Debate surrounding executive compensation is an enduring feature of the U.K. corporate landscape. Although concern over compensation levels continue to grab the attention of politicians and headline writers, concern is also growing over the extent to which performance measures that are widely used in executive compensation contracts (e.g., earnings per share growth and total shareholder return) represent appropriate measures of long-term corporate value creation. This debate partly reflects fears that U.K. executives face excessive pressure to deliver short-term results at the expense of long-term improvements in value.
The Chartered Financial Analysts (CFA) Society of the UK commissioned researchers at Lancaster to undertake a pilot study of executive compensation arrangements and their association with corporate value creation using a subsample of FTSE-100 companies over the period 2003 through 2013. While the results provide a degree of comfort they also create cause for concern. On the positive side, we document evidence of a material positive link between CEO pay and several measures of value creation. The evidence suggests that prevailing executive pay structures incentivize and reward important aspects of value creation even though contractual performance metrics are not directly linked with value creation in many cases.
More troubling, however, is the evidence that: a large fraction of CEO pay appears unrelated to periodic value creation; key aspects of compensation consistently correlate with performance metrics whose link with value creation is indirect at best; and in many cases the metrics used to incentivize and reward senior executives are not directly aligned with the key performance indicators (KPIs) that firms highlight as fundamental drivers of business value..
Although the structure and transparency of executive compensation practices has come a long way since the “fat cat” headlines of the 1990’s, the journey appears far from complete.
Read more details about this research as featured in a recent article in the Financial Times.