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How should a board approach exec pay and what are the risks of getting it wrong?

Published: 02 Mar 2023 Update History

In this special Insights In Focus episode, we discuss the thorny and often contentious topic of executive pay.


Peter van Veen, Director, Corporate Governance and Stewardship, ICAEW 


  • Sandy Pepper, Emeritus Professor of Management Practice, London School of Economics and Political Science  
  • George Yeandle FCA, Non-Executive Director, Liontrust Asset Management, and Chair of the Remuneration Committee  
  • Luke Hildyard, Director, High Pay Centre 

Peter van Veen: Hello and welcome to a special ICAEW Insights In Focus podcast exploring the role that board members should play in getting executive pay. I’m Peter van Veen, the Director of Corporate Governance and Stewardship at the Institute. In this episode, we will focus on some of the latest trends and provide some practical advice on how to navigate a thorny and often contentious topic, but one that’s a crucial part of managing an organisation successfully in the long term. I have a great panel to explore this. Sandy Pepper is Emeritus Professor of Management Practice at the London School of Economics and Political Science and the author of a recent book, If You’re So Ethical, Why Are You So Highly Paid? I also have with me George Yeandle FCA, non-executive director at Liontrust Asset Management, and chair of the remuneration committee. And finally, Luke Hildyard, Director at the High Pay Centre, a think tank focused on pay and governance.  

Let’s start with something that’s being discussed more and more in the world of executive pay: whether ESG metrics should be used to measure executives’ performance. PwC analysis shows that in 2021, nearly two thirds of FTSE 100 companies used ESG-related measures to assess the performance of their executives. As this trend spreads to FTSE 250 companies and beyond, Sandy, I wanted to start by asking you, is this a good idea? Should companies be using ESG metrics to assess the performance of their execs? 

Sandy Pepper: I’m actually a bit of a cynic on this topic. Executive pay goes in fashions. When I started my career back in 1980, executives were paid a salary and had a pension. Then we had share options; then we had long-term incentive plans with ever more complex metrics attaching to them – typically, financial metrics. At times, people tried to introduce other metrics to do with staff satisfaction, or customer satisfaction. But these things were always difficult to do, because it was difficult to get really good, accurate measurements. And I think this is the problem with ESG. There is a huge ongoing and very volatile debate about what actually constitutes a good ESG metric. It’s a slightly complex combination of different things anyway – environment, social and governance; these are three things that don’t necessarily sit very happily together. So I am dubious about attaching ESG metrics to long-term incentives. I can see that it might be possible to attach them to short-term incentives where measurement might be a little bit easier. My favoured approach would be to think about this more in the round when you’re assessing somebody’s performance, rather than trying to tie a particular part of their reward to a particular metric. 

George Yeandle: From a practical perspective as a chair of remco [remuneration committee] I agree with you about the difficulty around measurement, of course, and the plethora of different potential measures that there are. We also within my organisation have had a discussion around whether ESG metrics sit best in long-term incentive plans or short-term. Partly because of the problem that the longer you’re trying to measure something further out, the lack of consistent metrics creates more of an issue. And partly because I passionately believe – and I think this is important; we’ve actually always thought about not just the ‘what’ but the ‘how we get there’ as well – that if a proportion of annual bonuses assessed according to ESG sits in the short-term bonus plan, then that allows the organisation to incrementally improve through that performance year on year on year, and I think the big changes that we’re going to make and help drive will come through incremental improvement and building on things year by year. 

PVV: What’s the risk? There’s a lot of debate around how accurate ESG metrics are and whether companies are gaming them to get a favourable kind of rating with investment companies. Isn’t it just another incentive to try and game your ESG metrics if your executive pay is attached to them? 

