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Hefty executive payouts come under the spotlight

Author: ICAEW Insights

Published: 05 Apr 2023

As we await the verdict of the lawsuit challenging a $56bn pay package from Tesla to Elon Musk by aggrieved shareholders of the carmaker, is enormous executive remuneration really necessary – or indeed ethical – in today’s market?

The rise and rise of environmental, social and governance may suggest a trend towards doing the right thing in business – but when it comes to executive pay packets, at first sight it’s every man or woman for themselves, if some of the eye-wateringly high pay awards to the C-suite are anything to go by.

An extreme example that has brought the issue to head is Elon Musk’s $56bn pay package from Tesla, awarded in 2017 by the car manufacturer, which hit headlines not just because of its sheer scale. It has subsequently become the focus of a lawsuit brought by a disgruntled shareholder, who argued that Musk and the automaker breached their fiduciary duties by awarding Musk a pay package that was “beyond the bounds of reasonable judgment”. 

The Elon Musk case is not typical or representative of what’s going on in America – and it is certainly not representative of UK executive pay practices. In terms of its scale, these are staggering sums of money. Nonetheless, against a backdrop of soaring inflation in high pay, it does raise the question of what constitutes “reasonable judgement” and what needs to happen for executive pay deemed excessive by many to better align with the more wholesome values being extolled by today’s boardrooms. 

Sandy Pepper, Emeritus Professor of Management Practice at the London School of Economics, says over-complex and inefficient pay practices, rather than greed, are to blame for high executive pay. He says there’s a tendency for remuneration committees to copy other companies’ pay practices, but then to pay over-the-odds in the hope of winning the war for executive talent. And so the race to the top continues.

“Over the past 25 to 30 years, the UK has imported US-inspired pay practices – share-based incentive packages that have the potential to make senior executives very wealthy, with a view to incentivising them and aligning their interests with those of shareholders,” Pepper says. However, there’s no real evidence of a strong connection between share-based incentives and the financial performance of companies, Pepper warns. Instead, the strongest correlation is with company size. “And some of these plans become so complicated that there are all sorts of unforeseen consequences.”

Pepper is an expert on executive pay practices and the author of ‘If You're So Ethical, Why Are You So Highly Paid?’, published last November by LSE Press. His analysis suggests that in fact a relatively small proportion of executives conform to the popular stereotype of self-interested fat cats. Based on research among more than a thousand senior executives from around the world, Pepper and his colleagues found that although around a quarter of respondents might be classified as ‘free marketeers’, the rest had relatively egalitarian views about pay in society. 

“I don’t believe that all senior executives in big companies are, as a matter of course, greedy and selfish,” Pepper says. “Some are, but most are not. Actually, most people, most of the time, try and do the right thing. But they’ve been the lucky beneficiaries of a system in which companies have continued to copy each other and pay over the odds for senior executives. Everybody would be happy to pay more moderately, but they don’t want to be the first person to do that. And because everybody pays over the odds, it ends up not making any difference.” 

It is the market failure in executive pay that has created such wage inflation at the top, he argues, and this ultimately requires an ethical response from investors, companies and executives. “Most people would be content as long as they believe they’re being paid fairly relative to their peers, but instead we have an arms race approach to pay and the executives are the fortunate beneficiaries of this.” 

A backlash against these kinds of highly leveraged plans is underway, Pepper says. “What is gradually emerging is the idea that top executives should be paid a generous salary for their work and they should be encouraged to build up shareholdings in the companies that they work for, as a means to better align the interests of directors with those of shareholders. 

“Either you pay them bonuses that they invest in company shares – that’s my preference – or you pay bonuses in the form of restricted stock, shares that gradually become more valuable over the course of time. Either way, if the company does well, the director does well,” Pepper says. 

Back to Musk and Pepper says the case has touched a nerve around executive pay in general. Few batted an eyelid when Tesla was forced to come good on a $20bn pay plan for Musk entered into in 2012 by the then fledgling car manufacturer. After all, the consensus was that Musk had played an instrumental role in creating value for the company. 

The crux of the lawsuit is that the precedent set by the previous plan is neither here nor there, Pepper explains. “Tesla is now a very successful company and Elon Musk is already a major shareholder because of his earlier plan.” This $56bn payout is the remuneration equivalent of having your cake and eating it, Pepper explains.

“Musk is a very clever guy, but some people argue that his business practices go beyond the boundaries of what is ethically acceptable. And this payout looks like just another example of that,” he says. 

We need entrepreneurs and we should accept that the successful ones will become very wealthy because they’ve taken huge risks and they’ve shown huge ability to achieve that, Pepper argues, “but that doesn’t give them the right to go on milking what are now public companies for the same equivalent sums of money once the company has become established, particularly if the CEO has a pay plan that extracts enormous value from the other shareholders.”

The Musk case hasn’t been decided yet and Pepper suspects that it will ultimately be decided not on the amounts of money involved, but on questions of corporate governance. “There are questions about the ability of a minority shareholder – albeit one with a substantial 20% stake in the company – to have undue influence over the directors who awarded this pay package at the expense of other minority shareholders. When the decision comes out, I suspect it will come down to what many will regard as legal technicalities.”

  • Listen to a special ICAEW Insights in Focus podcast on executive pay and the risks of getting it wrong, where Sandy Pepper is joined by George Yeandle, Non-Executive Director at Liontrust Asset Management plc and Luke Hildyard, Director at the High Pay Centre.

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