On 21 October 2019, Namal Nawana, the CEO of UK medical devices firm Smith & Nephew, resigned after 18 months at the helm because he wasn’t being paid enough. The stock price fell by 9% on the announcement, translating to £1.4b of value loss.
Nawana previously ran US diagnostics company Alere, earning a total package of $11.1m in 2015 and $8.6m in 2016. At S&N, his base salary was $1.5m, which would rise to $6m if all targets were met. Great CEOs are motivated by the desire to create value for society rather than just money. Nawana joined S&N despite knowing that he’d be paid less, because – in his words – “I genuinely like this opportunity.” So they’re willing to take a pay cut for a job that excites them. But just like any other employee, there’s a limit to how much of a cut they’re prepared to accept. In Nawana’s case, the cut the board insisted upon was just too big.
Nawana had made great strides in his short tenure. He replaced or moved two-thirds of S&N’s senior leadership team and overhauled its operating structure. Previously, it focused on each region (e.g. US vs. international) rather than product. Nawana believed that S&N would only be top-class in innovation if it was run by specialists, so he installed heads for each division (sports medicine, orthopaedics and wound management). And these changes worked – S&N’s revenue growth soared, and its stock price rose 40% from £13.05 on 4 April, 2018 when he was appointed to £18.30 on the day before his departure.
While only a single example, this case illustrates a number of points in Pieconomics. The value created by growing the pie is orders of magnitude higher than how much can be saved by splitting the pie differently. The board may have cracked down on Nawana’s pay believing that it would be a cost saving for shareholders or could be redistributed to workers. But even using the upper bound of $6m (£4.6m), that’s only 0.3% of S&N’s £16b market cap – a drop in the ocean compared to the 40% stock price rise. Uncannily, while Nawana’s maximum pay potential was £4.6 million, the market cap of S&N had soared by £4.6 billion under his tenure. Of course, that increase wasn’t just thanks to Nawana – the broader stock market rose, and workers contributed substantially as well (so, if the board wished to reform pay, the more important dimension would be to ensure that workers share in pie growth, for example through all-employee share schemes). But even if he contributed only 1% of the £4.6b increase, that’s still ten times his pay. By focusing too much on pie-splitting, S&N caused the entire pie to shrink.
The S&N case is also inconsistent with two other arguments commonly made against high pay. One is that CEOs are paid far more than they need to be, and so you can reduce their salary without them quitting. The second is that CEOs are ten-a-penny – if they quit, someone else can simply step in. The sharply negative market reaction contradicts this idea (and, if pay critics think the market over-reacted, they should buy a huge chunk of S&N shares).
And S&N is consistent with the large-scale evidence presented in Chapter 5 of the book. Rigorous research isolates the value of the CEO in particular and finds that it’s orders of magnitude higher than her pay. It also shows that the structure of pay – whether it incentives long-term pie growth (rather than hitting short-term targets) has a much greater effect on both shareholders and society than its level. It’s also eerily consistent with the opening example of Chapter 5. Reckitt Benckiser’s CEO Bart Becht was criticised for his £92m pay package (which he’d accrued over 10 years, not a single year as many articles claimed), but he’d created £22b of value. On the day of his departure, RB’s market value fell by £1.8b.
What does this mean for CEO pay? It certainly doesn’t mean that boards should allow CEOs to hold them to ransom, writing their own pay cheque on the grounds that they have such a large effect on firm value. Instead it highlights the importance of getting the right CEO. If the board doesn’t think the CEO is worth her pay, the solution isn’t to pay her less, but to replace her. It also stresses that the structure of a pay contract is more important than its level, as the value created from growing the pie (in S&N’s case, undertaking a major restructuring) is far higher than what can be saved by splitting it differently. The more important component of pie division is to ensure that workers share in any rise in firm value – but this can only happen if the pie grows in the first place due to a great CEO being at the helm.