The pirates of pay

In his two decades as CEO of General Electric, Jack Welch built a billion-dollar personal fortune from a high salary, pension contributions, bonuses, and various capital incentives - mostly stock options. And this was probably the most highly admired executive in America.

The admiration was somewhat muted by the unhappy revelation, after the hero retired and suffered a bitter divorce, of massive fringe benefits that were plainly indefensible.

Welch's high reputation and visibility intensified the criticism, but there's no reason to suppose that other business leaders (including some of much lesser importance) have failed to dip their paws into the same trough of perks. And that, remember, is on top of financial 'compensation' and 'incentives' that always add up to colossal sums.

A few years ago, I reported some puzzling findings of business analysis by motivation consultant John Fisher. He noted that numerous studies over the years in the US had found virtually no correlation between increasing pay and corporate performance.

As for Britain, "A study by management academics drawn from three universities looked at the FTSE 350 companies to see whether long-term incentive plans did affect performance - and came up with an astonishing result.

"These LTIPs rewarded directors with free shares if they hit specified targets for total return to shareholders (in which the share price is by far the largest component). Companies whose bosses luxuriated in LTIPs increased shareholder returns by 20.71% over the period in question. As for those without LTIPs, the result was 20.74%. In other words, the schemes, costly to administer and a bureaucrat's delight, made not a scintilla of difference."

There's one obvious difference that I might have mentioned, though. The incentivised managers ended up considerably richer than the others by achieving exactly the same performance.

Looking at this business analysis, it's hard to avoid the conclusion that every device and every decision taken in the realm of executive pay has but one purpose: to enrich recipients as much and as often as possible.

In a sensible organisation, the principles for paying senior people would have a clear, strong base. Their reward would have the same rationale as rewards for all other employees. The only difference would be size, since plainly fairness demands that rewards should rise with responsibility, seniority and contribution.

Another basic principle is that the sum total of all these payments must leave a very healthy and wealthy share for the owners of the business. No payments other than base salary and pension should be made unless the organisation is covering its cost of capital, including equity as well as debt. The cost of equity belongs to investors, and they should explicitly receive that cost as a return on their investment.

That last paragraph should ring a bell. It's the same concept as that used in calculating EVA, or Economic Value Added. The EVA addict works out the cost of capital (including equity) as above, and compares it to the number for operating profits after tax. Unless there's a handsome surplus, management hasn't been doing its duty and doesn't deserve any bonus or other extras.

An added advantage of the suggested regime is that the non-executives and the outside investors will have a clear idea of the reward system and how it relates to genuine achievement. My bet is that the atmosphere and shared commitment in the business would also be invigorated. The trouble with the present order isn't only that it's greedy and crude. Worse still, it doesn't deliver the goods - except to the greedy pirates.