Monthly Archives: February 2012

Are bonuses fair?

When I wrote on the subject of bonuses in the middle of last year (Most bonuses are a waste of time) it was on the basis of my views on a subject that has long interested (and involved) me. The row over bankers’ pay had yet to reach the current level of political & public hysteria. Having first been on the receiving end of many different schemes and then being responsible for designing remuneration schemes in many other businesses (including my own), I have some experience of the subject.

Image courtesy of upscale-homes.org

Are bonuses really fair? Is boardroom pay too high? Have the multiples of executive earnings become too high relative to average workers’ pay? Let us consider some aspects of remuneration that don’t get a great deal of light and air in the highly charged political and media circus of today.

Too many issues concerning remuneration have become conflated into the one term ‘bonus’. The definition of bonus that I became familiar with and happen to prefer is ‘Something given or paid in addition to what is usual or expected’. It used to be customary in many large companies that, given a healthy overall company performance in any given year, then a bonus conforming to set formula (often a multiple of an individual’s weekly or monthly pay) was paid. Complex mechanisms were unnecessary and everyone in the company participated in what was a reward.

Sales people have traditionally been paid either commission on sales or a bonus on achievement of a sales revenue or profit target. Both of these two systems have usually included a basic salary. These sales ‘incentives’ often work well when a number of criteria are met – the target thresholds are realistic, the mechanisms are simple to understand, information on progress is readily available and the individual can measure what they are achieving in real time. However, not all schemes were or are well constructed; an old friend and colleague of mine tells the story of an employer who called him in at year end and informed him that he had failed to reach his target. “What target?” asked my friend, “What was it?” The answer came back “You’re not entitled to that information, it’s confidential”.

Sometime over the last 20~30 years, the concept of ‘performance related pay’ became the fashion item amongst consultants, senior management and HR departments. The siren song of a simple way to let money do the management and motivation of a company or department took hold like wildfire. There seemingly wasn’t a role that couldn’t be made to perform better when a carrot was dangled. Couldn’t fail, could it?  Seeds were sown.

Failure to differentiate between a bonus and a reward lies at the heart of the failure of many schemes. A suggestion currently being made is that no-one should receive a bonus (irrespective of their individual performance) until the company reaches a certain level of profit. This has a certain simplistic and populist appeal. However, it breaks most of the basic rules for incentives as detailed in paragraph three above. If I had moved heaven and earth and worked 90~100 hour weeks and had achieved all that had been set for me (or my department), I would be severely hacked off if I didn’t get my reward; a call to my favourite head-hunter would probably be the first call I made. If it’s an incentive, it isn’t or cannot be a reward or be discretionary.

Alignment of board room pay with shareholder interests became the next belief system; shareholder value became the new mantra. I may be in a minority of one but I do believe that managers are managers and shareholders are a different breed. Attempting to create alignment with shareholders via creation of long term incentives paid in share options doesn’t hack it when the vast majority of shares are traded over very short timescales. And as for the concept of paying for above average share price performance of the sector, sorry my friends, it’s laughable. Absolute performance is what counts. If management’s efforts produce satisfied customers, rising market share, cashflows and profits relative to competition then they have done a good job. These activities are the role of management. Linking executive pay to the share price won’t make management any more effective at their day job. If the sales force or managers have absolute targets, then don’t expect anything less at board level. There cannot be a salesman in the world who wouldn’t thank God for a system that retrospectively flexed his target down if the competition were failing. So why for the board?

Is there a better system for boardroom pay that rewards long term performance? There is hardly a main board director of a quoted company that struggles to live on his basic salary (unless he thinks he has a right to live like Bill Gates). Create absolute targets with performance up to the threshold represented by the basic salary and benefits package. For performance above the threshold (set at a genuinely tough level) pay an incentive. However, to ensure consistency of performance (and not short term gaming of the system) I would ensure one third is paid in cash, and two thirds of the incentive is paid over the next two years, but only if the targets for the next two years are met or exceeded.

