Justifying the bonus culture

Earlier this year it was reported in the national press that, despite the decline in its investments and fall in profit from £576m to £17m, the former mutual Standard Life’s chief executive, Sir Sandy Crombie, received £380,000 bonus on top of his salary of £754,000. Fellow director Keith Skeoch’s take was £1.3m while finance director David Nish’s take was £885,000.

The following extracts are from a letter, arguing the case made from a historical perspective in ‘The Rise and Fall of Management’, written to Sir Sandy Crombie asking how these payments could be justified:

Dear Sir Sandy,

I am writing to enquire about the salaries and bonuses you and senior colleagues are being paid. I don’t understand how these levels of remuneration can be justified and I would really appreciate some explanation.

Some time ago Peter Drucker suggested the ratio between top executive’s pay and that of the average hourly paid worker ‘could be no more than twenty to one without injury to company morale … Few executives can imagine the hatred, contempt and even fury that has been created – not primarily among blue-collar workers … – but among their middle management and professional people.’

The levels of remuneration received by yourself and colleagues far exceed Drucker’s ratio. The possibility of ‘hatred, contempt and even fury’ has recently manifested themselves amongst the general population focusing on the greed of financial executives, notably in the case of the now much reviled Sir Fred Goodwin, and were doubtless felt if not expressed by his RBS staff. The difference between Standard Life and RBS in terms of executive remuneration may not be seen as hugely significant by most people: the sums involved are simply unimaginable. Nor is the difference in performance likely to be perceived as of huge significance. The general problem, which I share, is that it is not understood why people such as yourself should be paid bonuses at all. Such incentive payments are seen as more relevant to jobs at the other end of the pay spectrum, where there may be little intrinsic to the job itself which would motivate performance. But surely you and your colleagues would be motivated to try and do a decent job without more money. Arguing, as some do, that these extreme emoluments are necessary ‘to retain talent’ is frankly insulting.

I would very much welcome your considered response.

Sir Sandy Crombie replied as follows:

Dear Mr Pearson,

My philosophy on people and pay (developed over nearly 43 years with the company) is fairly simple – pay policy should be set at or near market level. Pay significantly less and those who are motivated financially will leave and those who seek merely to be treated fairly well will feel undervalued. Either way, if we get our policy wrong, we will fail to keep and to get the best from the talented people we need at every level in the company.

From time to time I have seen artificial limits set and then, without exception, removed because of the distorting and damaging effects. In my experience, whether dealing with professional trainees, specialist disciplines, clerical or managerial positions the market for the relevant skills ultimately dictates what it is necessary to pay.

Our Remuneration Committee, comprising only non-executive directors, has approved the pay policy for the company and sets specific terms for the most senior executives, having taken independent advice. I have observed them at their work and they are extremely diligent in taking account of best practice guidelines laid down by interested parties. The Comittee sets out to be fair, but not over-generous relative to the market. Execiutives do not negotiate their packages, but are of course free to make their own career decisions.

I judge from your letter you will not agree with my view of how policy needs to be set in order to keep our company properly resourced. I think on the other hand the flaw in your argument is that while certain individuals might be willing ot fit within the pattern you propose, it is unlikely to prove possible to persuade a population, absent other mechanisms to apply compulsion, to agree to be restricted by artificial boundaries.

With best wishes,

Sandy Crombie

My reply to Sir Sandy included the following:

I do agree that it is extremely difficult for a competitive business unilaterally to buck the market. Pay levels for the categories you refer to are all established externally by the market and there is little argument over these. The problem arises with the pay for the top executive positions where the general public, egged on by the media, is clearly outraged by the levels of published earnings which seem not to be justified by performance or anything else.

I previously quoted Peter Drucker referring to ‘the hatred, contempt’ etc caused by excessive top executive pay. I could also go back to J P Morgan of all people saying much the same. And both of them were making their point when income taxation was far more progressive than it is today, as was advocated by Adam Smith and his successors right down to, but not including, Milton Friedman and colleagues.

The rationale for the level of top salaries is, as you say, that they are established by the market. But it has been widely argued that this particular market is fixed. Remuneration committees are largely populated by individuals who, though external to the particular company, occupy directorships of other companies and so have an interest in bidding up top incomes. Three of Standard Life’s four Remuneration Committee members fall into this category, and though they have no doubt acted properly and with care and, as you say, are ‘not over generous relative to the market’, they are nevertheless seen to be members of a compromised system. It has also been widely argued that the professional consultancies engaged in this area have a similar vested interest in raising top remuneration. Evidence of the ‘hatred, contempt’ etc is reported daily. The market argument for top salaries is being widely challenged as something of a confidence trick by the great and good on the rest of the population.

