Exec Pay - The Invisible Drag on Innovation

CEO remuneration packages actively discourage innovation in UK's top companies, new Nesta analysis finds

The way most big businesses reward their Chief Executives and other senior staff is inhibiting innovation and research and development, and encouraging short-term gains over long-term investment, according to a study of the remuneration packages of FTSE 350 companies released today by Nesta, the global innovation foundation, in collaboration with Minerva Analytics.

The report, titled ‘The invisible drag on UK R&D: How corporate incentives within the FTSE 350 inhibit innovation’, found that, in aggregate, remuneration packages are weighted towards conditions which discourage innovation spend rather than positively encouraging innovation in a ratio of about 3:1.

With data and research support from Minerva Analytics, the report compares publicly available information about the pay and bonuses of executives at the 350 biggest companies in the UK and compared them to OECD guidelines for measuring innovation.

Sarah Wilson, Chief Executive of Minerva Analytics, said: “Getting Pay for Performance right is crucial for shareholders, companies, indeed all their stakeholders. Too often compensation has been linked to short-term market metrics rather than real business drivers. Executive pay reform has largely been focussed on the ‘How Much’ rather than the ‘What For’; this research shows it’s time to change the equation.”

The Invisible Drag - Key Findings

• Just 16% of total FTSE 350 annual bonus conditions positively encourage spending on innovation compared to 39% which positively discourage it
• Long-Term Incentive Plans (LTIPs) are even more strongly skewed towards metrics which discourage executives from innovating.
• This happens despite the fact that companies, investors and regulators agree on the need to promote innovation and suggests they should pay closer attention to whether remuneration conditions are likely to stimulate innovation.

Commenting on the report, Dr Christopher Haley, Nesta’s Head of New Technology & Startup Research, said: “Innovation is a key driver of growth and prosperity, and increasing this is a core part of the UK’s Industrial Strategy. However, to maximise their competitiveness in a post-Brexit world, British firms should look more closely at their own innovation activities.”

Shareholders and innovation

Most companies have to put remuneration plans to shareholder vote in 2020 and to secure prosperity post-Brexit, UK businesses need to recognise innovation as a key driver of long-term growth and ensure that they are not inadvertently discouraging this. David Pitt-Watson, former Chair of Nesta’s Endowment noted: “Every one of these remuneration packages has been approved by shareholders. That has happened despite the fact that publicly, investment managers declare they want to promote innovation. So do companies and policy makers. If we are serious about creating a finance industry which supports a competitive economy in the long term, reform of these incentives is an obvious place to start.”

Nesta has made three recommendations to support this aim:

• Companies should examine their remuneration packages to ensure that they encourage the pursuit of innovation and long-term value creation;
• Investors should use their power to demand better incentives for investment in innovation, as many companies begin the three-year cycle of shareholder votes of remuneration packages;
• The Financial Reporting Council (or its successor body) should explicitly include innovation as a measure of effective stewardship.

“We know that companies, shareholders and policy-makers understand the importance of innovation," concluded Dr Haley, "yet there appears to be a disconnect between what firms say and the behaviour that they currently reward.”

Download your free copy of "The Invisible Drag"

Copies of the report are free to download at Nesta's site: https://media.nesta.org.uk/documents/The_invisible_drag_on_UK_RD.pdf

About the data and research used in this report

Nesta commissioned Minerva Analytics to use its proprietary governance database which contains information from company reports to analyse the metrics which were being used to incentivise executive directors. The sample covered all of the FTSE 350 as of late 2017. The analysis included:

• A ‘keyword search’ of corporate reports (including annual reports, AGM circulars and non-AGM circulars, RNS announcements), to discover whether companies acknowledged the importance of innovation.
• An analysis of board committees to see if the commitment to innovation was reflected in these governance structures.
• An analysis of the quantitative financial measures used in incentive systems (based primarily on the annual remuneration report which forms part of annual report and accounts).
• An analysis of the other, often qualitative, performance metrics used in determining remuneration.

To find out more about Minerva's unique governance, remuneration and sustainability research capabilities contact us at hello@minerva.info