By Xavier Baeten , Professor of Reward and Sustainability at Vlerick Business School
Every year, a research team at Vlerick Business School studies the remuneration reports of more than 500 listed firms spread over Europe. This approach is unique: an academic business school collecting and analysing international data on CEO remuneration levels, as well as CEO remuneration structure and the main factors driving CEO incentives. Out of these analyses, a number of interesting findings and challenges can be derived. In this opinion piece, we put some critical questions behind the drivers of CEO remuneration and the KPIs which are included in CEO incentive systems.
Our study found that 62% of the variance in CEO remuneration is driven by firm size, followed by the country in which the firm is located (33%). Only 5% of the variance in CEO remuneration is driven by firm performance. Moreover, if we take a look at the evolution over the last 3 years, we find that the country impact is increasing (from 25% of 33%). This shows that CEO remuneration is strongly driven by benchmarking and (national) regulations and cultures. In our opinion, both factors have an impact which is too strong, for a number of reasons. First of all, the elasticity of CEO remuneration for firm size is too big. While the median total remuneration of a CEO employed by a firm with a balance sheet total of less than 500 million euros is at almost 400.000 euros, the remuneration of his/her counterpart in a large listed firm in Europe (more than 5 billion euros of balance sheet total) is almost 3 million euros.
We might have to put some questions behind the ‘inter-CEO wage span’. Is the job of a CEO in a large listed firm 6 times as complex as the job of a CEO of a smaller listed firm? Do remuneration committees pay too much attention to benchmarking, rather than asking themselves the question what they consider to be a ‘decent’ wage for a CEO? Do remuneration committees pay more attention to the CEO’s pay history than to the company’s affordability and values? Do they pay enough attention to and are they critical enough towards the composition of the peer group used for benchmarking or is there some ‘gaming’ going on?
On the other hand, we see that also the country has an important impact. In this respect, we see the result of the numerous regulations which have been implied (mainly in financial services) following a number of malpractices. An underlying danger is that remuneration committees focus too much on legal compliance, which leads to box ticking rather than caring about true strategic alignment. In this respect, we plead for a better balance between market alignment, legal compliance, ethical considerations and strategic contingency.
Developing further on the topic of strategic consistency, we analysed the key performance indicators underlying the CEOs’ incentive systems. Here, we got a very clear, almost black and white picture. In 72% of the firms, operating income was used as a KPI driving the bonus (also called short-term incentives). This is followed from a distance by cash flow (26%). Taking a look at the vesting of share-based remuneration (long-term incentives), the main indicators include total shareholder return (61%) and operating income (40%). What does this mean? Taking for granted that ‘what gets rewarded gets done’, it means that companies are mainly managed based on financial measures (also called ‘lagging indicators’), either profit or share price-related.
In other words, and in terms of the so-called Triple P, 78% of the firms use profit-related measures to determine their CEOs’ bonuses, while only respectively 16% and 14% use people (e.g. employee engagement, employee safety, diversity, etc.) and planet-related (e.g., CO²-emissions) measures. At the same time, the media bombards us with stories on environmental and social problems in business and on our planet in general. Shouldn’t corporate sustainability and responsibility (CSR) a top business priority? Shouldn’t remuneration committees think more carefully about the (strategic) KPIs they include in their CEOs’ incentive systems?
As a conclusion: remuneration committees, time for action!