Recently, Financial Times published an article titled “Share price windfall reignites debate over executive pay.” Reigniting a fire that has not died down for decades seems a bit much, but let’s talk about it. The article focuses on how quantitative easing has increased share prices for companies in the UK. One argument is that this monetary policy relieves pressure on the economy and pushes stock prices upward even if companies underperform. The other argument is that by removing limiting barriers, this policy allows stock prices to perform as they should.
Executives usually have more pay linked to stock than other employees. Because of this, their pay is more beneficially impacted by upward market trends, even when those price increases may have little or nothing to do with individual performance. The recovery of the markets has lead to gains in executive pay not seen by most others in the workforce. This has lead to complaints about rising stock prices driving higher executive pay.
Ironically, one of the major “fixes” regularly discussed for executive compensation is more equity compensation. UK has been a leader in executive pay reform in the form of regulations. They have had Say on Pay for more than a decade. Similar to our own experience, the greatest impact was a move from time-based vesting to performance-based vesting for equity awards. The key metric used for these awards has been Total Shareholder Return or “TSR” (my 2010 article can be found here). This has apparently not appeased people because the UK will be moving from an advisory to a binding Say on Pay vote later this year.
But, there’s an obvious truth that we seldom speak of. Stock price (and/or Total Shareholder Return) is a great measure of performance for those people invested in your company. However, for those watching from the sidelines, it will always seem spurious at best. This basic fact drives much of the misunderstanding in executive compensation. Performance for those working at a company means jobs, raises and bonuses. Performance for those outside of the company generally means investment gains. In between are those in the media and politics who try to make the crowds happy without upsetting the applecart.
Executive compensation is a complex matrix of issues that will never leave everyone satisfied. It is important to note that stock price is often a poor analog for performance, especially for people who do not hold stock. It is also important to remember that every steep drop in the market, like that of four or five years ago, is followed by a recovery. Equity granted during those drops will always seem overvalued when the recovery is peaking. At the same time, equity granted during peaks will seem paltry when the price goes down in the future. This does not make stock price or TSR bad metrics. It means that those metrics are best when balanced by internal financial and operational metrics. More on that soon.
P.S. A shout out to pay equity. Burberry CEO Angela Ahrendts, an American woman, is currently the highest paid executive in the FTSE 100.