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Case Study: A Major Charitable OrganisationPeter Brown, Chairman, Top Pay Research Group |
Ladies and gentlemen, thank you very much for inviting me to speak to you today. I thought we'd take this a little wider than a large charitable trust and have a sort of tour of what's going on in the remuneration incentive and particularly the measurement of performance business. I'm afraid I haven't got my slides because to some extent, I've been in the incentive business this morning. One of my jobs is as a part-time non-executive chairman of a company called Dawson which bought a company from me five years ago, and I've served on their board ever since.
We produced our figures yesterday which were significantly better than the City and our brokers thought, so I've had a mass of telephone calls this morning all saying how wonderful we are and asking if I'd go and see them So I've spent the day unexpectedly in the City with investment analysts and fund managers - some of you I think come from that world. I've been patted on the back and I can tell you, it's not a bad way of incentivating people!
We brought our results forward on the basis that there wouldn't be quite as many companies reporting in the week before Christmas and we might get a bit more attention - but we didn't allow for how much attention we're actually getting. Like so many other people producing a profit warning, a month ago we had to put forward our profit warning but the other way round, in the sense that the City clearly underestimated how much money we were going to make this year. In the last couple of days, "4 million worth of shares have been traded!
So I'm afraid I haven't got the slides with me but you've got hard copies amongst your papers.
Let's look at the world of performance measurement in the UK. There are big companies, small companies and not-for-profit organisations which is the world that the Top Pay Research Group lives in. We do have some overseas clients but I wouldn't hold myself up as being an expert in overseas remuneration. Our most interesting client is a Greek shipping owner and as you probably know, the Greek fleets are still very much owned by individual people if not individual families. They have almost medieval systems of reward which work very well. It's very much a question of a sort of paternalistic situation where you're still asked to Christmas lunch by the owner of the line and that sort of thing. It matters enormously in the Greek community.
I only say that because I think it's important to realise that with the increasingly financial, mechanistic approach that's being taken in the States and to some extent in the UK following Greenbury, you can easily forget that an awful lot of really quite successful reward systems do not depend upon money or upon targets being set in a way which means they can't be removed if you're going to achieve them. I think we're becoming over-dominated by the concept that the only real thing that can be used as an incentive is money and I simply don't believe it. I come out of the small business world in which there is a sense of partnership and a sense of being trusted. There are all these slightly soft options but in our world, they aren't soft - they are the things that actually do incentivate a lot of people. It's quite important that this is said during seminars to big companies and sophisticated audiences such as yourselves.
I speak at a fair number of seminars and often in conjunction with representatives of the big remuneration benefit companies - usually they're either specialist divisions of law firms, of accountancy partnerships or general consultants. They spend their whole time talking about complicated systems which are all driven by cash targets and cash rewards. These are fine but I just hope you all bear in mind that this is not the be all and end all of incentive. The old fashioned human incentive, the thank-you, the congratulations, the chairman bothering to call you up and tell you that you've done a good job - these things actually do work and I think there's a danger that we're forgetting them in this country at the moment.
Let's start with the Greenbury report. It was part of a long process that has been going on in the UK and predates Cadbury, whereby shareholders particularly wanted to feel that there were more scientific ways of linking senior management to the shareholder type of outlook on what their company should achieve. It was quite normal before the war for directors of any company in Britain to be required to own one or two thousand shares (which in those days was probably slightly more, relative to their income, than it would be today). So there's nothing new about the idea of directors thinking of shareholders and being encouraged to think of shareholders.
In the 1970s and early 1980s, this practice dropped away enormously. Up to about 1982, most investment trusts and most insurance companies insisted that directors owned a nominal number of shares when they were appointed directors. But this practice was seen as old fashioned and therefore, the modern type of management man wasn't required to own shares. So it's partially re-discovery of that very old fashioned system that is behind the Cadbury and the Greenbury reports.
Cadbury of course was brought in partially as an answer to Mr Maxwell. Frankly, it isn't an answer to Mr Maxwell - I've tangled with Mr Maxwell twice in my business life and when he went overboard, he owed the Dawson company quite a lot of money. You are not going to solve the problem of the significant owner-manager who believes that he is in fact a sole proprietor with any set of rules. You can avoid buying his shares on the basis that sooner or later, they're going to crack up but it's not something that is amenable to the type of regulation that you're ever going to live with in democratic society.
