CEO & Executive Incentives – Success or Failure?

The theory is that by tying a significant portion of executives’ compensation to a company’s performance, the executives will be more motivated to improve the company’s financial and operational outcomes.

Why is the base pay not considered sufficient reward for doing one’s job?  Many executives’ base compensation, before short-term or long-term incentives, is extraordinarily high when compared to the average earnings in that business and indeed Australia as a whole. Is there any truth to the statement – “executives expect to be paid to come to work and if they work, they expect extra?”

How much of the success of an organisation is tied to the CEO? Are they really instrumental in coming up with game-changing ideas or are they just executives put in place to lead a very competent team?

Consider the findings of Jude T. Rich and John A. Larson, formerly of McKinsey & Company. In 1982, using interviews and proxy statements, they examined compensation programs at 90 major U.S. companies to determine whether return to shareholders was better for corporations that had incentive plans for top executives than it was for those companies that had no such plans. They were unable to find any difference. Those findings were over 40 years ago.

In a more recent paper published by the Harvard Law School Forum on 23 Oct 2023, it concluded;

‘To be successful, companies need to attract and reward leaders who create value over the long term, but executive remuneration often focuses on short-term targets. It’s no surprise that executive remuneration stands out as one of the most visible and closely examined aspects of a publicly listed company’s corporate governance program’

The base salary of Alan Joyce, the CEO of Qantas from 2008 until September 2023, was $2.145m – not excessive when considering the size of the organisation with 23,000 employees when I last looked.

There is no doubt Alan did a fantastic job on most things, including leading Qantas through Covid. However, according to newspaper reports,  he was paid $21.4 million in his last twelve month period during which time the Qantas brand plummeted from one of the country’s most-trusted brands, to Australia’s most distrusted airline.

History is littered with short-term financial performance metrics for executives which have encouraged less-than-desirable behaviour.

The Global Financial Crisis was caused because individuals were able to make huge bonuses by betting on risky ventures – bets made with significant amounts of other peoples’ money, leaving their institutions to require government intervention and bailouts to survive.

According to ABC News on August 5, 2023, CEOs’ pay climbed before layoffs at tech giants like Alphabet and Microsoft.  The numbers are staggering – Alphabet’s CEO was awarded compensation of more than $225m in 2022 shortly before announcing plans to lay off 10,000 workers. – Microsoft’s CEO was awarded $55m in compensation whilst also planning to lay off 10,000 workers. The list of companies with similar financial ‘rewards’ also include Meta, UBER and Salesforce. When looking at these incentives, and the layoffs that took place shortly after, are these layoffs to fuel the share price so the incentives become more valuable?

An article in The Guardian on 12 June 2024 headlined ‘Australian CEOs and other executives given double-digit pay rises amid cost-of-living crisis’. Senior executives at some of Australia’s biggest companies recorded double-digit pay rises over the past 12 months, far outpacing pay rises awarded to the rest of the workforce.

The pay rises far exceeded inflation during a time when many business leaders have called for wage restraint’ “Executives are clearly being compensated for delivering profits and returns for shareholders and are making the most of a competitive market for top talent,” Megan Motto – CEO – Governance Institute said.

“Against the backdrop of the cost of living crisis, and with so many doing it tough, it might be hard for some to stomach these figures on an individual basis.

Companies tend to rely on consultant benchmarking when devising executive pay increases and argue they risk losing talent in a tight labour market if they get their settings wrong.”

So what is the answer? How does one attract and retain the best talent and suitably reward these individuals? Is the CFO and indeed the Board strong enough to ensure that short-term profit strategies will lead to sustainable and maintainable profits without putting the whole business at risk? 

I am a firm believer that if a company does well financially, its employees should share, to varying degrees, in that success. But before any senior executive bonuses are paid, the company should have a gateway –  that is  a certain level of profits. Paying bonuses out of losses or mediocre profits is not a sustainable strategy.

Why do some executives believe success is their achievement and failure has nothing to do with them? When a company doesn’t do particularly well, it is amazing how many executives say this was out of their control, and they should get their bonuses anyway.

Does an incentive really improve performance and motivation, and should companies even employ people who don’t perform at the top of their game and are only motivated if they can earn extra money?

And should a portion of an executive bonus be paid depending on staff culture?  Executives should not be remunerated because the company is a good place to work because that should be the bare minimum requirement for any company.  If the work environment is not good, it is the role of a good CEO, indeed a basic part of their job to ensure corporate culture is good. If corporate culture is not good, should the CEO keep their Job?  People spend too many hours at work, to be badly treated. That is not to say an underperforming employee should get away with it.

There should be a balance of long-term and short-term goals which should include measures relating to employee engagement, innovation, sustainability and customer satisfaction and there should be clear consequences for unethical behaviour including the clawback of bonuses and salary.

When properly designed and implemented, employee incentives can significantly boost productivity, morale, and retention. However, careful planning and continuous evaluation are essential to ensure they deliver the desired outcomes.

Executives shouldn’t be paid bonuses if that doesn’t happen, otherwise the incentives have lost their value and become considered part of base pay.

Author: Jon Brett

Jon Brett is aNon-Executive Director of Corporate Travel Management (CTM) and Chair of the Audit and Risk Committee. Jon is also a Non-Executive director of Raiz Invest (RZI), the NASDAQ  listed Mobilicom, and the Chair-elect of Infomedia (IFM).

Jon is the author of the very successful podcast series “The Taking of Vocus” which chronicles the extraordinary rise of Vocus, what went wrong with the M2 merger and concludes with the privatisation of Vocus. The podcast is accessible on his LinkedIn profile: https://www.linkedin.com/in/jon-brett-95734732/