Last week the Financial Times reported that two executive directors at Interserve earned a combined £1.99 million by the end of the 2018 financial year, roughly one third of which was annual variable performance related bonuses. But by April 2019 Interserve had been taken over by its lenders in a pre-pack administration.
It would be unfair to pin all of the blame for Interserve’s collapse on these two directors – they were hired in the Autumn of 2017 when much of the damage to the company had already been done. The bonuses also still have to be approved, so may not actually be awarded. But it does beg the question of why the recommended payments were so high when performance was so awful, with the firm teetering on the brink of bankruptcy. More substantially, it raises questions about whether the reward structures at board level over the long term may have actually contributed to firm failure.
The latter point merits consideration. Much of the problem at Interserve was the arcane way performance was measured for the purposes of calculating the board’s bonus payment. At the centre of this problem is the murky accounting concepts of ‘underlying profits’ and ‘normalised earnings’. Both strip out one-off, non-recurring items that notionally interfere with an investors ability to judge the underlying performance of the firm over time. However, when this concept is linked to bonus payments, it can introduce perverse incentives because there is a great deal of discretion when choosing what items to include and exclude.
