Once more the issue of rewards and links to long term success of the company have been raised.  The Financial Reporting Council will be advocating stronger links and also clauses to enable bonuses to be clawed back [1].  However, focusing on the payment formula alone will not produce a sound scheme.  Like an iceberg, the danger is not the visible part – the formula – but the mass below the water line i.e. how the incentive will be achieved.

A bonus scheme legitimises certain behaviours as individuals seek to achieve the bonus and/or shares.  It is no good despairing that the wrong results and behaviours have arisen as incentives change behaviour in many, but not all, instances. The first key step is for the Remuneration Committee or the Board to invest time in being clear about what short and longer term outcomes are required and how those should be achieved.  By that I mean what type of behaviours should be encouraged or discouraged.   Then one can begin to examine the mechanics of the scheme but always with an eye as what type of behaviours are being legitimised.

For example, will the scheme foster reasonable risk taking or exploring innovative ways of obtaining the results?   If the ways in which the results are obtained is important to the company then the scheme should build ‘the how’ into the scheme.   Individual leaders and participants are then aware of where the edges of the path are i.e. they can walk anywhere on that path but may not step beyond the edges.

The pressure is not to eliminate such bonuses but, to quote Vince Cable, “Policies that reward executives out of proportion to the value they create are a clear dereliction of the duty.” [2].   Hence, the importance of being clear from the outset what the incentive scheme should reward and the ways in which the scheme should reinforce the desired ends and means. 

Previous articles on this blog covered the issues and pointers in more depth.  Read the following articles:

Board and Executive Pay – putting a sound policy in place (link reference to be added)
Board and Senior Management Pay – Equitable Approaches

Sources:
[1] Daily Telegraph – Business – report by Harry Wilson 24/04/14
[2] Vince Cable – reported by Harry Wilson, Banking Editor Daily Telegraph 22/04/14

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