The Secret Formula

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Expert Perspective by Grahall’s OmniMedia Editorial Board

expert perspective telescopeReuter’s journalist Steve Eder wrote in his September 25, 2009 article “U.S. ‘pay czar’ Feinberg using formulas, not caps” that “President Barack Obama’s ‘pay czar’ said on Friday he was using formulas and data analysis to determine executive compensation rather than relying on pay caps.”  We expect that this came as a great relief to many executives in the TARP companies.   

Formulas are something that Kenneth Fienberg is familiar with. In his role as “decider” of the compensation to be paid to 9/11 victims’ families, Feinberg “… didn’t authorize equal payments for all victims, instead adopting a formula that considered a victim’s age, income, marital status and family status…. On more than one occasion, Feinberg was forced to defend a formula that decided that a stock brokers’ family received more money than the family of a janitor or even a New York City fire fighter.” (according to a June 5, 2009 article in the Wall Street Journal by Michael Corkery (“Wall Street’s New Pay Czar: ‘It’s Like Nixon in China’”).

In fact, formulas are a very basic first step in the journey on which a compensation consultant takes his client to determine pay structures for executives.  But there are FORMULAS and then, of course there are formulas.  The inherent complexity of determining the correct pay for an executive demands a complex formula. 

The size of an organization might be a proxy for the complexity and an initial indicator of the range of possible pay.  Using, revenues, market capitalization, number of employees and other metrics, the complexity of an organization – and therefore the challenges before an executive – might be estimated.  The expectation is that the more difficult the job (i.e. the more complex the organization) the higher the pay.   But this is just a first step in the process of determining pay structure for an executive. 

The more important considerations beyond range of pay are the mix of reward components (base pay, incentives, etc) and the messages attached to those components.  (In “Grahall Language” these are M1: Money, M2: Mix and M3: Messages). To get M2 and M3 “right”, a consultant must turn to the company’s business strategy. Executives are charged with delivering on this business strategy and compensation can drive the behaviors to deliver success (or not).   

So what is Feinberg using?  A complex FORMULA that takes into account job complexity and business strategy? We hope so!  If it is a simple percentage of a metric (some percentage of operating profits, or revenues, etc.) that could spell disaster. 

Harkening back again to Feinberg’s 9/11 experience with formulas, it is interesting to consider the finality inherent in that earlier task. As challenging as his job was to determine payments to 9/11 victims’ families, once he had his formula, applied it to each situation and delivered a check, essentially his job was done.  This effort will have ongoing, observable consequences. This determination of compensation will be tested daily by the work of these executives and the viability of their companies. Any flaws in the formula might be exacerbated over time as the executives’ efforts will certainly be focused on maximizing their pay under the formula. 

All too often in our executive compensation work, we have seen individuals “managing” to a formula that doesn’t reflect the business strategy. The result? The executive’s efforts take the company down a path inconsistent with the business goals.

Each company needs its own pay structure. Clearly the formula for Citibank would be different from that for B of A (even though they are both “banks”) and should be far different from that for an organization like GMAC or AIG. 

As taxpayers and partial owners of these TARP companies, we wish Kenneth Feinberg good luck with his efforts. We know this is difficult work, we do it every day!  We hope the formulas are appropriately complex and reflect each company’s business strategy. If so, the formula will differ for each entity.

Contact Grahall’s OmniMedia Editorial Board at edie.kingston@grahall.com


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