How we learnt to over-value and over-compensate chief executives

The markets encouraged a culture where managers would puff up results, and accorded cult status to CEOs who did this

Outraged of Tunbridge Wells strikes back. Most people don't mind payment for success, but payment for failure sticks in the craw. The huge payoffs for sacked company directors have helped to undermine public confidence in the whole corporate world – which is why, at last, something might be done about them.

The process of revising the law will begin today, with the tabling of a Private Member's Bill by Archie Norman, the former head of Asda and now Tory MP for Tunbridge Wells. The problem is that provisions in the Companies Act, designed to make sure that ordinary employees who are sacked get proper compensation, can be used by top directors to make sure the courts support their claims too. Mr Norman is proposing an amendment to the Act requiring directors to demonstrate that they have taken the performance of the departing director into account when paying compensation for loss of office. This would take precedence over the terms of his or her contract. Other provisions include the immediate disclosure of any such payments, and a requirement to explain any payments of more than a year's salary.

All sensible, of course – and if the Government gives the Bill a fair wind there is every reason to expect these amendments to become law. But before you cheer too loudly, remember that these measures would only attack the outward manifestation of the problem, the payment for failure. What really matters far more is the failure itself. What, if anything, can be done to improve the performance of top managers? I can't recall any previous period when so many companies which one moment were worth billions or even tens of billions have suddenly been worth one-tenth of that – or gone under altogether. Corporate death used to come by a thousand cuts; now it is one swift chop.

Part of the problem is the cult of the celebrity chief executive officer. Of course the job is hugely important, for one great CEO can indeed turn a company around. There are many examples of this. Just this week, Vittorio Radice, the Italian CEO of Selfridges, has been poached by Marks & Spencer to head its home furnishings division, with M&S paying a £1.2m "golden hello" to buy him out of his Selfridges' contract. He has clearly done a great job there (Selfridges shares fell sharply on the news of his leaving) and few would grudge him the market price for his services.

By the same token it looks as though British Airways will get back into the FT100 share index this week thanks to Rod Eddington, the Australian CEO, who rescued the airline after it had been mismanaged by the previous incumbent.

On the other side of the scales, out of the index will go the telecom company Cable & Wireless, whose CEO, Graham Wallace, is being blamed for the collapse in the share price. Doubtless he will soon be collecting his pay-off, for in the cruel world of financial markets, the betting firm Financial Spreads is quoting a spread of 20 to 25 days before he gets sacked. Once the odds get as short as that it is virtually impossible to do the job: if the market thinks the chap is going to be sacked his authority is somewhat undermined.

But whatever one thinks of these individual cases, the fact remains that there is a capriciousness here. It is the football manager syndrome: a few good results and the manager is a hero, a few bad and it is the boot. The risk to reputation is so great that filling top jobs becomes extremely difficult. A good friend of mine became CEO of a troubled FT100 company. He did all the right things, though probably too slowly, and departed under a cloud. So he got a pay-off and there are other things he can do – but what had been a glittering career in effect ended in failure.

In that case it was mainly bad luck, for world demand went against the company. Other, less competent people have been lucky, done a mediocre job but managed to retire at the right time as heroes.

This capriciousness is partly the result of the restive short-term focus of the financial markets. We are living with the consequences of that now, because two or three years ago the markets were demanding quite unrealistic growth and profit performance from companies. In the short term, company managers could meet those demands but at the cost of damage in the future and – much more in the US than here – fiddling the books. The markets encouraged a culture where managers would puff up the results, and accorded cult status to CEOs who did this.

So while these proposed changes to the Companies Act are wholly welcome, what we also need is better selection of chief executives and a more realistic assessment of what they reasonably can and cannot do. Reward for failure is outrageous of course; but ultimately it is a second-order issue. The first-order issue is preventing the failure in the first place. Sadly there is no magic wand. It would be nice to think of a string of characteristics that the ideal chief executive would have and then hire people to fit the mould. Trouble is, different businesses require different sets of talent at different times. So much management is intuitive rather than rational that it is very hard to know whether any one individual will work in a different setting.

Still, there are some things that can be done. One is to get the structure right: things like the Cadbury committee's separation of the jobs of chairman and chief executive. Another is to get board structure right, with for example a reasonable balance of executives and non-execs. But there is a further problem here: finding good people to serve as non-execs will get harder as the legal liabilities piled into all directors rises. The risk-reward ratio for being a non-executive director has suddenly become very adverse. Much better to be a consultant, collect the fees for services rendered, and let someone else carry the can if things go wrong.

Another advance will come as the financial analysts learn from their mistakes in the bull market. Puffing up charismatic CEOs will not carry much conviction for a few years now, given that so many of the bull market heroes are now humiliated. Fund managers will be more circumspect too and it is interesting that Archie Norman's bill has the support of the main bodies representing the investment community. The more we can crush the cult of the celebrity the fewer the instances for rewarding failure.

But at the end of the day what matters is to establish a business culture of honesty and hard work, but also zest. One of the more cheering things about Britain nowadays is our willingness to scour the world for people who can bring that to our businesses: people like Messrs Radice and Eddington for example. Talent still matters, but we have to be thoughtful, measured and rational about assessing it.