Book Review - Fair Pay, Fair Play: Aligning Executive Performance and Pay

Fair Pay, Fair Play: Aligning Executive
Performance and Pay
is a recently released book by Robin Ferracone that sets a new standard
for
compensation design and pay-for-performance alignment.  Ferracone is the
Executive Chair and founder of executive pay and performance
consultancy,
Farient Advisors.  The book is targeted for board members, executives,
HR and
compensation professionals, and investors, and suggests a model for
establishing
common standards of fairness and propriety, and shows how responsible
board Directors
and compensation committee members alike can converge on solutions that
are
fair to both executives and investors.  Fair Pay, Fair Play
adheres to
the overriding objective: “executives should be paid on the basis of how
well they perform for their shareholders, relative to the external
market,
within contemporary standards of fairness and propriety.”

In discussing fair pay, Ferracone offers deep and
sometimes
counterintuitive insights regarding equity compensation.  Contrary to
popular
opinion, offering equity does not automatically mean that pay and
performance
are well-aligned.  Five problems with equity are:

·        
Changing equity plans (e.g., shifting from full
value shares when stock prices are high to stock options when stock
prices are
low and vice versa) compromises pay-for-performance alignment

·        
Granting above market equity essentially means
that a company’s total shareholder return (TSR) goals are lower than
those
of the market (i.e., it takes a lower TSR to generate a competitive
award
value)

·        
Replacing cash plans with highly leveraged
equity turbo-charges the pay, i.e., generates high rewards with
relatively
small increases in stock market or performance fluctuations, rather than
with sustainable
value creation

·        
While equity is a longer-term compensation
concept, relatively short-term vesting on stock options (e.g., 3 years)
coupled
with relatively long terms (e.g., 10 years) can create wide open stock
option “windows”
(e.g., 7 years).  Long windows can lead to short-term gains, but
long-term
pain, i.e., cashing in gains from stock options, accumulated over many
years, during
a temporary stock market run-up

·        
Value-based equity grants dampen
pay-for-performance
sensitivity, while fixed share grants strengthen alignment and steepen
pay-for-performance
sensitivity