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Putting the ‘extra-financial’ into CEO pay

When it comes to incentive pay schemes, it’s rare to encounter a scheme that strays from the ‘tried and trusted’ EPS and TSR performance measures. Anything that seeks to focus to a significant degree on extra-financial performance measures is for all practical purposes non-existent.

As the debate on performance-related pay rumbles on, many investors are beginning to openly question whether the metrics chosen by remuneration committees are appropriate and whether they truly align the interests of shareholders and executives. Looking at a recent example of this phenomenon, Knight Vinke, in relation to HSBC, last year argued that ROA may be a better performance measures than ROE as it better reflects the economic profitability of the bank’s assets.

One company which has made the leap to focus on non-financial key performance indicators and include extra-financial performance measures in its remuneration policy is United Utilities. Anthony Hilton in his Evening Standard column (13 Feb 2009) notes that its CEO, Philip Green told him that on taking over as CEO (April 2006), his first objectives were to “increase the motivation and engagement of his employees and to improve levels of customer satisfaction”.

Three years on Hilton notes that “there has been a dramatic improvement in both”. Employees have responded to Green’s leadership and customer satisfaction has increased, and this is paying off on the P&L too. United Utilities now ranks top of its sector in terms of total shareholder return? A coincidence?

Hilton suggests that “the ability to lead and motivate is the real talent that has been in too short supply in British business. It is the thing headhunters and nominations committees are normally unable to recognise”.

It’s a valid point in a week where the “pied piper” banking CEO’s have appeared before the Treasury Select Committee and been depicted as leading the rest of the lemmings over the edge of a cliff as they “were being paid so much to play that tune”.

Does the current crisis in the banking sector partly relate to unintended consequences of incentive arrangements for executive directors? The discussion paper published by Henderson and Universities Superannuation Scheme in February 2005 called for companies to include extra-financial performance measures alongside the financial measures used in traditional incentive schemes.

United Utilities has demonstrated the value of this approach. Perhaps extra-financial performance measures will be on the agenda for Remuneration Committees and investors alike?

What do you think?