Sir Martin’s problem with pay and performance

The debate between Sir Martin Sorrell and WPP investors is warming up nicely.  Yesterday, Sir Martin defended himself stoutly in an article written for the FT, much of which I found pretty persuasive.  He makes a good case for having created value across the patch – shareholders have seen above average returns over a long period, tens of thousands of employees have jobs and the result today, from a business formed in his front room, is the world’s largest advertising and public relations agency.  An extraordinary achievement indeed, and one that he would argue is worth every penny (and more) of what he is paid.

His little local difficulty, however, is that the 60% proposed rise in his pay packet this year compares with  WPP’s 10% under-performance against the FTSE during 2011.  And that of course is what has got shareholders angry.  If they didn’t get their return, why should he?

But this is exactly where the debate should be – working out how best to link management performance with shareholder returns.  There has been a considerable shift towards tying the two together over the past 20-odd years, but there are many who would argue that the right measures have not yet been chosen.  Too much emphasis on share price growth, for example, means that management may (or indeed, not take) actions which may threaten the price, for example making investments in the short term (such as marketing or R&D costs which will hurt profits) that will benefit the company in future years but only after they have departed and cashed in their options.

We think there are three core measures against which management performance should be judged and each falls neatly into the mantra we teach that says that growth plus returns creates value.  The measures are (a) EPS growth, (b) Return on Capital Employed or Capital Invested (ROCE or ROIC), and (c) Total Shareholder Return (TSR, the combination of returns to shareholders by way of dividends and share price growth in any one year).  There may be other KPIs that any individual company may choose to add (for example, in a company seeking to grow in emerging markets, the proportion of revenues derived from such markets), but any company that rewards its senior management team on a proportionate combination of these three metrics will find that rows with shareholders like that encountered by Sir Martin are few and far between.