Blog: CEO pay cuts – the unequal footing

Compensation & Benefits

CEO pay cuts – the unequal footing

What do the recurring instances of CEOs taking pay cuts indicate?
CEO pay cuts – the unequal footing

You must have read these headlines in the recent past. 

  • Apple cuts CEO Tim Cook’s salary following dip in iPhone sales
  • CEOs at Indian IT companies like Genpact, Infosys take a cut in their bonuses as growth slows
  • Cognizant CEO Francisco D’Souza’s pay falls 31% in 2016 as growth slows

And the very recent one on “Reckitt Benckiser cuts CEO’s pay after investor revolt”. What do all these essentially highlight? 

Most of the CEOs are not taking pay cut as per their wishes, rather are being forced to take it due to surmounting pressure. The pressure may be the decline in the profit margin of the company or may be due to stagnating company performance. In a few cases, they are coerced to accept the cut due to change in corporate governance issues. It seems there’s a mixed baggage of reasons attached to this phenomenon which have been generalized by the people around.

The UK government is planning to bring in reforms as a part of corporate governance to create a fairer economy. Soaring rates of top executive pay have actually led to shareholder and public uneasiness in recent years. In December 2016, the connection between high executive pay and strong corporate performance was questioned. This was a result of a study commissioned by the investment industry body the CFA Institute from the Lancaster University Management School.

The results revealed that although the median pay of chief executives at FTSE 350 companies in the UK increased by 82% in 13 years, returns on capital invested in those companies had risen by only 1%.

Companies on the other hand, across the globe are also looking ways to cut costs due to macroeconomic uncertainty, geopolitical tensions and divisive politics. Due to just a few rapacious CEOs creating gross income inequality, the backlash against the “metropolitan elite” is causing disquiet.  Some governments have begun tentative crackdowns. In Netherlands, bonuses are capped at 20 per cent of salary for top bankers. Credit Suisse has slashed its bonuses for top management by 40 percent. This being the second-largest bank in Switzerland represents a victory for investors who are increasingly pushing for more modest pay in an industry where profits have fallen but pay has often remained high.

The trend of pay cuts has a direct relationship with the push given by the shareholders. They are advocating their CEOs to take less pay.  Let’s look at some real life examples.

  • BP PLC has agreed to cut about 5 million pounds ($6.24 million) from Chief Executive Bob Dudley's maximum pay for the next three years in a bid to avoid a shareholder revolt.
  • eBay CEO asked to take a pay cut to fund marketing.
  • German rival Deutsche Bank (DB, +0.27%) cut bonuses drastically as it struggles to turn a profit and faces a big bill for litigation.
  • Brian Cornell of Target, took a sharp cut in compensation after the company failed to meet financial goals.

Not only this, the mystery of such trend also has an indirect relationship with certain unethical occurrences which has come up in some recent instances.  Reports of cases being brought in the eyes of the shareholders of fraud or wrong approvals by Leaders have made the Topmost Investors more vigilant. Hence, there’s an increase in audit and quality controls checks are being integrated to ensure minimal loopholes. 

But not to forget, our CEOs have greater organization specific capital. It is very hard for an outsider to come in and run a giant company. The unsurprising factor in this unequal footing is not how much you pay to your CEO, but how you pay. Let us re-look this in a different perspective.

It’s not about HOW MUCH you pay to your CEO, but “HOW” you pay

“Excessive” pay is not the only biggest issue. Essentially, it is the “not so structured” pay schemes with unblended aggressive pay-for-performance system adding to the woe. From architecture to audit, to Competence to Consequence mapping needs to be effectively planned and monitored. 

What HR Leaders need to re-look at are:

Restore integrity to equity grants  - Equity makes up a big share of a CEO’s retirement package. In some cases, a CEO tends to accumulate so much equity that additional grants provide little incremental motivation. At that point, the CEO should ask the compensation committee to put those grants back into the pool for other employees.

The Pay - a reflection of corporate performance - The compensation of top executives is virtually independent of performance in many public sector undertakings. Annual changes in executive compensation do not reflect changes in corporate performance. The stakeholders need to make the threat of dismissal for poor performance real in such situation. 

Should CEOs own substantial amounts of company stock? - The larger the share of company stock controlled by the CEO and senior management, the more substantial the linkage between shareholder wealth and executive wealth. In fact, there’s a common misconception promoted by many studies which states that CEOs are not touched for their poor performance because their salary and bonus don’t change much with performance. All of these studies overlook the substantial incentives that come from a CEO’s equity holdings. Let’s see a simple example. If the stock price falls by marginal 5%, the average Fortune 500 CEO loses millions of dollars. And such losses are not reported from the equity holdings. 

 All said and done; finding and retaining the best possible leadership team is a real daunting task. Hence, all such pay cuts and pay ratio strategies need to be handled in a balancing way. A high pay ratio can indicate promotion opportunities, which definitely motivates the Leadership Team to perform more. By just shrinking remuneration, the conundrum of performance and profitability may not be solved.  The fact remains: there is no simple solution. Small improvements and regulations as described above may be a step in the right direction, but don't do much to solve the underlying problem.

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Topics: Compensation & Benefits, Strategic HR, C-Suite

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