British executive pay culture contributed to Tesco’s troubles

Joe Wright, 22 April 2015

Tesco has posted the worst performance in its almost century-long history this morning. Indeed, its fall from pre-tax profits of £2.26bn last year to a loss of £6.8bn this year is one of the biggest in British corporate history. Once the darling of British retail, it has been left much diminished.

The reasons? ‘An erosion of our competitiveness over recent years,’ according to Dave Lewis, chief executive. But apart from stiff competition from discounters Aldi and Lidl, Tesco has been the victim of its own aggressive ambition. It overpaid for large amounts of property to set up large new stores at a time when shopping habits were changing (£4.7bn of losses were the result of the fall in property value). Ambitious ventures into Japan (ended in 2011), the US (2013) and China failed; the joint venture in China is among the loss-making enterprises contributing to today’s figures. According to the FT, a former executive said the strategy had, ‘broken the successful Tesco formula of making money in the UK and then reinvesting it there to benefit UK customers.’

In 2014, after this long period of falling profits, Tesco ousted chief executive Philip Clarke, the son of a store manager who rose from shelf stacker to the top job, replacing him with David Lewis, then Unilever CEO and the first outsider to run Tesco in its history. Lewis is scrapping many of the projects embarked upon abroad and has cut down on management. But Tesco’s future is uncertain. It’s paying a heavy price for this period of desperation to become a global goliath.

Mismanagement occurs for many reasons, but in the case of Britain’s largest retail business it once again raises the question of whether the right incentive structure exists for CEOs. Pay may seem a peripheral issue to strategy, but it is a primary driver of how boards are run. In an age where the share price is king, and linked to pay, aggressive and ill-advised expansion has become a common feature.

British executive pay is the highest in the world, despite our businesses being run no better than in any other countries, and as in today’s case, often worse. It is partly the fault of remuneration committees who are trapped in a race to pay the highest wages, to be in the top quartile of pay in the UK. Naturally they cannot all be in the top 25 per cent.

Tesco is a prime of example of how dysfunctionally we link pay with long-term business performance. Despite overseeing its worst results for 40 years, Tesco agreed to pay the outgoing CEO, Philip Clarke, £1,217,000, and its former finance director £970,880. This was after it was revealed Tesco had overstated its profits by £263m. They paid up to avoid a costly legal battle they felt they would lose.

Current executive pay structures are uneconomical. They cost companies more and more while increasingly failing to punish poor performance properly. It should take into account far more than the quarterly share price of a business. Clawback clauses are one option companies should consider more to make executives think long term.

By researcher Joe Wright (@JoeWtweets)