Therefore, the idea that this type of system can help in a situation like that, is nonsense. You've got people coming up now of that type - they're taking their business public or are buying the public companies. They have no real concept and nothing is going to persuade them to have this concept - that they are not effectively the entire owner of that company. You can take your chances with them. When they're going well, they make a fortune - or at least appear to. But by and large, in the increasingly competitive and sophisticated world we are in where you're not just dealing with national markets but international markets, those sort of organisations will not survive for very long.
One of the reasons is that the incentive systems within them don't work because they're all based upon the concept of the blue-eyed boy of the owner (or the guy who sees himself as the owner). They can be very generous. Maxwell gave a hell a lot of people bonuses of £20,00 or £30,000 but he didn't do it on any particular system. He did it because he said: "You've done something that I approve of and therefore, here's £20,000." Of course, there are a lot of losers in a system like that: people who stand up to the owner and are not the blue-eyed boy. That's one of the reasons why we've had to codify the system a bit more but it will not solve the Maxwell problem, although Cadbury was largely set up as a City response to that sort of situation.
In large companies in Britain, the biggest change that's taken place since Cadbury and which Greenbury reinforced, is the concept of the external comparitor. You will all be familiar with this. Previously, there was a question of beating your own budgets, putting up earnings per share by more than inflation plus 3% per year or whatever. Now, the investment community has got hold of the concept of the external comparitor. I have to tell you that it's a very dangerous concept.
The analyst world understands the indices they use every day of their working life. But they don't understand a particular group of companies that are genuine comparitors for the management team who you are trying to incentivate, because that group of companies is almost certainly (in Europe) not entirely in one country. We do quite a lot of work in this area, persuading remuneration committees not to let their shareholders dominate their thinking.
Their shareholders say: can you compare the 250 index or the 100, or something that we as shareholders understand? But this is not a sensible comparitor of the management because they do not see these companies as facing the same problems in the same industries with the same cycles that they do. We say: you want these three UK companies, you want this French company and that German company. This is where the analysts have difficulty because these companies are quoted on different markets so they immediately get a bit nervous and think it isn't going to work. But I think it is vital - if any of you are in the business of constructing incentive schemes - that you pick a group of external comparitors that are meaningful to the management team that you are trying to incentivate.
If you have to use the 250 index, for most companies in the UK you must straight away take out of it all the investment trusts, all the privatised utilities and all the oversees mining houses, and you'll get 250 down to about 165. That 165 is not necessarily a good group but it's a hell of a sight better group than the 250 index which is absolutely hopeless.
The second area which has become very popular and justifiably so, is the concept of significant rewards over time. Until about the mid 1980s, virtually all bonus schemes in Britain were one year schemes or they were options. The concept of having financial bonus schemes that were not paid out in a way that avoided cost on the P&L account (such as an option over more than one year) was almost unknown. It was done by some sophisticated American groups when they were operating their UK subsidiaries. But the "quoted on the London Stock Exchange" type companies simply weren't using it.
This is one of the best things that has come out recently. It's much better, I think, than the external comparitor. Most companies have cycles but the cycle is 12 months in very few. There are some service businesses and some dealing businesses in the City in which they have a fairly short cycle but most companies are on longer cycles than that. If the board is doing its job and looking at the future rather than trying to run last week's business, it is taking decisions today but the pay-off on those decisions is likely to be 24, 36 or in the case of heavy industry, 48 months ahead.
It's important to consider setting up remuneration schemes that match the cycle of the business. In some businesses, they are investing every year for the three years ahead in which case you can have a three year type scheme and you can start a new one going each year. But in other businesses, it's not like that: there are significant investment cycles. We've just had one in the paper converting industry - because there was a world wide shortage, everybody has rushed in to increase the amount of paper conversion equipment around and so suddenly we are facing a glut. In the Dawson company, we distribute and are the third biggest wholesaler of newspapers and magazines in the UK. Although it doesn't affect us directly, we are very conscious of the cost of newsprint because if it suddenly goes up, Mr Murdoch says: I've got to get some money from somewhere, and so he tries to squeeze our margins.