GY: Well, as we said, there is no single ESG metric. So I think you have to start by saying, where do you think you want to sit between what used to be called the hard financial metrics within an annual bonus, and the ‘softer metrics’ which might fit within ESG? We’ve been doing this for years. People used to have personal performance and risk as metrics and the investment community tended to say, well, funnily enough, executives always used to score quite highly in those. So there was a degree of cynicism about that. Now, I think, from my perspective, that ESG does now give us a good framework on which we need to start or on which we can hang some of the objectives here, which we can build on. But I think they do need, at the start, to be quite specifically targeted towards the business and the state and the cycle of the business that you’re in, and should only represent – well, in our company it’s 70:30; 70 for financial metrics, 30 for ESG – that’s the weighting we’ve gone for. But then I think you need to drive underneath the strategy, what the business is trying to do, the behaviours it’s trying to look at. And as Sandy says, setting metrics around the environment is very different from setting metrics around governance. 

Luke Hildyard: I think the question is, to some extent, about the value of performance-related pay in the existing executive pay practices more generally, because with financial metrics, if you’ve got an element of pay that’s tied to the share price or the profitability of the company, there are ways that executives can take decisions that will benefit those metrics in the short term and thus lead to enhanced payouts for them, but might not necessarily be in the interest of the company over the long term. Similarly, financial reporting can be manipulated. So obviously there are questions about whether ESG targets can be gamed and whether a high ESG score is necessarily reflective of a good outcome for all stakeholders.  

There was a company in the extractive industries a few years ago, where there was a huge controversy, because they did score very well on the operational performance and they very greatly improved the health and safety record in a year that was awful for the shareholders in terms of the profits and the shareholder returns.  

So the question in a way, I think, is obviously that companies should be looking at their social and environmental impact as a way of assessing the company performance and the individual executives’ performance. But whether they should be tying that to the to the CEO’s pay is a different question. But equally, we could be saying: should they have their pay packages formed of the multiple targets, different components – all incredibly complex – so that nobody really knows what it’s going to spit out in one or three years’ time? Would it not be better to simplify the pay package with, say, a restricted share award, and then just assessing the individual performance environmentally, socially, financially? 

SP: This is kind of where my sympathy lies. I wouldn’t wish anybody to misunderstand my first comment; I don’t think ESG metrics are not important, I think ESG is incredibly important. But I think the problem that we have is accurate measurement – having accurate measures of these different elements. 

GY: But surely each individual company and each individual chair of the remuneration committee, in consideration with the board [will be saying] we know what we’re trying to achieve as a company, we want to link pay to helping partners to achieve objectives, and those clearly will be different from company to company. But if we’re explicit, and by the way we know companies are explicit, but we should be more so in relation to explaining the outcome in the annual remuneration report and be more robust about how and why they’ve come to those decisions. But building on those as a starting block and continuing to build on those and starting to change behaviours – pay doesn’t rule this, but it’s one component of it. 

PVV: Are ESG metrics being more used as a hygiene factor? If you get it wrong, we might not pay some of your bonus, but as long as you’re not getting it wrong, we will focus on the financial performance – is that a more balanced way of looking at it? 

GY: I think so, yes. But I’m going to go back to what Sandy said. We know we can’t measure everything here. We can’t even get an agreement on what an adjusted profit measure might be when we’re looking at EPS measures, for example, but I think that’s to walk away from what this means across the organisation to be transparent about it, to actually to engage with your workforce about what this means. One of the things I do is meet the Workforce Advisory Council every year to talk about executive pay. So this is not just to do with the output for the executive directors, but it is something that cuts further across the business. 

LH: I’m really interested to know whether with an adjusted profit metric or, say, the health and safety record or the carbon footprint, do you think that if you have a metric in the plan, the CEO works harder towards that objective than if they didn’t have it there? Or is it a statement to shareholders and to other stakeholders saying this is what we as an organisation value? And so it focuses the culture of the organisation a little differently, perhaps? 

GY: Well, I’m not a psychological expert on behaviours, but if this was all about changing behaviours – I think somebody used the words gaming the system – clearly if you want to increase the diversity of your board, then it wouldn’t be difficult to do that to game the system. So it has to mean something further on down and through the organisation, to support the strategy that we’re trying to achieve. But do I think, in my experience, that the executive director behaviour is in some part – not driven by, but do they take account of some of those things? Yes. If we’ve chosen the right metrics that are important for the business, then absolutely; it will subtly change behaviours, I think. 

