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Executives don’t value their pay plans - PwC and LSE study

Incentives have become so complex and volatile that they no longer motivate executives, according to new PwC research in conjunction with the London School of Economics.

The study of over 1,100 participants reveals that all too many features of current pay packages mean that the value executives place on them is materially lower than the cost to companies of providing them. Indeed, it seems that many executives would be much happier being paid a smaller salary in a less complex and less volatile form.

PwC and LSE also discovered that executives are risk-averse, don’t like complexity and discount deferred pay.

Tom Gosling, head of PwC’s reward practice said: “We need to simplify pay significantly. We’ve tried to put too much of the package into complex incentives that executives don’t value, and this is leading to volatility of pay-outs and unintended consequences. If we had simpler, less volatile pay plans then most executives would be happy to be paid less.”


Deferred bonuses

According to the research, deferred bonuses hold little incentive, with the majority of executives valuing a £100 of bonus in a typical deferral plan at only half its value (£50). This discount is massively in excess of economic discount rates and the perceived value drops to as low as £33 for younger employees (those under the age of 39).

Discounts also vary significantly in different regions of the world, showing that “one-size-fits-all” pay packages may be ineffective.

These findings place a major question mark over the effectiveness of deferred bonuses, which have been championed by shareholders, regulators and corporate governance bodies as a powerful way of influencing behavior, while at the same time encouraging prudent risk-taking.

Gosling said: “It is difficult to see how a form of pay that has such low perceived value can have a significant influence on behaviour. A very real consequence is that as deferral increases, we would expect there to be pressure to increase pay levels.”

Complex pay plans demotivate executives

Complex and uncertain incentives are also a massive turn-off for most executives. The research reveals that two-thirds more respondents (51% versus 27%) favour a cash plan based on profit targets that they understand over a more ambiguous share plan based on their share price relative to other companies.

Gosling said: “UK executive pay is based on the motivational theory that loading executives up with large amounts of incentive pay with complex performance conditions means that they’ll perform better for shareholders. Unfortunately this isn’t supported by our study, which shows that complex pay plans are a motivation killer. The more complex the pay, the lower the value in executives’ eyes.”

He added: “We’re paying company managers as though they are risk-seeking entrepreneurs. Our research shows that corporate executives are generally risk averse, and don’t value long-term incentive plans and deferred bonuses.”

Fairness

The research suggests that executives are “very concerned about the perceived fairness of pay”. For the majority (51%) of respondents, getting paid more than their peers was more important than getting paid more in absolute terms (27%).

Disclosure

In many countries there is a drive for greater disclosure of pay on the basis that this will lead companies to exercise restraint. But the research suggests the opposite, that disclosure will simply provide more opportunities for cross-comparisons and consequent pay ratcheting.

A final word

“Executives are really focused on the fairness of pay outcomes. Complex and volatile plans lead to windfalls that executives don’t thank companies for, and periods of unfair underpayment that are highly demotivating. This creates a ‘lose-lose’ situation for executives and shareholders. Simpler, more stable plans, with a greater role for remuneration committee discretion, are likely to be more effective at motivating executives and will also cost companies less.” - Tom Gosling, head of PwC’s reward practice.

Want to know more?

Title: The Psychology of Incentives, PwC in conjunction with the London School of Economics and Political Science, May 2012.

Survey details: 1,106 participants took part in the study. 


Availability: For a full copy of the report visit www.pwc.co.uk/publications/index.jhtml.

PwC is a network of firms in 158 countries with close to 169,000 people who are “committed to delivering quality in assurance, tax and advisory services. To find out more visit www.pwc.com.

Date 29/05/2012

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