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If you think shiny new pay and incentives plans will motivate your senior executives, think again. Tom Gosling reports.

Critics of business in the UK and around the world say the way businesses pay senior executives encourages short-term tactical thinking and that pay must be restructured to encourage long-term, strategic behaviour. Research that we at PwC recently carried out with the London School of economics and Political Science (LSE) actually demonstrates that many aspects of current incentive plans are simply not working, as deferred bonuses, long-term stock options and complex structures aren’t valued by the workers they are aimed at motivating. The value executives place on them is materially lower than the cost to companies of providing them. In many cases executives would be happier being paid a smaller salary in a less complex and less volatile form.

The Psychology of Incentives study of over 1,100 participants reveals that executives are risk-averse when it comes to their own pay and don’t like complexity. Deferred bonuses hold little incentive, with the majority of executives valuing £100 of a bonus in a typical deferral plan at only half its value (£50). This discount is massively in excess of economic discount rates and the perceived value drops to as low as £33 for younger employees under the age of 39. Discounts also vary significantly in different regions of the world, showing that for companies with a global reach one-size-fits-all pay packages may be ineffective.

All of this places a major question mark over the effectiveness of deferred

two thirds more respondents (51% versus 27%) favoured a cash plan based on profit targets that they understand, over a more ambiguous share plan based on their share price relative to other companies. The more complicated the reward, the more likely participants were to choose the smaller but more certain reward, yet in the UK executive pay is based on the motivational theory that loading executives up with large amounts of incentive pay with complex performance conditions means that they’ll perform better for shareholders. Our study shows quite the opposite, that complex pay plans are a motivation killer.

About the study

1,106 participants took part in the study, 81% of whom were male and 19% female. 187 worked in the financial sector (22% of whom were female).

The executives had a wide range of senior roles in various sectors and were categorised into three earnings’ bands of $350,000 and under (66% of participants), between $350,000 and $725,000 (24% of participants), and over $725,000 (10% of participants).

bonuses, championed by shareholders, regulators and corporate governance bodies as a powerful way of influencing behaviour while at the same time encouraging prudent risk-taking. It is difficult to see how a form of pay that has such low perceived value can have a significant influence on behaviour. What we can say is that as the trend towards deferral increases, we would expect there to be reciprocal pressure to increase basic pay levels.

Complex and uncertain incentives are also revealed as a massive turn-off for most people. The research reveals that

Executives are also very concerned about the perceived fairness of pay. For the majority of respondents (51%), getting paid more than their peers was more important than being paid more in absolute terms (27%). In many countries there is a drive for greater disclosure of pay on the basis that this will lead companies to exercise restraint, but we believe the opposite to be the case, that disclosure will simply provide more opportunities for cross-comparisons and consequent pay escalation.

So this drive towards cleverly constructed, incentivised pay is a lose- lose for executives and shareholders. Simpler, more stable plans, with a greater role for remuneration committee discretion, are likely to be more effective at motivating executives. It will also cost companies less.


You can download a full copy of the report via services/publications/making- executive-pay-work.jhtm

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