PVV: And the role of investors in this? Because I think Luke’s question comes to the core of that: how much of this ESG metric as a measure – and in terms of influencing exec pay – how much is that driven by the investors? And are the investors looking for a signal back from management or the execs, if you’d like, to say yes, we think this is really important and we’ll work on that, and we’re happy to have our pay tied in to progress on some of those metrics, like diversity, for example. 

GY: From the investor community, I think that’s a very interesting question. Because undoubtedly, the pressure is on chairs of remuneration committees to make the short-term bonus payments and metrics as hard and measurable and financially driven as you possibly can. But they find themselves in a slight dip, because clearly doing things the right way, and across the ESG space, is certainly becoming important. That’s why I think when we come back to deciding, in discussion with our investors – because we do, of course, go out to talk to our investors before we put new remuneration policies and plans in place – what the appropriate balance between short-term and long-term, between financial metrics and ESG metrics, should be, once we’ve got within that balance, I think it is then down to the individual company, the chair, the remuneration committee, the board, to work out and set what are the most important things which apply to the growth and development of that company, across those three metrics. 

SP: I’m quite taken with Luke’s comment about complexity, and George says something about the psychology here. I think there is a discount for complexity. That is to say, I think executives discount the value of their reward plans for the level of complexity that they involve. The more difficult something is to understand – there’s lots of empirical evidence to show that you then discount the value of it. I would rather have these measures on the way in, rather than on the outputs. My belief about what’s gone awry with executive pay over the last 30 years is that we’ve put in all this complexity about business management – we’ve kind of tried to design it into our reward plans. Actually, I think people are better than that, in the main; I think executives – most of them – want to do the right thing from time to time. And they don’t necessarily need to have it programmed in as an algorithm to their remuneration arrangements. 

GY: Don’t you think these discussions aren’t already happening on the way in? I mean, these objectives are not set in isolation behind closed doors. They’re set as part of a discussion about where the business wants to go, the role of the executives, and as part of their own appraisal system. 

SP: I’m not saying that they don’t. And again, don’t misunderstand me. But I just think, actually, that’s the critical thing that affects behaviour: the discussions that take place at the beginning. 

LH: The discounting point is important in another way, as well, because if the complexity results in the value being discounted, it means more complex CEO pay packages need to be bigger, to have the same value as the simpler ones, if you see what I mean. And as the CEOs perceive them as being more conditional, and less likely to pay out, the potential value has to increase and you see CEO pay go up, with all the contentiousness and controversy that causes. And of course, it means that the business is having to spend more on top earners than would previously be the case. I think that the evidence shows this: as these long-term incentive plans – which tend to be more complex, subject to more performance conditions – have come in, that’s what really sets CEO pay running away from the pay of the wider workforce. 

GY: Obviously, I don’t disagree with what you say. But I think, as you said at the end there, that there is a far greater risk associated with more complex plans driven out over longer time periods. The other thing that’s critically important for me as chair of the remuneration committee, of course, is that this does not exist within the executive directors alone. We now have oversight of senior management pay, oversight of pay across the organisation as a whole. So doing it the right way, thinking about what those ESG metrics might mean for managers – hiring more diversity, or whatever else it might be – and building in and aligning that with performance appraisals and the bonus discussions down the business, together with the executive directors, is an important point for me.  

SP: So actually, there’s quite a lot of agreement around the table here. What I think we’re agreeing on is actually to keep ESG metrics out of long-term incentives for all sorts of reasons that we’ve talked about. So if you’re going to have them, focus them; build them into your short-term incentives, your annual bonus plans. I think, George, you’re entirely agreeing that it’s part of the performance discussion that takes place at the beginning of the year, as well as the end of the year. You know, it’s just a question of whether the metrics are yet robust enough for your annual bonus plan, to give them validity. 

