Commentary: Directors must perform for their pay
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Your support makes all the difference.The relationship between directors' pay and their companies' performance is an important issue for shareholders, but it is also crucial for the economy. If business leaders are rewarded whatever the vagaries of their performance, they are likely to take less care about delivering impressive results. That will translate into lower efficiency, poor returns on capital, and weaker growth.
The latest study from the London School of Economics makes depressing reading*. Directors' pay rose by about 20 per cent a year on average over the period from 1983 to 1991. But little of this large rise can be explained by good performance. Using state-of-the-art econometrics to look at 288 of Britain's biggest quoted companies, the researchers discovered that a 10 per cent improvement in shareholder returns (share price and dividends) - often an enormous sum for the companies involved - could explain a rise of a mere pounds 221 a year in directors' pay. A 10 per cent rise in earnings per share led to a rise in directors' compensation of some pounds 2,107.
After 1988, even this feeble relationship between pay and performance appeared to break down, whether performance is measured by stock market valuations or earnings per share.
The factor that appears to drive directors' pay is simply the size of the company: directors have, as the authors put it, 'a clear incentive to pursue merger and acquisition activity regardless of any benefit to shareholders, workers or the economy as a whole'.
It is easier to diagnose the problem than to find cures. But the traditional remuneration committees consisting of non-executive directors are not working well enough. Too many consist of executives of other companies, who in turn have their pay set by non- execs. They should be willing to pay for outstanding performance, but they need to be more critical about high rewards for indifferent returns.
*Centre for Economic Performance: The disappearing relationship between directors' pay and corporate performance by Paul Gregg, Stephen Machin and Stefan Szymanski.
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