The Big Myth About Long Term Incentives and A Cultural Change In The Boardroom

I admire risk takers. They perform an essential service for those in the business of transferring risk. Whether it is insurers assuming risk from their customers, reinsurers assuming risks from insurers, investment banks and institutional investors assuming risk from publicly traded businesses or bookmakers accepting risk from their customers. I think those that work in that arena are mostly following their passion.

What I detest are those that call themselves “risk takers” and who are running a business but actually don’t take any risk. In effect they are traders with no discernible “skin in the game”. They are asking for the respect that is accorded to someone, who puts their balance sheet at risk but are in fact quietly skimming a dollar, a pound, a euro or a yen off other parties who have the cojones to price and assume risk. All that I ask is that people are honest about their own “worth” and the value they provide (or dramatically) create for others.

The same applies with people in corporate organisations with over bloated egos, who demand the perks of entrepreneurs and shareholders with ACTUAL money at risk.  I am reminded of this when I see demands made of shareholders by top management  to support inflated long term incentive rewards, where there is visibly little or no personal risk (downside). So many of these arrangements set “targets”, which hardly stretch the executive to achieve a generous award. Complicit advisers happily create a pretext for toothless remuneration committees about the “need to attract world class talent that can produce results” and earn inflated fees, largely based on hourly billing. In other words, the longer they take to design, facilitate and implement a LTI arrangement the better off they are, in total conflict with shareholders’ interests, which best served by a quick solution. If the time, energy and effort was re-directed towards how top managers intend to produce results rather than reward results, shareholders would be exponentially better off. My point here is where is the accountability for top managers, Remuneration Committees, the plans they promote and the advisers they hire.

Yes, there are the headline cases where institutional investors “push back” but they resemble a fisherman casting a rod, not a fishing net to eliminate the abuse. My suggestion? Any LTI plan and those engaged to advise or approve the arrangement must meet these criteria:

  1. No plan pays out any benefit for “performance in line with target expectations”. The Manager get his salary and benefits, nothing more.
  2. Where “performance is below expectations”, the Plan has a clawback provision against any other accrued executive pay or benefits  upto 20% of the total amount received, which is “at risk” for upto 36 months after leaving service with the firm or a date to be agreed
  3. Benefits paid out for “out-performance” are only paid to those achieving top quartile results and behaviours. Objectives, measures of success or progress and the value created in meeting or exceeding those expectations are conceptually agreed in advance with shareholders . They are transparent for all shareholders.
  4. No Adviser is allowed to bill hourly fees. Their remuneration is in the form of a value-based fixed fee providing a dramatic return for the organisation and fair and equitable compensation for the practitioner.
  5. No Remuneration Committee Chair or Board Member is allowed to serve more than one term. They can only sit on one Company committee, at any one time. They are only electable based on a combination  of expertise and experience directly linked to the existing and anticipated market needs of the business and their ability to attract managers with the requisite skills and behaviour. No jobs for the boys!

I confidently predict a dramatic improvement in business results with the application of greater focus and discipline and shareholder resolve to see their interests best served by these arrangements.

© James Berkeley 2014. All Rights Reserved.

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