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Viewpoint: Making Executive Pay Work
 

By PricewaterhouseCoopers  6/1/2012

There is an emerging consensus that something is deeply flawed about the current model of executive compensation. Executive pay has risen dramatically over a period when, in hindsight, the Western economic model has not been at its most successful. Surely something must be wrong.

The debate about executive pay has focused on whether shareholders are getting what they want, whether current levels of executive pay are acceptable to society and whether remuneration committees are doing their job properly. But surprisingly little attention has been paid to perhaps the most important constituency: executives themselves.

If executive pay were genuinely motivating executives toward higher levels of performance, with benefits for all, there would surely be less controversy about the subject. But does the current model really work for the individuals it is meant to be motivating?

To shed light on what truly motivates senior managers, a global study of more than 1,000 corporate executives was conducted by PricewaterhouseCoopers in conjunction with the London School of Economics and Political Science. A May 2012 study report, Making Executive Pay Work: The Psychology of Incentives, reveals the following insights.

Executives are risk averse. Most respondents chose fixed pay over a bonus of a higher value. Only 28 percent chose the bonus, which has higher risk. Executives in Australia and the U.K. are most risk averse; those in Brazil and China are most willing to take on risk in their pay.

Complexity and ambiguity destroy value. More executives chose a clearer pay package over an ambiguous one of the same or potentially higher value, and more prefer an internal measure they can control (such as profit) as opposed to an external relative measure (such as total shareholder return).

The longer the wait, the less it's worth. Executives value deferred pay significantly below its economic or accounting value. A deferred bonus is typically discounted by around 50 percent over three years. Discounts are particularly high in Asia and Latin America, with deferred payments being discounted by up to two-thirds in the eyes of executives. The conventional wisdom is that deferral makes executives think longer term. But it is difficult to see how something that has such low perceived value can be a significant influence on behavior.

It's all relative—fairness is fundamental. Most executives would choose to be paid less in absolute terms but more than their peers. Fairness is much less important in Brazil and China than in many other countries, but it is most important in India.

People don't work just for money. Participants would take a 28 percent pay cut for their ideal job. The result was consistent globally, with the lowest cut being 24 percent (India) and the highest 35 percent (U.S.).

The key motivation of a long-term incentive plan is recognition. Fewer than half of executives think that their long-term incentive plan is an effective incentive. Still, two-thirds value the opportunity to participate in their firm’s long-term incentive plan.

Going Forward

The study findings suggest that companies might have tried to make incentives too big a part of total executive compensation. Simpler, less leveraged packages, with less volatile outcomes, might be more valuable (and motivating) to executives and cheaper for shareholders.

Performance pay still has an important role to play, but its use should be more discriminating—and the business case for it needs to be clear. Most of all, the design of performance pay needs to be more relevant to the people whose behavior it’s meant to influence–executives.

(View a PricewaterhouseCoopers video in which Scott Olsen, head of PwC's U.S. Human Resource Services consulting practice, discusses the report's findings on executive compensation.)

PricewaterhouseCoopers is a network of firms in 158 countries with close to 169,000 people providing services in assurance, tax and advisory services.

Related SHRM Articles:

Incentive Compensation Tips and Pitfalls Shared, SHRM Online Compensation Discipline, May 2012

Reward Strategies Should Target Key Talent, SHRM Online Compensation Discipline, May 2012

Microsoft's Rewards Strategy Evolves, SHRM Online Compensation Discipline, May 2012

CEO Pay Increased Modestly as Profitability Rose, SHRM Online Compensation Discipline, May 2012

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