Called out on pay
Allister Heath suggests several reforms for pay in his recent editor’s letter [Rights and wrongs of boardroom pay, last Wednesday]. Among them, he argues that in his proposed system “pay would be linked very closely to a shareholder value and would go down as well as up.” However, he fails to address the problem that return on equity (ROE) is a bad metric for quantifying company employee remuneration.
A company employee whose remuneration varies as a function of ROE effectively has a call option on her company. In the good times she may, if she chooses, leverage up her company’s balance sheet to maximise ROE, and enrich herself correspondingly. In the bad times, her company may go bust due to the high amount of leverage she may have put on, and she will have lost her job. However, she will keep her profits.