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Anyone who watched Liam Halligan’s brilliant TV exposé into the dreadful quality of new houses built by Persimmon will have been horrified by the shoddy workmanship.
It’s an extraordinary indictment on the state of Britain today that the country’s second biggest house builder thought it could get away with selling homes which, in some cases, had up to 295 defects, from leaking taps to faulty windows.
What was even more shocking about Halligan’s Dispatches documentary was that no one from Persimmon dared be interviewed to either apologise or explain. The only statement made was from a spokesman who said they “apologised without reservation.”
That’s pathetic, and no wonder the shares fell by 5% after the programme. It’s not a good enough for a FTSE 100 listed company, valued at £6.3bn with £3.7bn of sales, and which builds around 14,000 new homes a year in 400 locations.
Nor one whose mission statement claims it is “proud to be the one of the UK’s most successful house builders, committed to the highest standards of design, construction and service.” Persimmon’s silence is even more of an outrage because its top bosses shared in the biggest bonus bonanza in the history of the industry.
And what a bonus. Over the last two years a group of Persimmon’s 130 top managers were rewarded with a £500m bonus scheme which was based on a Long Term Incentive Plan, otherwise known as LTIPs.
It was this controversial LTIP plan, set up in 2012 without a bonus cap, which delivered £75 million to the then, chief executive, Jeff Fairburn, and millions more for each of its 31 regional managers.
Persimmon’s bosses were eligible for these sensational bonuses because over the five year period from when the LTIP kicked in, the company’s share price surged. It did so well because Persimmon was a significant beneficiary of the government’s Help to Buy scheme. This helped boost the number of homes sold over the period, and therefore boosted the share price beyond what might have been expected. Luck played its part too.
Is there a link between the shoddy quality of Persimmon homes and the huge bonus payments paid out to directors? It is impossible to prove but you have to wonder whether the fact that the directors knew how much money they would make coloured their attitude to how they approached their work ?
Did directors, perhaps unwittingly, cut corners to get as many houses built during the incentive period so that they met their targets? Or did the exceptionally generous LTIPs indirectly remove some of the intrinsic reward that people feel for their jobs? That they lost their emotional attachment? Probably all those factors came into play. LTIPs were designed in the 1970s as long-term incentives to help align directors to performance. The problem is that almost all the academic research shows there is no direct correlation between the reward and performance: in most cases, the pay of the CEO and top directors is a function of size.
Professor Sandy Pepper of the London School of Economics believes that LTIPs are fundamentally flawed. “They have had their day. This long-term share approach executive pay is based on neoclassical economics – the problem is it doesn’t properly take account of behavioural considerations.”
Pepper should know: he is the ultimate poacher turned gamekeeper, having worked at PwC as an executive pay consultant before turning to academia to study the phenomenon.
His research came up with a three pertinent reasons why LTIPs do not match better performance: executives are more wary of uncertainty and risk around pay than previously thought; most executives would prefer a fixed pay packet rather than a bonus or complex share schemes; and that most directors discount their deferred pay at a high rate.
“Most executives prefer being paid more now than in the future, and they will have discounted the long-term reward. That’s human nature for you. I’ve applied many of Daniel Hahnemann’s findings to pay and the findings are similar.”
Pepper also believes that by pushing pay higher and higher, any intrinsic motivations a director has for doing their job are crowded out. Indeed, that is what may well have happened at Persimmon. “I was struck by the number of Deutsche Bank employees who lost their job recently who shrugged their shoulders, and said they would find another job. They showed little emotion towards Deutsche at all. This is the financialisation thesis where pay has got to such astronomical levels that people are only motivated by money.”
Yet LTIPs have become the fashion, and deeply embedded into the psyche of Britain’s bosses across all industries. A study by CIPD into executive pay at the UK’s 100 biggest companies last year found that only 16% of top earners received a fixed salary: the rest was in bonus or share schemes.
Remuneration committees are partly to blame, as the chairs like to think they compete for top talent and that pay is a measure of worth. Pepper calls this the “remuneration committee’s dilemma”; a play on the prisoner’s dilemma in game theory, and he’s written a book with this as the title.
So what’s to be done? Pepper says there are signs of a shift in mood, and that the notorious Persimmon bonus may well be forcing Remcos and institutional shareholders to investigate a little harder.
Some are. The most outspoken has been Norges Investment Management, Norway’s sovereign wealth fund, which has said it frowns on companies which use LTIPs. As one of the world’s biggest investors, Norges may make waves. The directors of Weir Group have banned their use and introduced restricted share options instead.
Yet the problem remains that because most big institutional investors, in the UK and overseas, only own a tiny slice of capital in the companies in which they invest they have little incentive to sort out executive pay. Pepper puts it bluntly: “If the CEO gets a big pay package, it really makes no difference to them as shareholders.”
There is of course a straightforward and healthy solution: stop all LTIPs, and pay directors with a fixed salary and cash bonus. Directors should be encouraged to use the cash to buy their own shares – at the market rate. It should be a no-brainer: having skin in the game that you have paid for directly is the superior way of aligning interests.
That’s what Warren Buffett does at Berkshire Hathaway: his staff are paid salaries and cash bonuses. No complex fancy LTIPs. If its good enough for one of the world’s smartest investors, then it surely its enough for the UK’s top companies.
And if companies don’t change their ways, they may find government intervening instead.
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Iain Martin and the team make sense of the news, providing commentary and analysis on the stories that matter in politics, geopolitics, economics and culture.