Executive Pay: It's About "How" - Not "How Much" - 22 Oct 2009

COMPENSATION IN CONTEXT

October 22, 2009

Executive Pay: It's About "How" - Not "How Much"

It seems we're rapidly moving from an era when "greed was good" to one in which "jealousy is justified".



The executive compensation regulations being considered now by the
government and advocated by shareholder activists aren't very
thoughtful. I believe they're born out of jealousy and misinformation.

"How much should CEOs be paid?" is the wrong question to be asking right now.



The right question is "How should they be paid?"



Pay has
to be structured to attract the right executives and give them
effective incentives to lead their companies to great performance. The
poor showing of too many companies, despite ample CEO salaries and
equity packages, coupled with excessive executive compensation during
times of poor performance, shows that compensation programs
aren't structured properly, and that executive compensation practices
need serious reform.

All
too often, executive incentives are based primarily on short-term
financial metrics and shareholder returns. Financial results are the
consequence of a company's strategy formulation and implementation.
Effective short- (annual) and long-term (3-5 year) incentive
plans should focus on achievement of financial and operational
performance objectives, effective organizational learning and growth,
process improvements, and customer-related metrics and milestones.



Additionally, companies should design compensation packages to attract
the right people for implementing the company's strategy. For instance,
below market salaries coupled with aggressive incentive pay linked to
individual performance is likely to attract self-motivated
entrepreneurial individuals, however, that very type of pay strategy
may create increased risk taking as well, and would need to be designed
with appropriate checks, balances and controls.

Companies
also need to assure their executives longer tenure and horizons -
without the necessity of pay guarantees. A CEO who is afraid of being
fired for not making short-term financials will not focus on the long
term. A board that is actively engaged in strategy formulation and
implementation and compensates a CEO for strategy implementation
milestones, along with monitoring long-term performance, is more likely
to understand, appreciate, and encourage a CEO's efforts, even if they
yield short-term financial results that are below expectations. Thus
there is an urgent need for boards to evaluate their executives'
performance annually to determine their progress on long-term goals.



Boards should engage in active succession planning so that they do not
find themselves looking for a superstar CEO to rescue them from their
financial problems. It is precisely in those situations that CEOs are
able to negotiate often outrageous pay packages. Simultaneously,
companies should get rid of egregious practices such as over-the-top
severance packages (more than two times annual compensation), tax
gross-ups, defined-benefits SERPs, guaranteed returns on deferred
compensation, automatic vesting of long-term incentive plans in the
event of change-in-control, and pure time-based (versus
performance-based) vesting of stock options and restricted stock.



It
would be highly unfortunate if, as it now seems possible, massive
amounts of government regulation and active intervention were to be the
dominant forces determining how American executives are compensated.
Caps on pay, shareholder "say on pay," ceilings on ratios of CEO pay to
worker pay, appointment of a federal compensation czar, and labeling of
incentive pay as pay that causes excessive risk. All these will do
nothing but reduce innovation in American companies and hurt
shareholders - without necessarily reducing excessive executive
compensation.

Governmental
and shareholder second-guessing on pay is starting to create an
environment of fear in which no board would dare try an approach that's
different from the herd's, or that is tailored to the company's
particular strategy, as it should be.



One size definitely does not fit all when it comes to compensation -
when business strategies differ between companies, their compensation
practices ought to differ as well. Worse yet, government regulation
will probably have unintended consequences, without curbing excessive
pay. For example, if the maximum ratio of CEO pay to worker pay were
mandated, companies would likely respond by outsourcing the work of the
lowest paid workers, rather than curbing CEO pay.

All-in-all,
while executive compensation reform is certainly needed, it must come
from within - from executives and boards, acting in the company's best
interests.

FBG