LH: On the metrics point and ESG, is it something really meaningful – or a fad? The complexity of ESG metrics doesn’t mean we should just ignore that. The fact that it’s so difficult to get a consistent, comparable, accurate way of assessing a company’s social and environmental impact means that boards, investors, policymakers should be thinking more about it, because it’s incredibly important. 

PVV: Of course, if ESG metrics have that impact on the bottom line and on the profitability of the company, through customers getting turned off, then it should be filtered through your performance and therefore your remuneration that way as well, be it in the short term or the long term. 

GY: I don’t think any business can feel comfortable about their long-term success if they’re not doing it the right way, that will have an impact on their long-term success. I totally agree with what Luke said here and by the way, dare I say it – I’m bound to say it – you have to put an element of trust in the chairs of the remuneration committees and the boards to make these robust assessments correctly, where you can’t automatically point to some external number to try and measure it. And I come back to what I said right at the start. This is evolving, I don’t think it’s going away. I think it’s evolving. We’re all – chairs of remuneration committees – grappling with this. And I come back to the point I made, which is, if we set the things [up] right, build on them consistently year on year on year, with more stretching targets each year, then we will see improvement. And what we want to avoid, of course – and this again comes back to chairs of remuneration – is not saying oh, well, you know, we ticked three boxes last year, easy ones, so let’s tick three different boxes next year. This has to be part of something that that grows year on year. 

PVV: Complexity also then prevents transparency and clarity for people analysing why you’re paid what you’re paid and so forth, because it becomes quite hard to unpick. I think that’s one aspect. The other aspect is very much about shareholders versus stakeholders and the short term versus the long term debate around incentivising execs for the long-term sustainable, profitable growth of the business, which is a perennial debate. And it’s nothing new. I think that debate’s been around a long time. But you’ve seen a few CEOs – I guess, with the support of their boards – take the fairly brave move, like Paul Polman at Unilever, to say: ‘I’m not going to do quarterly figures; we’re not going to do quarterly reporting; we’re only going to do annual reporting. And you’ll have to just assess us on the annual results, because that’s what you’re going to get.’ Is there more of a trend towards that? 

SP: I don’t know that there’s a trend; I think this is a very live debate. One of the responses to Unilever most recently comes from Terry Smith, another famous fund manager. He basically says, this is all a load of baloney being used by companies like Unilever, to disguise poor financial performance – where’s the money? Now, I’m certainly not advocating that point of view. And I’m much more attracted to the kind of view that George has just been describing. But I think this is a very live discussion at the moment. And if you got a different group of people in the room, you might get some very different views about the rights and wrongs of it. 

PVV: One of the things I’ve picked up in the media is that, in a number of cases where exec pay has been the headline, the role of the remco is front and centre. And in some cases quite explicitly, they’re being singled out for not doing their job correctly. So how difficult a balancing act is it for the remco? And how much pressure are you under to try and get this right? How do you do your job? 

GY: Well, obviously, we’re under considerable pressure. There is a history, maybe too often, of remcos not getting this right. Clearly, that gets more difficult when you look at incentive plans that span years, and we were talking about that earlier, in terms of getting some unforeseen outcomes – good or bad. I would answer that by saying listen, maybe it’s time to stand up as remuneration committee chairs now. Every plan that we put in place will have an overriding discretion by the committee to look at the outcomes. We need to man up, and we need to make sure we use that discretion to help get the right answers, even if that might be unpopular with management. And not just as I think an external view would say, oh, my gosh, every time remco uses discretion, it’s to up the pay. 

PVV: Luke, what are your thoughts on this in terms of the core role of the remco in this debate? 

