In Nesta’s report, The Invisible Drag on UK R&D, the innovation charity studied the incentives for FTSE 350 executives and found that long-term plans discourage innovation.
Here’s an edited extract
Innovation is widely recognised to be one of the key drivers of economic growth and productivity. Shareholding institutions have asked companies to prioritise long-termism and innovation, including corporate research and development, R&D. The UK government spends billions of pounds subsidising business R&D. One would therefore expect that the incentives given to company directors would, on balance, encourage innovation.
The study shows that the opposite is the case. In an exhaustive analysis of the metrics used as performance conditions in incentive pay in the FTSE 350, it suggests that where innovation-related metrics are used, they invariably sit alongside, and are frequently outweighed by, short-term financial measures which can be enhanced by cutting innovation.
This does not mean that innovation is entirely overlooked. Almost all companies operate short-term incentive plans and whilst on the most generous interpretation a majority, 65.4%, of FTSE 350 firms do utilise a metric which might encourage innovation, 91.1% use a metric which discourages innovation. Such disincentivising metrics also vastly outweigh the innovation-related metrics, with an average weighting of 38.8% compared to 16.1%.
Further, only a minority, 23.2%, of FTSE 350 firms use an innovation-metric in long-term incentive plans, compared to 84.2% using a metric which disincentivises innovation. Again, in almost all cases, innovation-related metrics have a lesser weighting than other performance conditions, an average of 49.5% for negative and 33.4% for positive.
The study also investigates whether, perhaps as a counter to these incentives, a committee of the board had been appointed with a specific remit to encourage innovation. It found that this was rarely the case.
As a result, Nesta argues that in order to drive greater corporate innovation:
- Company remuneration committees should ensure that remuneration packages are balanced in promoting appropriate innovation
- Institutional investors and shareholders should not approve remuneration packages which clearly discourage innovation
- The Financial Reporting Council, or its successor body, should explicitly include innovation within their considerations of regulatory frameworks for effective stewardship
- The Government, which spends billions annually on subsidising research should indicate its will and desire to see this bias against innovation removed from remuneration packages.
However, Nesta recognises there are barriers to change. If this issue is to be resolved, investors and institutions need to champion the solution. With over £20bn being spent on corporate R&D, and with government targets to increase that number, Nesta hopes that such champion(s) will emerge.