The March 11, 2010 article from The Economist print edition (Cheques and balances: Efforts to reform how bosses’ salaries are set are unlikely to work) begins: “SPRING is in the air, bringing with it angry thoughts about executive pay. This year the economic downturn is adding extra emotion to the season’s familiar fury…There is even a new fad nicknamed the “pity bonus”, paid to bosses who failed to qualify for a big enough payout under the established bonus scheme due to the unforgiving economy. Mark Hurd, the boss of HP, was given an extra $1m bonus on top of the $15m he received under the firm’s annual incentive scheme to reflect the board’s view that he had not been “fully rewarded” for relative outperformance against competitors…”
(The article also bashed IBM, GE, Starbucks, BP and Goldman Sachs for their executive bonuses.)
Yes, the bonus numbers are very big, and with millions of Americans still unemployed, it appears there is a lot to be angry about. But on the other hand it is important to consider a few facts that might provide a more balanced perspective.
First, the article failed to mention that each for these companies has over the past year provided a significant increase in value to its shareholders. Using “Google Finance” today (March 20), the one year increase in share price for each company is as follows:
· GE: Stock price increased $8.53 to $18.07 (89% increase)
· Starbucks: Stock price increased $13.81 to $24.97 (123% increase)
· BP Plc: Stock price increased $162 to $626 (35% increase)
· IBM: Stock price increased $35.20 to $127.71(38% increase)
· Goldman Sachs: Stock price increased $80.58 to $177.90 (82% increase)
· HP: Stock price increased $23.64 to $52.49 (82% increase)
And other than IBM, these are generally better than their listed competitors. We do fully understand that these increases in shareholder value need to be taken into perspective and that we would be the last to advocate a one year look at anything having to do with company performance or for that mater a one year view of executive compensation. Executives are generally operating in at least a 3 or 5 year horizon and that is also the central range within which their company results and executive compensation ought to be evaluated on. Some of us would contend that the real time horizon ought to be even longer.
Second, in the vast majority of public companies the Directors and especially those who sit on compensation committees have tremendous experience on how to deliver pay.
Yes, yes, there are entrenched boards who are just the handmaidens to the CEO, but again that is the exception NOT the rule. And we need to remember that it is the Directors and the Compensation committee members who have the information necessary to make the decision about compensation. (Like maybe the boards of these companies knew that shareholders would be pleased with the share price increase!)
Lambasting the result without knowledge of the underlying policy, decision making process or relevant details is just an act of petulance. (i.e. don’t be a grumpy second guesser).
Even the AFL-CIO admits that at least from 2000-2008 the ratio of CEO pay to that of the average worker has declined significantly (see 2008 Trends in CEO Pay) . OK the numbers are still staggering at 525 to 1 in 2000 “dropping” to 319 to 1 in 2008, but it is directionally correct. And the nay-sayers will point out that it is possibly an aberration and not a trend because the value of CEO held stock has suffered a steep decline as a result of the recession. But it is still a meaningful data point in our view, and evidence that many Committees are backing up their pay for performance rhetoric with real teeth.
With regard to these discretionary bonuses though, directors should consider the concept of the “1-for-1 relationship” that addresses performance relative to the competition. In companies mentioned in the article, perhaps the Board determined that company management handled the unexpected recession better on a relative basis than the competition and decided to give an extra reward for this success. If the pay policies of these companies were only “look forward” (i.e. based on forward looking business plans for the organization) and “look back” (i.e. based upon increasing performance over last years levels) then they might not have considered performance relative to competition. Grahall calls these relative performance criteria a “look around” feature.
A valuable aspect of “look around” is that it provides excellent “checks and balances” in changing economic conditions. It offers the chance for discretion to address unique economic circumstances, but with the requirement that there be clear objectivity.
For example, when unexpected and uncontrollable situations occur, “look around” dictates that if executive performance is low compared to goals, but high compared to competition the relative performance is high and the incentive should reflect this. On the other hand, it also demands that under normal circumstances, if executive performance is high compared to goals but low compared to competition the relative performance is down and so should be the incentive.
A good way to check this is the “1:1” performance payout ration. Stated simply: a guide for determining relative pay and performance is to review a good survey (such as our own Grahall research series on executive compensation) and determine the performance percentile of the organization on one of all of the key performance statistics. Then determine the pay percentile that matches that relative performance. If the two percentiles generally match then the reward program is operating in a reasonable zone on a “relative pay for relative performance.” If the two percentiles don’t match (either the relative pay is too high or too low given the relative performance) then it would point to the need for a review of the executive compensation program.
We believe that a qualified compensation committee shouldn’t be afraid to make discretionary decisions, since generally they are experienced and have sufficient information. We have to assume that those decisions are thoughtful.
As James Thurber would say “Let us not look back to the past with anger, nor towards the future with fear, but look around with awareness”.
Contact Grahalls’ OmniMedia Editorial Director at email@example.com