It's very important that the remuneration system takes into account issues such as this. If you don't take them into account, you then suddenly find that you're facing a situation in which a management has worked extremely well but has failed to reach some target because the cycle has moved against it.
This leads me onto my third point: you need increasingly to keep discretion in your remuneration committee to override what in fact become unmanageable, mechanistic targets. If in fact the concept of having non-executive directors means anything, it means you're putting onto your board and then onto your remuneration committee outsiders who can take objective decisions (because they do not themselves benefit from them) about the performance of the executive team.
Having strengthened the non-executive body in a way which allows them to use their discretion, their training and their skill, increasingly you find the big companies are trying to circumscribe their decision-making power and their discretion by setting up almost entirely mechanistic systems based upon EPS, based upon a comparitor group or The Times 100 index. So in fact, you're wasting their skill as assessors of how a management group is doing, facing certain changes in a market over a year to three years. We have difficulty with the remuneration committees and the chairmen of the committees in getting them to consider the idea that they should keep more discretion. They've persuaded themselves that the City likes externally measured indices so there's no question of anybody being allowed to have a bonus unless they've actually earned it. The only way to ensure that this doesn't happen is to make the thing virtually entirely mechanistic.
I think this is significantly mistaken. It would not be mistaken if you had not tried to strengthen your board with outsiders whose discretion is one of the things you're buying when you put them on the board. But to bring in these experts, put them on a remuneration committee and then waste their skills because all they can do is push the buttons on a mechanistic system, is in our view ridiculous. But I have to tell you and will be interested in your questions afterwards, we meet great resistance to this - not just from human resource professionals who may well have grown up in a world of attempting to mechanise all sorts of things to remove discretion because they were so worried about management's abilities in the 1970s and 1980s (when management was weak in the UK) to use their discretion sensibly, but from non-executives themselves. They seem to be extremely nervous of using their discretion to award or withhold bonus payments in a situation in which they know that's what should happen. They like to feel the security of these mechanistic systems.
I realise this is a very broad discussion around the issue of performance measurement in Britain but you're a sophisticated group and I think this is probably more useful to you than detailed analysis of one or two of the different mechanistic systems available.
When you're looking at three year performance, what are genuinely the sort of things against which you need to measure in that company? The first group are clearly those that benefit shareholders. They are not the only group, and when we participated in the RSA Tomorrow's Company in quite a big way, my wife headed the small business panel which came to a completely different conclusion than the main conclusions of the report. The shareholder group is the principal group for which the management is working. It's terribly important that it sees that as almost its overriding responsibility. I know and you know that good companies are good neighbours: they have good stakeholder relationships with all sorts of people. But if you start to try to measure this and put it into remuneration packages in any sort of even semi automatic way, it is a very dangerous dispersion and dilution of the principal things that the organisation is trying to achieve.
We would love to be able to say: of course, you can bring these issues in and put them into the top management remuneration package in a meaningful way. After a relatively short time of looking at this, we've come to the conclusion (and I don't think we're alone in this) that you really can't. It gives too many excuses for a management group to fail to deliver against the principal responsibility they have which in a private, for-profit, economic organisation called a plc is shareholder value.
How you measure shareholder value is complicated but the one thing I would again warn you against is: don't just go to the profit and loss account. Some of the worst systems we have ever seen (and some of these have been recommended by consultants) have been entirely based upon the P&L account - not just one year's P&L but two or three years. I think there was a cult growing up in some of the bigger consultancies where they would train their consultants (who of course have not necessarily got business or financial training behind them as some have gone straight into remuneration consulting from university) on P&L accounts because they know what they are. They know how you can fiddle around with depreciation. They know the sort of tricks you can get up to if you want to. They don't train them on balance sheets because it's too complicated. Therefore, you find systems which are really quite dangerous.
For instance, if you have good brand names, you can undoubtedly rape them over a year or two by over-pricing. You can significantly reduce the value of the brand by doing this. Or you can under-price to get the volume and do the same thing. As the brand name does not show up as an item in the balance sheet, unless you understand total value and how service companies' balance sheets really measure things, you are in very significant danger of allowing a particular generation of managers to hit very profitable performance targets just measured on a P&L basis. The cost of that is only going to show up when they've moved on in terms of a completely weakened structure because you have gone for short-term benefit by over-sweating your assets.
