Expert Perspective by Grahall’s OmniMedia Editorial Board
Rick Newman’s September 23rd article “Outlandish CEO Pay: How to Fix the Problem” published in Seeking Alpha summarizes, simplistically, the problem of excess CEO pay and the possible solutions to this problem, recounting the problems faced by Merrill Lynch, Citigroup and AIG following poor leadership by Stan O’Neal, Charles Prince and Martin Sullivan, respectively. Newman’s point being these Wall Street icons made millions (and millions) while the companies they led lost billions.
Although overly simplified, we don’t disagree with most of what Newman says – in particular, linking pay to long term performance and establishing claw backs as standard protocols in executive contracts. 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. The time span of discretion refers to the longest span of time that employees spend working on a task and Jacques found that the time span of discretion rises steadily with the position of an employee in the company hierarchy. An hourly worker may have a time span of discretion of one hour, a middle manager of one year, and a chief executive of a large company of 20 years.” (Paraphrased from dictionary.bnet.com ).
So here is the part that is not quite so simple as Newman would have us believe. How does a Board compensate to motivate and retain a CEO when the events that he should be paid for could have a time horizon of 5, 10 or even 20 years? Think about this from your own perspective. Would you take a job if the contract offered payment 5 years hence, let alone 10 or 20? Probably not. So M2, compensation mix, becomes extremely important. 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. Claw backs are certainly helpful to manage unforeseen risk resulting from poor judgment or nefarious actions, but the best approach is to structure a pay package delivering the right amount (M1) with the right components (M2), which sends the right messages (M3) to ensure that behaviors are consistent with strategy and expectations.
Don’t be fooled into thinking this is simple or into thinking that anyone who says it’s difficult is trying to “obfuscate” efforts to implement meaningful change. Be informed.
To learn more about Grahall’s approach to executive compensation, peruse our OmniMedia blogs (for example, read “It’s Complicated” and pick up the book “Effective Executive Compensation” by Grahall’s Michael Graham.
Contact Grahall’s OmniMedia Editorial Board at firstname.lastname@example.org
Side bar: Ironically, while researching another article for this week’s Digest I came across the following article from April 29, 2009 issue of Business Week titled: “Chesapeake Energy Battles CEO Compensation Furor. After founder Aubrey K. McClendon lost his fortune in 2008, the company’s board raised his pay and bought his art. Wall Street is enraged.” WALL STREET IS ENRAGED?! Perhaps they thought they had the monopoly on excess compensation for a CEO. It’s a little disingenuous to accuse others of wrongdoing when the same thing is happening in your own industry, and perhaps even in your own firm – Edie