While there are signs of change, our research shows that shareholder primacy continues to underpin performance-related CEO pay. Luke Hildyard writes for Board Agenda
Board Agenda readers will have noticed the growing criticism in recent times of the doctrine of shareholder primacy, and the promotion of alternative philosophies based on concepts such as “purposeful business” or “stakeholder capitalism”.
Prominent new initiatives on these topics include the Financial Times campaign Capitalism: Time for a Reset, launched in September 2019, with with the editor noting that “the liberal capitalist model model… has come under strain, particularly the focus on maximising profits and shareholder value”.
Similarly, the British Academy is running a programme of research and policy development focused on its Principles for Purposeful Business, encouraging companies to manage and prioritise their social and environmental performance as well as their financial returns. A project managed by the Big Innovation Centre, The Purposeful Company, has attracted the sponsorship of several major companies and the leadership of heavyweight figures from business and academia.
Internationally, the Business Roundtable group of top US corporate leaders committed to abandoning the doctrine of shareholder primacy, and committed “to lead their companies for the benefit of all stakeholders—customers, employees, suppliers, communities and shareholders”.
The 2019 Davos Manifesto set out the case for “stakeholder capitalism… (which) positions private corporations as trustees of society” in contrast to the dominant “shareholder capitalism” model in the West or the “state capitalism” approach followed in China.
However, the deeply cynical might suspect ulterior motives for businesses—including many who are not widely considered to have consistently served the public interest in recent times—to associate themselves with these initiatives.
Talk versus action
Business is arguably suffering from a crisis of public confidence. Polling by YouGov found that a majority of people in the UK disagreed with the notion that “what is good for business is usually good for the rest of society”. Whether or not this is the case, it not illogical to imagine that the interests of business and wider society can occasionally conflict. Lower pay, oppressive management practices or cutting corners on health and safety or environmental protections, for example, could in theory result in higher profits for businesses while being net negative for the community as a whole.
The UK is one of the most unequal economies in the developed world, pay growth throughout the 2010s was the worst for a century even as the stock market enjoyed consistent growth, and concern about climate change is at record levels. In this context, the likelihood of policymakers viewing the pursuit of profit and shareholder returns as a problem to be alleviated with regulation is high.
However, if businesses talk about these issues for long and loud enough, they may be able to convince the relevant authorities that the matter is in hand. Measures imposed on businesses designed to align their practices with the interests of wider society are superfluous because the necessary change in business culture is already under way.
Therefore, it’s useful to examine how the talk of stakeholder capitalism and business with purpose compares with the action on performance-related pay.
Performance-related pay reflects priorities
To this end, the High Pay Centre carried out research looking at the performance metrics in FTSE 100 CEOs’ pay plans and the outcomes that they incentivise.
CEO pay incentives reflect boards’ priorities. If the proportion of potential incentive pay linked to financial returns is much greater than that linked to good outcomes for employees, this would lend credence to anyone inclined to take the promotion of “stakeholder capitalism” with a pinch of salt.
For every £1 that CEOs can earn from delivering good outcomes for employees, they can make £42 from hitting financial targets relating to profitability, shareholder returns or revenue
Our research suggests that this is indeed the case. The research found that only 34% of FTSE 100 companies used employee-related metrics in their CEO performance-related pay package. Amongst the companies that used these metrics, they account for just 5.9% on average of the maximum incentive pay available to CEOs. Across the FTSE 100 as whole, employee-related metrics accounted for only 2% of maximum incentive pay.
By contrast, all companies analysed in the research use financial metrics for their performance-related pay packages. These metrics had an average weighting of 82.4% of total maximum potential incentive pay.
In other words, for every £1 that CEOs can earn from delivering good outcomes for employees—such as an improved health and safety record, or higher levels of employee engagement—they could make £42 from hitting financial targets relating to measures such as profitability, shareholder returns or revenue.
Measuring stakeholder-related outcomes
Other similar studies suggests that the proportion of performance-related pay linked to employee-related metrics—and ESG measures more generally—has increased in recent years, but from a low base.
The charitable interpretation of this is that it reflects the difficulty of measuring the outcomes that businesses deliver for employees and other stakeholders, compared with well-established measures of financial performance. The alternative view is that shareholders remain the dominant force in business governance, and corporate culture remains overwhelmingly focused on maximising financial return over all other objectives.
At the High Pay Centre, we’re undertaking further work examining how we make measures of social and environmental performance a more consistent and clearly understood part of corporate reporting and of conceptions of business success. In the meantime though, our research suggests it would be premature to equate criticism of the shareholder primacy doctrine with its decline.