Are executive salaries becoming less relevant to a business?
Dec 21, 2012 3:54:00 PM
As our office prepares to decamp for Christmas, I was thinking ahead to 2013, and contemplating a potential reblossoming of the shareholder spring, particularly with regards to director's remuneration.
The unfashionable view says that this is less relevant than ever and has to be carefully handled because there are instances where the CEOs might just be being underpaid.
CEO / board salary is an emotional subject, which is rarely put to purely objective analysis. It is preferable for shareholders that people are not paid more than they need to be, are not paid for failure and do not set off wage inflation within their own business because everyone wants to be paid more. The most corrosive is the last of these, namely the example set to the rest of the business. But shareholders should be less alarmed by this than ever before because salaries are less relevant to their business than ever before.
Before we get excited about the salary issue, it needs to be put in context. Our research on the FTSE 350 shows that total salaries now are equivalent to 12.8% of turnover, down from 15% three years earlier. Overpaying everyone in the business by 10% will only cause a 7% reduction on EBITDA. By contrast, overpaying suppliers by 10% and EBITDA drops by more than one third! Perhaps more energy should go into this.
Suggesting that some FTSE CEOs could be underpaid will probably have some readers vexed and choking on their cornflakes but I suspect that there are some examples where messing with CEO pay should be done with care. There are many ways of evaluating a CEO. If we simplify it to a market based approach, it is a question of what would it cost to replace the CEO with someone of equivalent or better talents.
Most people's working assumption is that CEOs are the most expensive talent in a business as they are the top of the tree. This assumption falls over in finance where traders, for example, can see higher remuneration than their bosses and in the area of sales where commissions can be very significant.
That matters when CEOs participate in the sales process. Take a topical example - I have no doubt that Martin Sorrell will be one of the CEOs whose remuneration will be under scrutiny in 2013. I cannot think of a better performing global salesman over the last two decades. I have no commercial dealings direct with WPP but being on the other side for clients I have lost count how many times I have heard FTSE CEOs discussing marketing and mentioning that "I had Martin on the phone" or "I could just ring Martin", and he actively participates in pitches.
If he was lost, WPP would lose its greatest salesman. Replacing his sales pazzazz would cost millions in commissions to replacement sales people; possibly significantly more than he is paid. His market value is not just as a CEO but as a salesman - an ambassador for his organization and British industry more generally.
I hope that remuneration committees make sure that they understand the reference points upon which they are assessing CEOs and their compensation packages, and they do not throw the baby out with the bath water. We shall see.Guy Strafford