weir Group plc has been leading the way on the new way of thinking with many other PLCs following suit. Weir replaced its LTIP with an annual system of restricted shares instead, with pay-outs delayed up to seven years.  LTIPs are not completely redundant though; it can be argued that these schemes can be very effective for start-ups or SMEs.

Most of our enquiries have been from SMEs, so what advice have we been giving them to ensure they are keeping up with market trends? As a Purpose driven organisation ourselves, we start with purpose as our first point, in addition to other considerations when building executive compensation packages:

• Remuneration policies should support the purpose and values of the organisation, while also reflecting the longer-term strategy and the current economic situation
• They should consider key objectives across Environmental, Social and Governance (ESG). Investors are now looking towards organisations that compensate this way, considering carbon footprint and emission reduction goals as part of bonus schemes.  If you’re not looking at this – you should be!
• Diversity, Equity, and Inclusion: We recently met with a professional services firm who has set specific D,E&I objectives connected to pay for its SLT.  Again, a key motivator for investors, as well as just doing the right thing
• Cost of Living Crisis: Organisations have a responsibility to pay their executives proportionately, pay their SLT appropriately and provide all their workers with a living wage

So, the above should be considered and used when looking at the bonus element or longer-term incentives, and the below shows the recommended structure which usually consists of a mix of four components:

• Annual base salary
• Annual incentive or bonus plan, generally tied to short-term performance measures (some connected to above points)
• Long-term incentives consisting of a mix of restricted stock, stock options and other long-term performance plans tied to total shareholder return, financial performance and points above
• Benefits plan including car (watch out on your emissions), Pension (Ethical of course) etc

As mentioned, when considering your Executive compensation for 2023 and beyond, I told you it was complicated; but get it right and it’s worth it.

If you would like a conversation about Executive compensation benchmarking, please get in touch with Alistair Shaw at [email protected]