1. Paid to Perform? What do we Want our Business Leaders to Achieve?
Luke Hildyard
16 January 2013

2. COMPANY PERFORMANCE OVERWHELMINGLY JUDGED BY PROFIT/SHARE PRICE
Findings
94 FTSE 100 companies use EPS or TSR to calculate their LTIP
TSR used by 74 companies to calculate at least part of PRP (64 companies used EPS)
Only 38 companies use specific, measurable non-financial PRP criteria. Only 7 for LTIPs
Most progressive companies have generally undergone massive scandal – BP & the Banks
Analysis of FTSE 100 remuneration reports demonstrates that the objectives set for executives, and by extension major UK companies as a sector, are overwhelmingly financial
COMPANY PERFORMANCE OVERWHELMINGLY JUDGED BY PROFIT/SHARE PRICE

3. PROFIT/SHARE PRICE UNRELIABLE GUIDES TO COMPANY PERFORMANCE
Market-based measures (like TSR)
Accountancy-based measures (like EPS)
Company accounts ‘are inevitably based on a series of assumptions about the future… accounts provide precise indicators of performance only in as much as they apply precise rules to a set of uncertain events’ (Andrew Likierman, London Business School)
‘the market’s collective view was that risks to bank creditworthiness had fallen steadily between 2002 and 2007, reaching a historic low in the early Summer of 2007, the very eve of the worst financial crisis in 70 years’ (Lord Adair Turner)
Why is this a problem? Firstly, because crude financial measures are highly unreliable. The financial statements from which profits are extrapolated contain huge uncertainties around depreciation of assets; provision for bad debt; and pension liabilities… Share price is as much about future expectations as past performance, and ultimately just reflects the judgement of a community of investors who can easily be completely wrong
PROFIT/SHARE PRICE UNRELIABLE GUIDES TO COMPANY PERFORMANCE

4. BEST INDICATORS OF LONG-TERM, SUSTAINABLE SUCCESS ARE NON-FINANCIAL
Critical measures of performance: Companies as ‘enduring social institutions’
Employee engagement
Brand/
reputation
‘The value that a company creates should be measured not just in terms of short-term profits, but how it sustains the conditions that enable it to flourish over time’
Rosabeth Moss Kanter, Harvard Business Review
Financial performance measures reflect ‘what’ has been achieved rather than ‘how’. There are a number of key areas that are vital to determining how well an executive has positioned their company to deliver sustained success that are n’t necessarily captured by profit or share price. It generally takes longer to deliver significant improvement in these areas than the 3 year timeframe of exec LTIPs
Corporate social performance
Customer satisfaction
BEST INDICATORS OF LONG-TERM, SUSTAINABLE SUCCESS ARE NON-FINANCIAL

5. Manifestation of short-term share price/ profit orientation
Action
Impact
Ruthless cost-cutting
Debt-fuelled peculation and acquisition
Share buyback (quadrupled in UK since mid-90s)
Reduced business investment (lower in UK than France, Germany & US)
In fact, critical areas of non-financial performance often conflict with short-term financial objectives. When the latter win out – as one would expect to be the case when they are prioritised by boards and incentivised in exec pay packages – real harm can be done to the company’s long-term sustainability, and to the wider UK economy
SHORT-TERM FINANCIAL PERFORMANCE CAN COME AT THE COST OF LONG-TERM SUSTAINABILITY

6. PRACTICAL & MORAL BASIS FOR WIDER INPUT INTO EXEC/COMPANY OBJECTIVES
Grounds for Action
Taxpayer bears cost of CO2 emissions/inequality
Volatile business environment affects public finances
Millions of people depend on big companies as employer/supplier
Taxpayer is multi-billion/£ customer of big business through procurement budget
Taxpayer contributes 32% of UK R&D funding, & funds other critical infrastructure
There is a clear need for company and executive objectives, as demonstrated in pay packages, to reflect the interests of those stakeholders that are effected by a company’s actions, and who contributes to its success. This includes employees, customers and society as a whole…
PRACTICAL & MORAL BASIS FOR WIDER INPUT INTO EXEC/COMPANY OBJECTIVES

7. Recommendations Non-financial measures should constitute 50% of PRP
Companies should disclose Environmental/Social performance
Tax rates and procurement decisions should favour environmental/social disclosers
Investment chain should be required to consider social/environmental impact
Employee representation on boards
We recommend a series of measures that would increase the profile of non-financial performance in areas including customer satisfaction, employee engagement and wider social environmental impact. This would encourage a cultural shift away from existing short-termism, both through executive incentives and through transparent procedures that would encourage exercise of ‘soft’ regulation from employees and civil society
EXECUTIVE/COMPANY PERFORMANCE MUST BE UNDERSTOOD AND EVALUATED IN A WAY THAT REFLECTS ALL STAKEHOLDER INTERESTS