The baby or the bath water?

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Expert Perspective by Grahall’s OmniMedia Editorial Board 

expert perspective telescopeIn his July 10, 2009 article in Harvard Business blogs titled “Scrap Stock-Based Compensation and Go Back to Principles”, Roger Martin says: “…stock-based compensation [has] caused executives to manufacture stock market volatility rather than build long term value… Scrap stock-based compensation entirely and compensate executives on the basis of improving real measures…”

No doubt stock based compensation has been widely used and sometimes misused as part of executive compensation programs. Corporate America overdosed on stock options, which were the sole or primary compensation vehicle at many companies during this most recent chapter in economic history.  But we say let’s not throw the baby out with the bathwater. The goal of executive compensation programs is to drive risk appropriate behaviors that result in enhanced shareholder value and wealth creation. One of the best, and maybe the only true measure of shareholder value creation is long-term growth in stock price. Thus, risk should not be avoided, but managed appropriately.

While we believe options can have a proper role in a well designed compensation scheme, we do not generally endorse stock option only programs where vast sums on wealth can be accumulated solely as a result of a “rising tide” lifting all boats – where executives profit from stock price increases that are not even relatively superior than the market “norm”.  It is incremental performance above the norm that truly benefits shareholders, and the delivery of above average performance consistently over long-term business cycles should be rewarded handsomely. 

Grahall’s executive compensation designs show how stock can be used appropriately based on rigorous scientific methods reflecting business strategy and risk considerations.  For example, Grahall’s Performance Based Wealth Accumulation and Retention Program” (gPB-Warp), is a plan that links an executive’s long-term wealth accumulation first to the accomplishment of long-term strategic goals approved by the Board of Directors, and secondly to the long-term stock performance above the average of the company’s direct competitors, a stock index or both of these. 

Unlike Roger Martin’s recommendation, which excludes all stock incentives, gPB-Warp incorporates company stock as an incentive upon the accomplishment of the strategic goals.  Stock incentives tying the executive’s wealth to the company’s performance have long been considered the key link between the executive’s and the shareholders’ interests. This provides the executive with a direct attachment to the company’s long-term sustainable performance.  But too much stock can sometimes tempt an executive, especially one nearing retirement, to avoid taking even acceptable risks.  So, gPB-WARP also includes maximum predetermined exposures and the ability to diversify as the executive nears retirement.

We urge companies to consider all aspects of total rewards when developing executive compensation programs: the money (how much), the mix (what components are used) and the messages (how the money and mix drive behaviors).  Taking this holistic approach, company stock can be effectively incorporated into executive compensation programs. Critiquing the use of company stock in an executive reward strategy is like the proverbial carpenter with a hammer, hoping to find some nails. Where only cash is used to reward executives, shareholders had better hope that the directors set the correct goals.

Email Grahall’s Editorial Director at edie.kingston@grahall.com

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