Monday, 22 June 2009

Stephen Hester's pay package

The BBC has reported that the chief executive of RBS, Stephen Hester, is about to be offered a new pay deal by the board. If one thing is predictable in life, it's the howls of outrage that will accompany the headline figure: £9.6 million.

But the real figure is not £9.6 million - it's £1.2 million. Still a big salary, but on nothing like the same scale. The biggest chunk of the rest will be payable only if the share price of the bank hits 70p - double its current level and 40% up from the 50p at which the government originally invested - meaning that the taxpayer will have made an £8 billion profit on its RBS investment.

So why is it being presented as a £9.6 million deal? Of course this might just be the BBC's spin. Perhaps they put together all the figures themselves and picked the highest figure, a natural thing for any reporter to do.

But in fact it may be the bank who has decided to lead on this figure. If so, why would they do that? Surely they have an interest in keeping the core figure as low as possible, keeping their heads down and avoiding the media where possible?

First question: are the newspapers always going to calculate the maximum possible figure and run with that? Well, it can't be beyond the wit of the remuneration consultant to design a logarithmic share scale. This would keep an effective cap on rewards while ensuring that there is no fixed maximum amount to act as an anchor point. If they haven't done so, there must be a reason for that.

I think that the core reason is this: outrage is a non-proportional effect, and most people can't relate well to numbers outside of their realm of experience. If they said that Hester were getting £1.2 million, the public response would be almost identical to the announcement of £9.6 million. Both figures are well outside of the salary experience of 99% of the population.

But by leading on the top figure, they can follow up with: "but nearly 90 percent of it will only be paid if he makes a profit for the taxpayer". Once people are psychologically anchored on the £9.6 million figure, the £1.2 million of guaranteed salary sounds much more reasonable.

If on the other hand they started by announcing the £1.2 million, journalistic outrage would only be further fuelled by "and what's more, he can get another EIGHT million by just getting the bank's shares back to where they were a year ago".

Really, the initial figure is almost irrelevant - £9.6 million is more than what 99.9% of the population earns, but then so is £960,000. Even £96,000 is more than about 98% of other people, so no matter if the package is reduced to completely commercially unviable levels - the likely public reaction would not be much diluted.

Whether the package is seen as fair is more important than the number that's attached to it. And with this structure, the bank at least has a chance of pulling that off.

Thus: by an alert use of the technique of anchoring, the board is able to pay Hester a viable market rate which will keep him in the job for a few years - while keeping at least some kind of control over the damage to its public image.

Update: Robert Peston has been told that UKFI - the arm of government which holds its stakes in listed companies, and thus the majority shareholder in RBS - insisted that the headline number in the package be kept less than £10 million. Even given the anchoring argument I've made, I think this is still a very sensible decision. There is definitely some kind of perception effect from adding another digit to the number, though I don't know if this has ever been measured experimentally.

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