Will it be the “Shareholder Spring” or the psychology of the Savannah? 

By Martin Hopkins

The world of executive reward continues to evoke debate and controversy around the world. In recent weeks we have seen the sustained levels of shareholder and regulatory activism intensify, to the point that reward professionals in the UK are referring to the “Shareholder Spring” a parallel of the political uprisings in the Arab world!

On the other hand, some fascinating research by my colleague Tom Gosling from our London practice, indicates that the levels of risk and deferral inherent in the packages that shareholders and regulators require are perceived as highly unattractive by executives. As a result, the discount they apply to their package elements leads to a significant difference between the economic cost of their packages and the value perceived by the incumbents.

“Shareholder Spring” continues

The regulators in the Euro zone have fired the next salvo in the battle, with a decree by the European parliament that seeks to cap executive bonuses in the banking sector. On 14 May, MEPs in the European parliament voted on amendments to the text of the Capital Requirements Directive (CRD4). Amongst the amendments increasing capital requirements for credit institutions and investment firms, MEPs have agreed to implement a cap that would have the effect of limiting the ratio of variable remuneration to base salary to one to one.

The European Parliament CRD4 text is one of three drafts that is set to be debated over the next few weeks as part of the ‘trialogue’ process. This involves discussions between the European Parliament, European Commission and European Council. This final text will be part of the Directive, which is set to come into force on 1 January 2013. It is currently unclear as to what the cap will apply to, and whether Member States and/or firms will be able to interpret such a definition. Until we have greater clarity on the remuneration that is likely to be included in this cap, we will be unsure of its full impact.

Who will this cap apply to?

It is likely that application of this restriction will be limited to the identified Code Staff population. Given the discussions by MEPs this week, it looks as though this ‘risk taker’ test may be formalised using a remuneration threshold. Whilst the exact threshold is not currently clear, the discussions suggest that it will be set at a level materially below EUR 1 million, which would have the effect of bringing many more employees into scope of Code Staff.

Of course, this does not directly impact South African banks, or anybody outside the banking sector, but our regulators and institutional investors are definitely influenced by UK and European bodies, so we need to keep an eye on international developments.

Business Leadership SA (BLSA) initiatives

South African Business is not sitting on the sidelines in this debate either. BLSA is looking to proactively address the issue of executive pay by issuing a “Remuneration Report” and an “Annual Report” for business in South Africa. The “Remuneration Report” is due for publication in June – keep an eye on the BLSA website!

The BLSA recently noted in its response to the National Development Plan (NDP) that “Wage moderation should be pursued at all levels, including some sacrifices by management”. It will be interesting to see the degree of consensus that business achieves in determining the extent of these sacrifices. We have certainly seen a degree of moderation in executive salary increases. In the last decade executive pay increases generally exceeded that of more junior employees, but in the last year or two, they have been a percent or two behind the general level of increases.

Psychology of incentives

So what do executives think of all this? Some recent research, in conjunction with Dr Alexander Pepper at the London School of Economics and Political Science, sought to provide the evidence that’s needed about how executives – the population whose performance is meant to be enhanced by incentive pay – react to incentives. The research involved asking senior executives to complete a structured interview questionnaire that explored the trade-offs that individuals make between risk, reward, certainty and time. The participants comprised 1,106 executives in 43 countries, within a wide range of senior roles, companies and industries. The survey shows that executives are surprisingly risk averse when it comes to their own finances, and unconsciously apply large discounts to the risk and time delay applied to their variable pay.

The debate continues...

Keep a look-out for these publications on the websites of the responsible organisations – it is a fascinating debate, and one that business and society is watching with great interest!

Martin Hopkins is a member of the South African Reward Association Executive Committee, www.sara.co.za, and Head of Reward Consulting, Director at PwC Tax Services, www.pwc.co.za.