Rewards for failure?  Executive tenure has been getting shorter for years. The executive who can move companies and go on repeating above average performance is rare (although no-one wishes to acknowledge the fact). Performance is a complex mixture that involves personal qualifications, experience, behavioural attributes and skills plus the right team and a complimentary company culture. If an executive is encouraged to move companies then there is a high possibility of failure (not infrequently due to the hiring management). A contract that requires the giving of a long period of notice on the part of the job holder (as a means of retention) also requires a matching period of notice to terminate. Trying to apportion blame when an executive fails is as complex as attempting to adjudicate where blame lies in a failed marriage. A contract is a contract.

Are high rewards ‘fair’? It very much depends upon the definition of ‘fair’. Most dictionaries have a long list of common meanings for the word – Just to all parties; equitable: a compromise that is fair to both factions; being in accordance with relative merit or significance; consistent with rules, logic, or ethics. It’s difficult to construct an argument that a contract freely entered into by the parties concerned is the business of anyone else by these definitions. The general population is not a party to the process. However, there is a further definition – superficially true or appealing; specious. Fertile ground indeed for politicians and the envious masses. Perhaps we should retain the use of the word fair but restricted to the under fives who seem to understand its meaning so much better.

Whatever your views, vast sums from taxation on the salaries, bonuses and incentives of high earners flows into the exchequer and help pay for much of which is taken for granted. Yes, there are those who find (legal) tax avoidance schemes but it lies within the remit of the Government to simplify the horrendous mess that is our tax system that permits (and encourages) such schemes. Government could also work far harder to eliminate the appalling waste that would never be permitted in the private sector. And evidence based programmes are far more effective than sound bite political dogma and knee-jerk legislation. And if chief executives have ratcheted up their rates of pay by the technique of comparability, isn’t this what unions have been doing for a lot longer?

Finally, by HMRC’s own figures the top 1% pay 27.7% of total tax in the UK; fair or not?

When the Perfect Storm hits (part 3 The aftermath)

With Richard gone I appointed Tim as MD, we started the hunt for a finance director and commenced the process of forecasting the next twelve months ahead.  We quickly discovered that, such was the mess, it was not possible to establish the true working capital position.  Our auditors hired us the services of an experienced accountant who quickly set about the process of investigating the current state of the company’s books. The management accounts were not worth the paper they had been printed on and, worse, the VAT had not been reconciled for months. Whatever vestiges of empathy I had had for Richard quickly evaporated.

With a twelve month plan completed, Tim and I presented this to our finance company and visited every one of our key suppliers to explain the current situation and to present our plans.  Luckily, we gained the full support of everyone.  Tim proceeded to do a remarkable job as the new MD, working tirelessly to rally the whole team, whilst I started the process of seeking a new finance director. With the aid of our VC, we quickly met and appointed a very experienced FD who quickly set about bringing the company’s books up to the required standard.  With the correct information guiding us, and the whole team working effectively, sales and margins slowly started to improve.

By mid year (our second) we were trading profitably but cash remained as tight as ever.  Further close examination revealed that our finance company were slowly but surely reeling in their loan by reducing their advances against our invoices.  It was galling in an extreme to realise that, had we not had the actions of the vendor and his illicit cash strip, we would have been in a healthy cash position with no liquidity concerns. However, with Offhand (the vendor) again doing a disappearing act at my latest attempt to arrange a dispute resolution meeting, it was clear that we were running out of time before we had to go to court.  Although we were sure of the odds of winning on our main claim (the cash strip), there was unfortunately (due to the poor state of the books before our purchase) a degree of uncertainty over the smaller claim.  With the prospect of enormous legal bills even if we won the main claim, it was clear that drastic action was needed.  My first foray into business ownership looked like it could hit the rocks.

With the business trading in two entirely separate markets, with two different product ranges, it was apparent that, potentially, we could package one half of the business and sell this to a competitor.  One of the product ranges had lower margins and poorer quality debtors but had potentially a higher strategic value to competition.  With a range of cautious estimates for a sale price, it became clear that the rump business, operating with lower overheads, could prosper even without the reducing invoice discounting facility.