You can over-sweat non-physical assets like brand names quite hard. I'm not saying this always applies but if you're in the business of performance measurement over time, you've got to look at the effect of the short-term incentive in terms of the total value of the business in the long term. Most big companies now have significant goodwill wrapped up in intangible assets, some of which will not show in their balance sheets and which need to be protected against the incentive to damage them through having to achieve performance targets on which say 90% of your bonus is based. That's increasingly dangerous as the bonuses get bigger.
I'm in favour of a different performance culture for guaranteed remuneration, particularly for senior directors who have grown-up children, no longer have a big mortgage and therefore don't need to have a lot of money coming in every year to support their lifestyle - they've got past that point. Most directors on most main boards are at that level. We're not talking about people in their late 30s or early 40s. You have to look at the group you're designing incentives for quite carefully in this area. You're looking at men in their late 50s - I'm afraid it is nearly always all men!
Therefore, a situation in which over 50% of their remuneration comes from incentive pay is not wrong and doesn't mean you're trying to turn them into currency dealers - it's a very sensible type of proportion. If they can get a bonus which will double or triple their basic pay if they deliver successfully in three or four years, that seems to us to be a very reasonable balance. It's unusual in the UK - we're used to the concept of an annual bonus being 20% or 30%. We're used to situations in which the salary is the overriding cash benefit that you get from a company. But we're moving into a culture where that's not true.
A lot of it is internally driven but there are a lot of consultants like us who are saying this,. We're moving into a culture in which over a four year period, the incentive pay is well over half the total remuneration - even in businesses with heavy manufacturing investment, not the sort of foot-in-the-door types where everything depends upon the individual skill and push of the salesmen, but serious businesses. We're moving into that situation so you have to watch the balance sheet. You're not providing an incentive package which is dangerous in terms of over-pushing profit and loss items.
Now let's get down to the charity case study. Measurement of performance is very, very difficult . You can have the mechanistic financial targets but this is the world of not-for-profit organisations. Our client in this case is a very large dispenser of funds - it's not a "doing" charity. It's not one that takes other peoples' money and puts it to good work. It is a dispenser of funds to charities, particularly those that encourage the outstanding young to achieve early in their career. It gives the outstanding performers additional assistance to spend time training and I'm hoping to persuade it to move to the sports as well as the arts area.
How should an organisation like this be measured? When they asked us to advise them, they had no concept that we would come up with any sort of measurement system. They simply thought we would suggest to them suitable salaries for their executive team on a par with the private sector. They don't expect to recruit staff from the charity sector. Most charities are exchanging staff the whole time - it's become a major employer in its own right with the development of the contract culture whereby charities are undertaking a lot of work that local authorities or central government used to do for itself. Therefore, in turnover terms, the not-for-profit charity sector in Britain is growing very fast. It has tended to recruit a lot of its staff from within itself. You move from a junior position in one charity to a medium rank in another and a senior position in a third. This organisation prides itself on recruiting entirely from outside the charity sector and I think they're probably right.
But when you looked at what they were doing, they really had three objectives. The first was to make sure their inherited funds yielded over time significant income so they could become a bigger and bigger benefactor of the sector. So there's a normal sort of investment performance type criteria that you'd get in an investment management organisation because they had a very hands-on role in deciding how their money was invested. They moved it between fund managers but in a way which meant that were determining to some extent the performance of the fund, depending on which fund managers they asked to use. They were taking a very significant position in their own fund management business, although they were not in a legal sense the fund managers.
The second objective was: did the individuals in the organisations to whom they gave the money use it successfully? The third was that they badly needed to raise their profile - they are a significant benefactor for Britain and are giving away about "10 million per year and yet nobody has heard of them. One of things they've had to do was to raise their profile as an organisation. If you do that, you start to get people writing to you saying: would you like to finance this or do that? So they would get many more opportunities to use their money in the best possible way in the areas that they wanted to do it.
The system had to help them to do these three things. The fund management one is fairly easy - a lot of you have probably come out of that world. It's fairly easy to measure fund management against predetermined indices of comparitors. It's one of the few areas where comparitors are very valid indeed. You can measure whether people are doing better or worse. I do think however that you should never, in an organisation like this, measure on a quarterly basis - it's much too short. You should only use the indices over longer periods.