LH: Can I bring it back to the question of the problem? Because I think it’s an interesting one. There are examples of where the remco gets it wrong and it has really dire consequences for the business, or brings about great disruption and upheaval. The obvious example is Persimmon, the house-building company where they set a very generous pay award that didn’t account for the effects that external things – specifically the Help to Buy scheme – could have on the housing market. And the CEO got paid, I think, close to if not over £100m for basically being in the right place at the right time. And that devoured the company’s attention. It was obviously a source of huge controversy. The CEO eventually wound up resigning after an interview where he was supposed to be talking about housing developments, but just ended up being constantly asked about his obscene pay levels. But I think that’s a rare case that was so egregious, and so badly wrong that heads had had to roll as it were.  

But I think in general, part of the problem is that the remcos collectively often deliver outcomes that are bad for society, because they’re all competing with each other, bidding up pay to outbid their rivals to get better people – or perceived better people – into the top positions. This means companies spending more on a tiny number of people at the top, the so-called 1%, grasping a bigger and bigger share of total incomes, leaving less for everybody else – and the gap is widening. But that doesn’t necessarily factor into business performance. And of course, I don’t think remcos – people like George – should be sitting there thinking, how do we solve societal inequality? Of course, they’ve got to be thinking about what to do that’s best for the business. So I think there’s a sort of mismatch, an externality, if you will, in terms of inequality that arises from the remco decisions. And I think it does show, again, the importance of understanding a business’s – and businesses’ collectively – social impact, as well as its financial performance. 

PVV: I’d like, finally, to finish off with a couple of questions around the international perspective, because we clearly see a very different approach to this in the United States, in the UK, and mainland Europe. The UK is literally between those two, and they’re quite difference in their approach to executive pay, and the use of non-financial measures or short-term versus long-term measures. The US seems to be particularly an example of where a CEO can get paid a multiple of the employee’s salary that is so much higher than in the UK. In fact, there is a very high-profile court case at the moment in the US, on Tesla and the package that Elon Musk got out of Tesla, which is in the billions; this seems inconceivable in the UK context. And in Europe, there is a very different approach to exec pay, which is much more in line with perhaps the salary progression through the ranks up to the senior leadership posts. Luke, from your perspective, are we seeing any movement? Are we moving more towards the US model? Are we developing our own model in the UK? Or are we more moving more towards a continental European model of exec pay? 

LH: Certainly in terms of the amounts that CEOs are paid, the UK tends to be a bit higher than the rest of Europe, but much closer to Europe than to Elon Musk levels of pay in America. And I think that’s probably a good thing. Some people would say that the American economy is more dynamic as a result of its winner-takes-all culture, but that’s maybe in aggregate. But that level of inequality in America means some people have very hard lives indeed. So I think that approach in Europe, where pay is seen more in the context of wider society, is probably a little bit healthier. There was some interesting research that showed that the higher a proportion of a firm’s ownership that’s US-based, US fund managers and so on, the higher the executive pay, and the more likely it is to follow an American-style structure with very high levels of reward for the for the top executives, and the proportion of UK plc that is US-owned is gradually increasing. So perhaps we will start to go more in that direction. I would hope not. 

GY: Just two points, I think. One is that I take the international aspects here of pay – don’t forget the impacts of pay competition in the private equity space. That’s a smarter comparator for people within this country as well as overseas. Beyond that, I absolutely passionately believe that those companies that are going to be successful in the longer term, will be doing it the right way and not just focused on generating profit and big payouts for senior executives. So I do believe that therefore we should continue – and get better at – putting those ESG metrics into the culture of the way in which we do business in this country. 

SP: My view is that – as in so many other things – when it comes to pay, and the way we do business in the UK, we don’t quite know whether we want to be like the Americans or like the Europeans. I certainly hope, George, that you’re right, and that our leanings are more to the European than the American end. But I think we as a nation have still got some hard thinking to do about that. 

GY: Sadly, I don’t have a problem with people being well-paid for success the right way, so long as that is spread throughout the organisation. 

SP: And I think we’ll probably all violently agree on that point. 

PVV: And I think on that note, we can conclude. I think we’ve been on a whirlwind tour through what is a very complex topic of executive pay, ESG metrics being put into that mix, as well as short term versus long term, and the international perspective.