I initiated a series of discrete discussions with our competition for the more saleable business. My approach was based on the premise that having recently acquired Riverbridge, I was conducting a exploratory review to ascertain if we should either expand the business by acquisition of a suitable competitor (were they interested in selling) or to dispose of one business to concentrate on the other (were they interested in acquisition).  Two such meetings sparked interest that I progressed leading me to believe that we could achieve a price at the upper end of our estimates.   Nevertheless, whilst we were now trading profitably, we were far from being out of the woods in terms of liquidity and whilst in this situation we lacked the cash to pursue the legal action. I drove the long way back home that week convinced we could make the plan work.

Given the somewhat vague legal definition of insolvency, I wanted to be sure that we were on safe ground selling off company assets and sought specialist advice from one of the big four accountancy firms.  It transpired that to be certain that we were seen to be acting in the best interests of all the creditors, we needed to advise them of our plans and gain their agreement.  As I was returning from the meeting I received a call from one of the two interested parties advising me that they were withdrawing.  This robbed me of the opportunity to have two parties bidding against each other but all you need is one willing purchaser; so, press on.  When I got back to the office I found that sales in the previous month had failed to reach our projection.  Immediately, the finance company reduced advances against our invoices still further.

Good news came at last in the form of an encouraging offer for the part of the business we had put up for sale.  We only now needed to gain the agreement of our creditors to a new overall plan, realise the sale at the agreed sum and we were home and dry.  We would be able to pay off all overdue creditors and finance court proceedings against Offhand.  We carefully revised our rolling twelve month business plan and Tim & I started the arduous task of again travelling the country to meet our creditors.  The full story we presented included a fall back position (if the sale failed or we did not receive the full backing of all creditors) of having to place the business into administration.  In the event, we achieved 100% acceptance of our plan but to no avail.

The hammer blow came several days later, when I received a call from the CEO of the competitor that had made the offer; he had heard of the precarious state of the overall business and was withdrawing his offer. It subsequently transpired that the credit control manager of our largest supplier (who had pledged full support to me) had revealed our situation to our competitor. We discussed the situation as a board but there was no way out; with the working capital financing now almost depleted (and soon to disappear completely) and no way of raising further finance to continue trading and fight our legal case we had run out of road.  The same day I appointed the firm I had met as administrators and arranged to meet them at the office the following morning.

Over the next 24 hours I was relieved of my duties as an employee and director.  Tim was kept on for a few weeks more whilst the administrators tried to sell the business as a going concern.  The part of the business we had originally received a healthy offer for went as an asset sale for a fraction of its worth immediately prior to the administration.  I lost a great deal of money and the creditors never received a penny.  Our wonderful administrators then managed to string the process out for ten whole years and took everything they raised in fees.

What had I learnt from all this?

Without a shadow of a doubt, we were robbed by our vendor.  When making an acquisition you can have all the guarantees and indemnities you and your lawyers can negotiate but you still take a hell of a risk.  Fighting legal claims is a very expensive process.  The only satisfaction I got was hearing some years later that Offhand’s mistress threw him over and his wife divorced him, winning most of his ill-gotten gains.

The references that had been obtained for Richard had been a fairy tale; I discovered that he had run a prior business into the ground in similar fashion.  Over the years I’ve found that references are frequently a waste of time, or at least, it’s not what people say that counts it’s the bits they leave out.

If our experience of appointing one of the big four firms is typical, the administration process does not seem to work in favour of the creditors.  Without exaggerating, I’d say we (and our creditors) were robbed on the way out as well as on the way in to this business.

Tim went on to form his own business and last heard was making a very good job of it.  Of all the people I’ve worked with, Tim ranks amongst the very best.  All of the team who worked with us through those trying months did their best; I only wish for their sakes we could have pulled it off.

Had I made horrendous mistakes? I could blame myself but apart from believing in Richard and supporting the acquisition in the first place, I think I made the appropriate decisions in a timely fashion.

 Yes, if you throw enough hot c**p at a blanket some of it will stick.  Shortly after acquiring Bridgestream my favourite VC and I did two more deals; one soon looked like it was also heading to the graveyard when we uncovered a horrendous loss and the other quickly threw up a very bad case of fraud (and years of legal fees).  These are tales for another day but I did learn to multitask as both of these situations occurred at the same time as Bridgestream!

Bye for now!

Image courtesy of seasonsofthemoon.com