Executive Summary - Organisation Effectiveness and Top Executive Pay

Organisation effectiveness and top executive pay DISCUSSION PAPER, NOVEMBER 2013 David Creelman & Andrew Lambert

EXECUTIVE SUMMARY 1 There is unease that organisations focus too much on short-term results, often due to investor pressures. Might placing more importance on organisation effectiveness alleviate this?

2 There is unease that executive pay is poorly related to performance. Would including an assessment of contribution to enhancing organisation effectiveness improve matters?

3 Multiple stakeholders now make demands on organisations, and assess whether they are doing a good job in many other ways than just shareholder return. How willing and capable are boards in responding to these pressures, thus guarding reputation and pre-empting regulation?

4 Organisation effectiveness is best thought of as the ability to deliver sustainably good results. It is behavioural and future focused, unlike the financial results – intrinsically rearward looking – commonly used to judge performance.

• clarity – purpose, direction, identity, values, strategy and objectives • governance and alignment – is there robust oversight to keep us on track, and are the right questions being asked?

• capabilities – what do we need to succeed on a continuing basis, whatever the challenges?

• results and resilience – how good are we at assessing and learning from our results so that we enhance our resilience, including through the way we reward performance?

8 Moving from assessing organisation effectiveness to executive pay design is difficult, because the public debate on executive pay contains some half-truths.

5 Our consultation identified that mostly organisational performance and executive reward are assessed in terms of financial results. Other data – eg customer or employee – are presented, but generally carry far less weight. Risk registers are used mainly to assess threats rather than opportunities.

Effectiveness per se is rarely assessed formally, although it does get discussed.

• Pay for failure: critics (especially the media) fail to recognise that boards are right to hesitate to punish a good CEO where poor financial performance was not his or her fault.

6 To facilitate deeper consideration, we identify various debates on how to approach organisation effectiveness.

• Equity based pay is THE way to align interests: all forms of equity based pay have significant drawbacks; there is no magic formula that always and reliably reveals added value and makes managing executive remuneration painless.

• Planning vs emergence: do we focus on a defined strategy or let strategy emerge?

• A few drivers vs a value creation model: do we identify just a few key drivers of success or have a comprehensive, balanced scorecard style, model.

• Reputation management vs deep values: do we pay attention to corporate responsibility as part of reputation management or because we truly believe in values that go beyond profits?

• Strengths vs sickness: should we focus on our strengths or simply make sure we avoid the many common dysfunctions of organisations?

• Key performance questions vs key performance indicators: should we focus on asking the right questions or be more hard-nosed and stick to looking at the numbers?

• Sustainability versus resilience: should we focus on the ability to sustain the current business model or on the ability to re-invent the organisation?

• Three vs ten(+) year time horizon: should we focus on the reasonably ‘knowable’ three year future or set our sights on doing the right things with a 10+ year time horizon?

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7 An organisation can assess its effectiveness by tough, systemic evaluation of its

• Pay motivates performance: the conventional belief that incentive pay is essential to motivate CEOs is highly questionable. Most are already motivated, and don’t need bribing.

9 Boards need to • be clearer about what organisation effectiveness means both to them and to important stakeholders; and have a well structured way to assess it , just as they have a reasonably structured way to think about risk – past results alone guarantee nothing • have deep insight into how to enhance organisational performance and develop long-term resilience; they need to make time and use systems thinking to deepen their understanding.

10 There is no neat formula that ties organization effectiveness measures to pay. However, pay decisions should be rooted in a board’s deep understanding of what drives the organisation’s performance over time, and how key executives have added lasting value to its capabilities, not just its financial value.

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