Tuesday, June 19, 2012

Stopping the madness.

Restoring trust and clearing the fog around executive pay.

We trust another human being or institution on a very simple principle: whether we believe that person or institution genuinely has our interest at heart. This trust can be promoted only marginally by spin, branding or advertising. Indeed, these efforts can be risky and counter-productive in creating expectations that ultimately are not met. The real test in demonstrating whether these people or institutions have our interest at heart is the way they behave.

The annual survey released by the Reputation Institute shows that “South Africa is losing faith in its business bosses”: to quote a Business Report headline. Only one of the country’s 20 largest firms has emerged with a “strong and robust” reputation.

When research shows that globally trust in business is at an all-time low (50% of informed people do not trust business to do the right thing) then we have to ask ourselves whether an intolerable and dangerous rupture has not happened in society. When we add the very low trust in government (less than 45% trust governments to do the right thing) then by and large we have a global population that has lost faith in its most important institutions. The social effects cannot be understated. They impact on attitudes, scepticism, productivity, domestic harmony, family relations, crime and lawlessness and promote increasing popular activism, sometimes leading to violent uprisings such as the Arab spring.

The issue around executive remuneration and the intolerable income disparities world-wide cannot be ignored as a contributor to the rift in society and the breakdown in trust in business, particularly corporate business, reflected in movements such as Occupy Wall Street. Mike Schussler’s latest research showing that lower skilled work in South Africa is overpaid compared with higher skilled work may resonate well with most reasonably informed people. But he himself in a later Moneyweb podcast interview conceded that the 6-1 skilled to unskilled ratio had to exclude executive remuneration.

But can we? When the ratio there often exceeds 300-1, and is widely reported in the media. It must be extremely difficult for any company bargaining unit to counter belligerent union demands when they are confronted with this argument, especially when there is little credible scientific market evidence to support these pay levels and they are generally defended by sweetheart remuneration committees or consultants, all of whom either have a vested interest or link in kowtowing to the beneficiaries.

Recent reports have highlighted another serious concern – the degree to which company boards have not been able to coherently justify executive remuneration decisions. Not only have they been caught flatfooted by questions from shareholder activist Theo Botha, but some major institutional investors such as the Public Investment Corporation have voted against the decisions.

All of this could be dismissed as growing pains in corporate governance and demonstrations of sound shareholder democracy. But we should not lightly dismiss the fact that we are talking about millions of Rand going to an individual and that ultimately for the most part either customers or other employees will foot this bill. The argument that shareholders settle the account ignores the additional pressure to increase profits to maintain earnings after diluting the shares. A vague “what” and “why” around executive pay is simply unacceptable in today’s social environment. It is also a moot point whether the root of the problem will be addressed by simply penalising executive pay through taxation, or by major shareholders such as Trade Union pension funds and the P.I.C. rejecting executive incentives. The latter has been suggested by journalist Ann Crotty who is probably the country’s most prolific writer on the subject.

The most important issue of all in executive pay is the criteria being used in their determination. There is little doubt that the most weight is given to shareholder value, which in turn mostly translates into short term profit maximisation, exacerbating the economic woes of the past three decades. Only a handful of very enlightened boards have made the wider stakeholder approach the predominant weighting in remuneration criteria. In most cases this approach is either ignored or forms the lesser part of the pay structure and bonus determination.

Trust in business can only be restored by an alignment of business intent to society’s needs. This is not “socialism”, but indeed business sense. Shareholders, especially institutional investors, have a vested interest in this alignment because it affects the whole socio-economic order. The most important by far is a focus on customers’ needs and this should be the overwhelmingly predominant criterion in determining executive pay. Most big companies relegate these accountabilities to a much lower level of management. The executive, for the most part, is shareholder focussed and profit driven on the long ago disproven belief that profit maximisation spawns customer satisfaction.

Global research has shown that nearly 70% of informed people believe that “listening to customers” is the most important strategic issue facing business today. Only 36% of these respondents believe that business is meeting this expectation. Of the top five strategic issues listed, four deal with customer expectations. The other, ranked third is the need to treat employees well. Delivering on financial returns is seen as important by only 39% of those questioned and ranks 13th out of 16.

There will always be a debate about whether executives should be paid as much as they are. At the very least there should be far wider and deeper credible research to convince the general public that they are warranted. But companies can go a long way in restoring trust by realigning executive pay and bonus allocations to customer criteria. These are mostly highly measurable, easily understood and pretty self-evident. The time for “murkiness” and smoke and mirrors is past.

After all, customer loyalty and satisfaction are the only valid, sustainable and tangible wealth creators. The value that a company adds is measured by simply deducting outside costs, interest and depreciation from turnover. This should be shared sensibly and equitably not to line the pockets of shareholders or executives, but to meet the legitimate expectations of all of the contributors and to ensure their continued contribution. The simple axiom that the customer is the ultimate evaluator and determinant of wealth creation should be enough to maintain customer focus.

We trust those that have our interest at heart. Customer care and service excellence are by far the best way of showing this care, so trust and customer care are inextricably linked.

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