Executive pay: Are they only in it for the money?

If motivating priests to maximise revenues can have perverse results, does that apply to senior executives too? In the 13th and 14th centuries, when the faithful could buy their way into heaven with gifts, the Catholic church found itself recruiting priests more interested in personal enrichment than pastoral care, says Canice Prendergast, professor of economics at the University of Chicago Booth School of Business.

Though the practice of simony was stamped out in the reformation, Prof Prendergast believes misdirected incentives remain a hazard today.

“There is a danger at the recruitment stage that if you reward people well you will recruit people who like the money, rather than the job itself,” he says.

Company boards deploy a battery of headhunters and other consultants to find top talent and recommend remuneration packages. Yet many find the results perplexing. In 2009, the median annual pay package of highest-paid directors in FTSE 100 companies, at almost £3m, was 117 times the UK average gross wage of £25,487.

Will executives really not get out of bed and do a good job for less?

As Richard Brown, managing partner of Cognosis, the strategy consultancy, remarks, the financial crisis has changed attitudes to high salaries. During most of the decade now ending, Britons accepted a widening pay gap between top earners and the average. “When everybody feels they are getting wealthier, widening differentials are tolerated,” he says. “But when times get tough it becomes not OK because it starts to offend a sense of what is fair.”

High pay can be a sign of market failures rather than Adam Smith’s invisible hand guiding the best into managing the rest. Darren Burns, a director of Hudson, the recruiter, points to the surge in hiring by London-based financial services firms in the fourth quarter of 2009 as evidence.

After many months of job cuts, banks found themselves short of specialists in risk management, compliance and audit who were needed to implement a far more exacting regulatory agenda. People with the right skills were scarce and reluctant to move. Mr Burns says: “I saw a candidate earning £100,000 a year who agreed to change job for £140,000, and who was then bought back by his employer for £160,000.”

Though the upsurge in demand for these skills was externally imposed, it exposed the banks’ under-investment in long-term human resource management, says Mr Burns. For years, while other employers offered interesting jobs and developed the art of talent management, banks relied on high pay to attract people willing to work 12 or 14-hour days. In the City, many senior staff still do – even though, as Mr Burns points out, banks now “pay lip-service” to the quality of the work environment they offer.

But employee needs go far beyond free or subsidised gym memberships. Professor Silvia Bagdadli, director of the Executive Master programme in Strategic Human Resource Management at SDA Bocconi School of Management in Milan, says: “If you are basing your capacity to attract recruits only on money, they will have weak motivation to stay: they will leave you for more money.”

Increasingly, organisations are competing instead to be “great places to work”, says Prof Bagdadli. “Leading companies are working on their brand and value propositions.”

Image matters: “In Italy, everyone wants to work for Ferrari,” she says. And when graduates debate which consultancy to join, it is the firm’s image as an employer, not the pay and benefits package, that determines which they select.

The true recruitment challenge, she says, lies in tailoring jobs to what is known in the trade as “intrinsic motivation”.

So the critical question becomes whether top executives have different motivations from everyone else. Mr Brown of Cognosis says: “My experience with senior executives is that most are motivated by power and the need for respect, not by money. As they acquire respect they gain more power in negotiating their packages – and for the most part they are negotiating with relatively weak boards.”

Successful executives strong-arm boards into paying them large sums, but in reality, Mr Brown reckons, “most chief executives are motivated by the opportunities that enable them to win the respect of their peers”.

Intrinsic motivation can move employees to deliver extraordinary performance and commitment that has little to do with financial rewards. “If you got monkeys by paying peanuts, that would be to assume that the armed forces and the National Health Service were staffed by lower-level primates,” observes Mr Brown.

But even in the upper reaches of business, times are changing. Many human resource specialists agree that hierarchical structures with inspired chief executives are being supplanted by flatter organisations where transparency, inclusiveness and teamwork deliver better results. “One of the things we have found from our own research is that leadership teams have more than four times as much impact as a single executive in terms of the ability to create and implement effective growth strategies,” says Mr Brown.

Performance pay packages could perhaps be structured to promote effective team-working. But creating effective metrics and then designing incentives that deliver appropriate behaviour is fraught with hazard.

Prof Prendergast, an expert on pay and performance, says understanding the interaction between money and other motivations is critical to avoid three situations in which pay for performance can backfire.

“Performance pay can lead people to concentrate only on what can be seen to be achieved,” he says. So in the US educational programme No Child Left Behind, teachers get bonuses based upon how well pupils do in classroom tests. This can lead them to concentrate on the marginal pupils who will get through the test with intensive coaching. Those who will pass or fail the test anyway may get less attention.

Furthermore, “it is really dangerous to use performance pay if a diagnosis is important”, he says. Doctors may carry out unnecessary operations, mechanics may fix sound cars.

Feedback from “customers” must also be trustworthy. In a restaurant or courier company it is, but arrests by Los Angeles Police Department officers fell by 35 per cent when excessive weight was given to complaints by wrongdoers. Officers chose to “drive and wave” rather than tackle criminals.

And a year-end bonus for all, based on the share price of a company with 460,000 employees, offers no motivation, because few individuals can affect the outcome.

The irony is that in many organisations and occupations, the importance of intrinsic motivation has long been understood informally, and used to deliver effective motivation. “Many organisations have long-standing structures that motivate people to do well,” says Prof Prendergast. “People who do a good job end up getting promoted. Such subjective assessments can work well.”

Too often, then, job candidates may be offered money, rather than the assurance that the role will bring fulfilment, or prove a stepping stone to greater things. Such promises, of course, have to be predicated upon trust – a conviction on the part of the job candidate or employee that the employer’s promises are credible.

High salaries therefore contain risk. They can attract people who lack intrinsic motivation, or override their intrinsic desire to do something else. They can motivate people to achieve the wrong goals. And they can signal that the role is unfulfilling or insecure, or that the organisation is an unpleasant place to work, and cannot be trusted.