Taking a long term perspective, the current level is clearly an aberration. Change looks inevitable. It could come through voluntary regulation, statutory enforcement or fundamentally revised taxation. In this context, boards of directors may have to decide whether to be in the vanguard of change, being seen to welcome a more equitable distribution, or to defend the status quo. One position would look, to customers and employees as well as the general population, more enlightened than the other. As you indicate, there would be considerable difficulties achieving change, but square one would be a positive expression in its favour.

Any response from Sir Sandy will be posted.

6 thoughts on “Justifying the bonus culture”

  1. It is so tiresome when extraordinarily well paid managers make this routine invocation of the market for talent. Does that mean that talent will only turn up for huge wads of cash then? And consequently that we should treat all any statements about public interest, csr, ethics and so on as no more than venal self interest? Does it also mean that people working in the public and third sectors are not talented, or perhaps merely that their version of talent doesn’t require compensation on the same level?

    This is self interested rubbish, the sort of thing you would dismiss as greed if you heard it from a footballers agent, but somehow Sir Sandy and his ilk keep getting away with it.

    Like

  2. Sir Sandy’s argument does look pretty tired. Especially as the so called talent achieved such a disastrous result, Standard Life being a case in point. It is now a shadow of its former mutual self. That’s to assess so called talent in their own terms ie money. If you broadened the analysis to include other criteria, as most human beings do, it is easy to see why the overpaid bankers earn what Peter Drucker described as ‘hatred, contempt and fury’.

    Like

  3. What really drives me crazy with Sir Sandy’s response is the utter illogicality of the “performance” element. If, the company has salespeople working on commission (which I also disagree with), then if there sales go down to the equivalent point, i.e. a fall of 97%, they would, at best, earn no commission; but more likely lose their job. And no excuse like, the market has collapsed, would suffice. So, once again, in this invidious business climate, what is sauce for the goose is not sauce fro the gander.
    But the more important principle is that bonuses – for anyone – are just plain bad. They do not work – as Deming, Kohn and others have amply demonstrated. You cannot conceive of the organisation as a system and then reward so-called individual performance. That too is utterly illogical. But, when the trough is so wide and accessible that you are actually standing in it, that is a perspective that is hard to get.
    Finally, the average UK person can have an acceptable quality of life spending £18,000 a year; which means a salary of say, £25,000. Sir Sandy’s BONUS is 15 times that. Just where has the sense of proportion gone?

    Like

  4. I agree with everything that has been said.

    Sir Sandy is being disingenuous in using the market to justify these salaries. A properly functioning market has buyers and sellers who are not in conflict and who are roughly equal in bargaining terms. The market for top executives does not exist. There is a tiny corporate elite which is both buyer and seller. In other words, it is rigged by the insiders. Indeed James Galbraith argues in The Predator State (2008)that the ‘labour market’as a whole does not exist.

    Like

  5. There are other connections here too. The head hunters who claim that they are the only people who understand the ‘search for talent’. The business media who laud their heroes running these big organizations. Publishers who sell ghost written biographies for people to read at airports. The accountants, lawyers and tax specialists who work out how to extract their slice. Its easy, and fun, to blame Sir Lord Sandy Whatnot Esq, but its a systemic problem. A kind of X Factor for Executives, when organizations actually work because of everybody, not just the white middle aged bloke in the corner office.

    Like

  6. John Carlisle made the point above that ‘bonuses are just plain bad’. David Ellerman (‘Helping People to Help Themselves’) made the same point, arguing that they pervert behaviour. As did Simon Caulkin in one his later Observer columns, asking would you prefer to have brain surgery from a dedicated service oriented surgeon or from one who was working for a financial incentive? Ken McIntyre is surely right to say the “market”, if it exists at all, is fixed. And it may be part of a broader hi-jacking of real economic activity, seducing bright young people to go into finance rather than any more productive activity, just for the money. That is an example of what Ellerman described as perversion – extraordinary pay has become so endemic that working for anything less is seen as simply not smart.

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s