1. Why might measures such as ROCE (also called ROI) continue to be used to determine executive remuneration even though the limitations of such measures have been highlighted for many years?
2. Why is the use of additional non-financial measures recommended to determine executive remuneration and what are the disadvantages of incorporating such measures?

As a result of the recent financial troubles at Tesco its shares declined to an 11-year low in 2014. Terry Smith, chief executive of investment house Fund-smith, stated in an article published in  The Financial Times that investors had long ignored warning signs that Tesco’s return on capital employed/return on investment (ROCE/ROI) had fallen sharply between 1995 and 2011. Instead, during this period the investors had reacted favourably to Tesco’s reported results because they had become fixated on its rising earnings per share (EPS) which had quadrupled.
This raises questions about the metrics Tesco uses to calculate executive remuneration, and whether this might have led managers to prioritize EPS over ROCE. Deloitte’s annual review of FTSE 100 directors’ executive remuneration reported an ‘over-emphasis on measures such as EPS, total shareholder return (a combination of share price changes and dividend payouts over a period of time) and return measures such as ROCE/ROI’.
The article highlights comments from a major asset management company for Dutch pension scheme members (APG) and Homes Equity Ownership Services which advises more than 30 institutional investors. APG recently issued remuneration guidelines for the companies it invests in. The guidelines express concerns about incentives that seem vulnerable to the risk of manipulation of corporate activity to improve payouts. ‘In the most basic terms, we believe that long-term value creation to shareholders is the added economic value over and above the cost of capital. We believe pay policies should be set to reflect and support this.’ APG is also in favour of the additional use of non-financial factors, such as customer satisfaction, human capital, health and safety, and sustainability performance, in determining pay.
The director of Homes Equity Ownership Ser-vices stated that ROCE can produce ‘a very profitable business, but a very small business. For instance, if a company has a ROCE of 30 percent, this figure will fall if it embarks on a project with an estimated ROCE of 20 percent. A ROCE maximizer would therefore avoid this investment. Yet if the company’s cost of capital is 10 percent, taking on this project would still increase its profitability.’ The director recommends that ROCE should be used in combination with a measure of profit, such as economic value added or economic profit.