Regarding the second objective, we said to them: you are incapable of assessing your own performance in terms of whether the money you've given to organisations supporting young people has been relatively successful in producing the outstanding performers that you want. We said: it's too difficult for you to assess this yourself, although we're not saying you wouldn't try to be objective. You must therefore have an assessment panel that's rather like having non-executive directors and we suggested they do this every three years. We said: the panel will have two objectives when it's assessing you. The first is: has the money resulted in likely outstanding performance among a small number of those you've supported? It's impossible for you to guess at 18 whether people are going to be great successes at 28, but after three years, is there a high enough percentage of those beneficiary groups who are still likely to be outstanding performers? This is terribly difficult. If you're talking about the arts and film makers, it's very difficult to tell but you must have an external assessment and we think three years is about the right time period.
The second thing is: has the giving of this money been done in a way which has helped to raise your profile? The assessors should also look at this issue. You might want to have different assessors to do this because you might want to go, for instance, to other people in the charity sector who are aware of who are seen as the comers and who are seen as the losers in the world of big fund giving, particularly when the lottery money is coming in against you.
The only point really of putting this charity up to you is that they accepted this. They accepted that they need to have outside assessors who operate for them for about six months every three years to do what you might call an investment audit and a profile audit. I think there's a lesson in this for the private sector and a lesson in it for remuneration committees, in terms of using external assessors to consider some of the soft things that you cannot measure in pounds, shillings and pence such as the reputation of the company, how the brand is seen and these sort of issues. I think these types of consummate audits will increasingly come to be used as one of the measures against three year performance payment schemes. They are in their absolute infancy in Britain. We have known of only two companies, one of which is Kodak, to use audits of not only their own consumers but audits of their internal clients within a big group like this. They have an audit of the groups within Kodak that your division services and that your division draws from, because of course a lot of the Kodak staff are not selling to the outside world, they're selling within Kodak and are part of an integrated, very large company.
As far as we can see, these are extremely successful because it stops people achieving their own targets at extraordinarily high inconvenience, pressure and possibly cost factors to the units on each side of them in a big integrated company. These are the sort of issues that I think we're going to move towards as we get much more sophisticated in the use of three year targeting. We're going to move away from just divisional or unit profit because that is usually the measure within a company, and we're going to start having much more of this sort of auditing. I know it sounds expensive, slow and a bit wimpish. But just as we have discovered that public opinion surveys really can be quite valuable, I think we're going to discover that we have to have not just internal financial auditors but we need to bring into our companies (if they're of any size at all) an external team that assesses the real performance of operating units in terms of their assistance or dis-assistance to the other units in the organisation that they have to deal with, as well as the consumer. We have seen almost no concept on remuneration committees of having any sort of consumer input in their deliberations in terms of: are some of the products of that company increasing the respect in which they are held or not?
I think this comes back to the argument about the balance sheet. I think we'll get much more of this type of soft assessment alongside the cash, finance and profit assessment that we're getting at the moment. I think it will be a very good thing if we do.
I hope there are going to be quite a lot of questions. I realise I've been whisking around from issue to issue here but as we're actually dealing with performance measurement which is an extraordinarily complicated area, these are the ideas (and most are fairly strategic) that we're starting to put to our clients and are starting to get a reasonably positive reaction to.
I have to say though that we do find the investment community is behind the clients in terms of being interested in using these sort of assessment criteria. I think the reason is that although we've persuaded this foundation only to assess the performance of their investment team on an annual basis, too many investment organisations are on these quarterly comparitors which seem to me to be really dangerous things. They are encouraging real short termism and I can't believe it makes sense.
On the other hand, the people who are putting them under this quarterly measurement are the pension committees of the companies who are complaining as companies that they are being put under this short-term performance measurement by their investment houses, and so you find it's a sort of viscous circle. The pension trustees are often saying that people have said to the investment house: if you can't perform over three months, we'll go to Mercury Asset Management. On the other side, the managers of the company are saying to Mercury Asset Management: for goodness sake, stop trying to assess us over three months.
