Profit or purpose: the remuneration conundrum facing directors

The age-old conundrum of which comes first, the chicken or the egg, has come home to roost in corporate boardrooms with the question to be asked: which should come first, shareholders or customers?

While it would be nice to think the two weren’t mutually exclusive, the early findings from the Hayne royal commission into the banking and finance sector has shown exactly how incompatible the interests of the two can be.

In his interim report, Hayne clearly links incentive-based remuneration practices to behaviour and culture that may have been good for shareholders but not so for customers.

At its most basic and simple, the issue is: when it comes to measuring success, should fulfillment of a purpose be sacrificed for profit?

At what point should an organisation question the pursuit of a profit margin over customer satisfaction?

Incentives aren’t always financial

As the fallout from the royal commission continues, and the commissioner’s interim report is dissected, corporate directors are called to question remuneration structures and practices and if they are offering value to their organisation, or in fact, posing a risk to the business.

In his interim report, Hayne says all the conduct criticised in the report had a direct financial benefit for the individual and the organisation, without exception, and he called into question the validity of incentive or performance-based pay structures given he found they had a direct link to unethical practices and the creation of a culture where that behaviour was not only tolerated, but accepted.

All the conduct identified and criticised in this report was conduct that provided a financial benefit to the individuals and entities concerned … The banks say that they have changed or are changing their remuneration policies and it will be necessary to look carefully at those claims. But almost every piece of conduct identified and criticised in this report can be connected directly to the relevant actor gaining some monetary benefit from engaging in the conduct.Kenneth Hayne,

Financial incentives for performance make sense in theory.

Unless you look at some of the theory that actually shows the opposite – that when an incentive is offered, human nature is to begin to focus more on the incentive, rather than the job itself.

Researchers at Northwestern University in a paper titled Paying for Performance, found the reward structure to which an individual is exposed acts as an environmental factor that intensifies desire for the reward object. The findings also hinted at the possibility that performance incentives might increase unethical behaviour .

Certainly, this would appear to be the case for the banks.

Hayne himself suggests the idea that people won’t do a good job without incentive needs to be challenged.

Indeed research shows us that Millenials are motivated by more than simply money and it’s reasonable to assume so too are many Gen X senior managers.

Flexible working arrangements, promotion and leadership pathways, generous salaries (without target bonuses), and the opportunity to do good work for a greater cause are all incentives that help cultivate a workforce of highly engaged and motivated employees.

Success isn’t always the profit

The banks have gone to the edge of what is permitted, and too often beyond that limit, in pursuit of profit. And they have gone beyond the limit: because they can; and because they profit from the misconduct that is described in this report.Kenneth Hayne

Profit is without question a key desired outcome for any organisation or business but there’s a risk if it becomes the sole or overwhelming goal to the point it obscures all other tenants of good business.

When financial performance and money become the central focus and metric of success, then it can give rise to a risk of corruption of not just culture but also the product and ability to achieve purpose.

This is when cost-cutting measures are adopted regardless of potential risk; when shortcuts are taken; or when pressure sales tactics employed.

It may have some short-term payoff, but what is the corresponding impact on quality?

There’s a common argument in newspaper newsrooms in which advertising reps, tasked with selling the ads and meeting sales targets, regularly approach editors to ask for exceptions to editorial policy in order to give advertisers more space or liberties.

Their argument is that advertisers are needed to support the paper, which is not incorrect.

From the editorial team’s viewpoint though, the main measure of success is reader satisfaction. The more readers, the more attractive a prospect the paper is for advertisers to invest in. And reader satisfaction means that news value is the priority, and ‘advertorial’ space cheapens the product.

For editorial teams, the measure of success is readership, not revenue, but the revenue followed as a result of that readership success.

There is truth in both sides of the argument and it’s a legitimate balance for newspaper editors and managers to negotiate.

For boards left to grapple with the issue of remuneration, it’s the same question: other than revenue and profit, how are they measuring success and how can all of the tenants of good business come together?

Are the remuneration structures at the organisation encouraging employees to do the right thing or is there a risk of the product or organisation’s integrity being compromised?

Directors right now need to be questioning and investigating whether remuneration structures are in anyway hampering purpose within the organisation.

Reward – reality and reputation

If performance-based pay structures are in question for junior management then it’s questionable they still be offered to senior management.

Given leadership comes from the top, board directors would be well-advised to discuss if executive-level bonuses are in alignment with the desired culture and practices of the organisation.

It’s not a simple question to answer or task to tackle: pay parity to attract a top-performing CEO isn’t something that will shift collectively very quickly.

However it seems short-sighted and close-minded to assume an organisation can’t attract a quality CEO without a multi million-dollar bonus structure, particularly an organisation that boasts a quality reputation for being a good place to work, with strong culture and leadership.

We are witnessing some extraordinary push-back on this from shareholders at the moment, at a time when CEO payments are at an all time high, up 17 per cent (and at a time when wages growth is stagnate).

While NAB and AMP have made reductions and adjustments, the boards of Telstra, Tabcorp and TPG have been sent back to the table after shareholders gave them their first strike.

Myer is on the brink of its second strike, as Solomon Lew continues to agitate for a board spill, saying the board has used Myer as a personal piggy bank at the expense of shareholders.

To be clear, shareholder anger will likely be more about the retribution costs and loss of share value rather than ethics, customers being treated poorly or regulatory breaches.

However, regardless of the true reasons for the disquiet, the situation is reinforcing an already long-established mistrust the public have of big banks, big business and multi million-dollar bonuses for executives.

It will be some time before the dust settles from the royal commission.

We can expect to see deeper regulatory scrutiny, particularly as Hayne pointed a finger at those bodies for failing to enforce existing laws designed to protect against these types of breaches in the first place.

All of which means directors should at a minimum review their existing remuneration structures, discuss non-financial success metrics, and assess how well or otherwise they are holding individuals to account for outcomes.

Further, boards need to carefully consider the impact these structures may be having on all stakeholders not just shareholders, particularly customers, employees, the community, environment and beyond, and whether the rewards match with the reality and reputation the organisation aspires to.

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