Expert Perspective by Grahall’s Editorial Board
In her November 8, 2009 article Windfall Is Seen as Bank Bonuses Are Paid in Stock, Louise Story says “As banks cut bonuses last year, they shifted more pay into stock and options from cash. Within months, the financial system began to mend — partly with the help of billions of dollars in government aid — and that stock began surging in value. Some of it can be cashed in starting in just a few months… The Treasury Department declined to comment when asked if these bank executives were being set up for windfalls. Lucian A. Bebchuk, a Harvard Law School professor who advised Treasury on pay rules, said, ‘What should we have done differently?’”
There are troubling aspects to this situation. Grahall’s Garry Rogers said: “Never underestimate the power of greed. Appreciation based vehicles, particularly stock options, will come roaring back as a way to recoup the losses of the past years. This is the tip of the iceberg rather than an aberration. This outcome, where executives who nearly bankrupted the country and caused significant economic hardship for many Americans are now getting a windfall when they haven’t really ‘paid the piper’ for the problems caused last year, is very hard story to swallow and likely to fan the flames of anger typical working Americans.”
I asked our Editorial Board that question: “What should have been done differently?”
Michael Graham says that one way to fix the problem is to match the reward vehicles to the time span of discretion (when we know the outcome from the decision being made) and create a family of vehicles including short-, mid-, long- and career-term. In our recent blog Don’t be Fooled we share that Grahall’s approach to structuring executive compensation packages is to link pay to events. In many companies there is a mismatch between these elements. Elliot Jacques originated a concept called Time Span of Discretion, which helps in understanding the issue of linking pay to events. He describes this as “the time between starting and completing the longest task within a job. Pay structures need to include short term, medium term, long term and career term components in order to both attract and retain high quality executives while ensuring that their actions are consistent with business strategy and in the best long term interest of shareholders and the company.
The second component of this change would be to make sure the gain is only paid in a substantial way when your gain is more than your competitors, if you are only gaining because the stock market was down and now it’s up that is ruled out. The company’s stock has to go up more than your competitors’ stock prices and your reward is proportional to the amount your stock price beat the competition, Michael Graham says: “Once again the compensation decisions were made without considering the long term (or in this case the not very long term) results of this change.” He refers us to recent blogs including Balance is the Key in Executive Compensation where we outline a new wealth accumulation plan that links long-term wealth accumulation directly to performance. Called the Grahall Performance-Based Wealth Accumulation and Retention Plan—or gPB-WARP—this revolutionary plan, unlike traditional retirement or stock option plans, is designed so that a portion of the executive’s total reward program and ultimately their wealth accumulation rewards are based on company performance, stock performance, or a combination of both. These plans go beyond the “alignment of shareholders” and effectively combine career incentives and defined contribution retirement plans with deferred compensation awarded only when the corporation beats the competition. These plans ensure that exceptional retirement income is reserved for only those executives who perform exceedingly well and whose companies succeed as a result of their efforts.”
Paying more simply because the “tide is rising”, as is happening now, is a poorly structured compensation technique. It does not reward executives for enhancing shareholder value, either in the short term or the long term, over and above that of their competition. In addition, this approach perpetuates our current economic problems. Structuring executive compensation so individuals are more focused on the long-term and career growth may help to ensure that the short-minded decisions that got us into this recession will not be made again.
Contact Grahall’s OmniMedia Editorial Board at firstname.lastname@example.org