It's a very odd situation indeed that's going on here in which the pension funds are blamed for having short termism. I don't think it's quite true. I think the investment houses have got used to this three month assessment and in many cases, their bonuses are much too short term. But you've only got to sit back for five minutes and think about it to see that this type of assessing investment performance over three months makes absolute nonsense on the scale of investment in which a lot of these organisations are involved.
Anti-short termism is a very important thing to bear in mind when you're involved in incentive planning. You want always if you can to push it longer. You'll be under a lot of pressure the whole time to keep it on a one year basis as everybody thinks in one year or quarterly time periods in Britain. The pressures are on because the accounts come out on a one year basis. I have to say that not just at the main board level but lower down too, you need to think longer term if you're really going to put in schemes that are going to run in a cycle and match what the management team see as their challenge over the next three years. If they achieve it, they are rewarded but if they don't, they're either rewarded less or not at all.
Lord Butterworth
Thank you, Peter. Are there any questions or any points that anyone would like to make?
Paul Norris
I would agree absolutely with your comments about discretion but I think it's important where discretion is retained to be able to set out the parameters of the exercise. It's maybe one of the reasons why remuneration committees are reluctant to go along with it because that's what's due. Unless you do it, you're not giving the recipients any idea of what it is you're going to base your decision on at the end of the day.
Peter Brown
I think I agree but we're probably a halfway house. One of the things we suspect is going to change is that the current rush to put all your non-executives on a remuneration committee will finish. Most medium sized companies are adjusting to the idea of having non-executives on their board. In order to comply with Greenbury, they've put the whole lot on all the sub-committees. Inevitably, if they had been chosen as good all-round non-executive directors, a fair percentage are quite unsuited to go on the audit committee because they have very little financial background. They are equally unsuited to go on the remuneration committee.
I hope very much that in the next two or three years, this will be sorted out. It's much better to have a small remuneration committee that knows its business than one with four directors on it, three of whom know nothing and are by and large therefore just going to be sheep. I think we need to have a more professional approach - we're advocating this and have got absolutely nowhere. We've put it up to Greenbury (and got a very nice letter back) that in medium sized companies, remuneration committees should not just draw on full non-executive directors to be members. They should be able to draw on outsiders as members of the remuneration committee who are not non-executive directors of the company in order to overcome this problem that in a lot of small or medium sized companies, there's actually nobody who can staff the remuneration committee who has got any background or knowledge in the area at all.
Therefore, these committees are to some extent meaningless because they realise that their job is not just to be liked by the executives. They can be overwhelmed so easily with a bunch of statistics. You can commission any study in Britain to prove you're underpaid - it's the easiest thing in the world. It's all a question of what comparitor companies you pick. Some of these committees are giving the appearance that they are applying a measure of judgement but in fact, they are not applying any judgement at all because the members do not feel confident to do so. This I think is going to change over the next years. I think you're going to have people like Kirke (who are not totally in favour but have at least put some cats among pigeons), who start to ask chairmen - particularly at AGMs when the chairman of the remuneration committee is meant to answer - whether his committee is strong enough to counter independent judgements. Given that sort of committee, I don't think you necessarily have to lay down all the criteria.
Question
Just building on that point, in terms of discretion on a remuneration committee, what about market productivity or market structure? We've often heard that many of these non-executive directors on the remuneration committees are interested in establishing a high market worth for executive directors because they know that if they can do that for this firm, they can go back to their own firm and a comparison is made, then they benefit as well. Or is that not true on this occasion?
Peter Brown
No, I think it's less true than it was. We have a thing we call the upper quartile syndrome. This is the automatic guaranteed inflationary system whereby you gather together eight companies, two of which will give salaries in March, two in June, two in September and two in December. They all say they want to be above average payers. It doesn't take you to be a mathematician to see that that is an absolutely cast iron system of how inflationary based their salaries are.
There certainly are (or there were - there are less now because they think they are being watched), a number of non-executives on remuneration committees who actually did think it was important to be popular with their executive colleagues. It's a very tricky issue. It's a bigger issue than remuneration as it affects the audit committee too. It affects the relationships on British boards between the executives and the non-executives over the next five years.
The American experience is of some value, but the continental experience with two tier boards is of almost no value to us. There are quite a lot of groups that are working out their modus vivandi at the moment. Emap is not going to be the last of those where non-executives are forced to resign and I have to tell you that in some cases, they ought to resign. There's a dangerous situation in some groups in which four or five non-executives - often quite well known outside their group - are getting too close to running the company at least in terms of its six monthly or annual strategy. All I can say is that we are beginning to see this. We're beginning to become aware that although not necessarily intentional by the non-executives, instead of just contributing their skills, they are beginning to seriously annoy their executive colleagues. There are going to be some explosions on British boards. The idea that the non-executive is always the good guy, looking after shareholder interest, is rubbish.
Nicholas Jackson
Thank you very much for an excellent presentation. It was very interesting. I'm also delighted to hear you stressing the non-quantifiable and the consumer end of things. Could I ask your opinion on two points? One is my own prejudice on awarding the team rather than the individual and the other is 360 degree reviews. You also mentioned the internal customer.
Peter Brown
On the first, I would completely agree with you. There are some situations (not usually on the main board) in which individual performance is important but we've all seen from Nick Leeson how dangerous it can be. Mostly, individual performance is a sort of commission. It is often based upon volume rather than real profit performance and it's not sensible for most main boards or divisional boards.
We have a system called 70/30 which works quite well. It's a collective bonus pool. 70% is divided up on a predetermined method, usually related to base salary. So if the pool is £200,000, the guy who is earning £100,000 salary gets a higher sum out of that than the person earning £70,000. But 30% of it is discretionary award. So you can compensate for the fact that in that particular year, the salary differentials did not actually reflect the individual contribution of separate directors to the performance of the period. This seems to be accepted by most of our clients as a sensible sort of system. Depending upon their company, how collectivist the board is and whether in fact the board is made up of a production director, a sales director, a managing director and a finance director - or is made up of a group overall CEO, a managing director Europe, a managing director for America and managing director for Asia - you could alter these percentages from 60/40 to 80/20. Clearly, if you've got three area managing directors plus a CEO on your board, you probably want to have a bigger discretionary element in that because some areas will have out-performed others.
The alternative to that is of course to have half the bonus for divisional directors (even though they sit on the main board) determined by the operations of their division. That's fine for cash bonuses. It becomes much more tricky if the bonus currency is shares or options, or something like that. I'm not saying that you can apply anything completely but on the whole, we find the 60/40 to 80/20 split of a collective bonus pool is the one that seems to bring the best cohesive, collective effort plus enough discretion so that people don't feel it's extremely unfair - say if the CEO was ill for six months and a lower paid director covered for him, yet the CEO ended up with a bigger bonus.
You'll have to help me a bit with the 360 degree review - it is the one where you examine the impact on everyone else of that individual?
Nicholas Jackson
I've tried this in a couple of organisations and find it very useful. It's where you get input from your boss but you also get input from your subordinates on a confidential basis (you can't identify who said what), and you also get input from your internal customers.
Peter Brown
So it's as I said - I've heard the expression 360 degree review but I didn't realise exactly what it was.
Nicholas Jackson
I myself find it very useful.
Peter Brown
I've never seen a 360 degree review done although I have seen a 270 degree one done. My guess is that you can't do it full 360 degrees. Even if they think they are never going to be rumbled, I don't think we would actually recommend the idea of getting direct subordinates to report. We certainly do recommend adjacent, departmental consumer audits, so you're not just talking about the outside client but you're also talking about the inside clients when you assess someone's total performance. My guess is that a 270 degree review is sensible but 360 degree ones probably aren't, I'm afraid.
Nicholas Jackson
Could I challenge that and ask why not? It makes them say: I report to you - in a sense, I'm one of your clients because you've got to create an environment to work in. So long as there are not just one or two people reporting directly to the person - if there are four, five or more - then you've got a fair chance of it being reasonably anonymous because you've got an overall pattern. You can say: your overall score was this, that or whatever. You don't know who said what.
Peter Brown
I think the danger of that is that you might not be as aggressive as you ought to be with your subordinates during the year. I'm not certain as I've never seen it done - actually I have seen it done on big surveys but not as a regular annual part of the remuneration review. I have a feeling that it would tend to lead to not sufficiently abrasive management where it might be necessary, but I might be wrong. You've probably seen it done and I haven't.
Lord Butterworth
Thank you very much, Peter.