In his article for Business Week How to Handle CEO Pay Before Dodd-Frank Hits Bill George subtitles his article “Financial reform will bring unintended effects.” And then goes on to outline “six policies that should be rigorously followed, including in bad times when boards are more prone to bend the rules for those in their top ranks.” On the surface, George’s ideas seems reasonable but lets dive down a bit deeper into them and see what the unintended consequences might be of these directives.
George starts with a demand for “full transparency for compensation policies and actual practices.” We agree that more transparency would benefit boards, shareholder, investors, and even executives. But “full transparency” may not benefit any of these groups. Performance measures are surely part of executive compensation and many of these are based on plans for growth that might include things such as acquisitions, product and new product releases. Would a company be wise to be fully transparent around these objectives? Clearly not. Increased transparency is good, full transparency is neither realistic nor beneficial.
George continues with a demand that board “[c]reate policies that reward long-term performance with long-term pay. Yeah, good idea. But, in fact it would be even better for companies to look at ALL performance horizons and make sure that each is matched with relevant pay. Short term, mid-term, long term, and career term are each relevant to an executive’s responsibilities and pay. In our experience, the expression “long term” is far from that. Even Most companies consider 5 years to be “long” but many business decisions require more than that to come to fruition and prove themselves successful. Executives need to be rewarded for performance based on successful outcomes of their decisions, not on the successful launch.
Next George suggests that companies should “Reward executives for their performance, not the company’s stock price.” Here we do agree, at least for those executives who do not directly influence the company’s stock price. The CEO, president, and CFO perhaps might be exceptions to this rule as we have seen with the departure and hiring of Mark Hurd and his apparent impact on the stock price of both HP and Oracle.
Mr. George suggests that companies “lengthen the time horizon for bonuses”. Huh? For companies who have done the hard work outlined two paragraphs ago to look at ALL performance horizons and make sure that each is matched with relevant pay, this should not be an issue at all. The “problem” if there is one, is solved when the compensation structure rewards individuals at the right time, not the earliest time.
Number five on George’s list made us all laugh a bit as he recommends that companies “Avoid formulaic approaches”. Like this one we questioned? No doubt Grahall espouses the need to develop surgical approaches to compensation structuring based on business strategy, people strategy and goals. Linking compensation to these is the best (and maybe the only way) to be sure people are incented to do what the company needs o be done. And it is far from formulaic. It is difficult and challenging and might make some executives and some employees unhappy. But it works. As we said in our blog It’s Too Easy to Blame Compensation for Every Business Problem: “Too often, companies design a single compensation structure. This “peanut butter” approach is simple, easy to explain and might even be perceived as “fair,” but unfortunately it won’t sustain business results or drive innovation. Top performing people should be placed in critical jobs (as defined by the business strategy) and these people in these jobs should reap the lion’s share of rewards (assuming they are effective).”
Last, but not least, George recommends that companies “[b]oost equity between workers and executives,” drawing the example of his own company, Medtronic “who gives employees a ‘means to share in the company’s success’ by enabling them to become shareholders through company-funded employee stock ownership plans.” Maybe Medtronic is the exception to the rule, but the research we have seen on employee stock ownership suggest that broad based plans that offer stock to low level employees is a waste of economic resources. In fact substantial ownership of stock by employees can create an imbalance in the power in and around the organization. The need for broad consensus can slow down decision making and limit a company’s ability to respond to and exploit change.
Let’s get back to basics. One size does not fit all. A company cannot apply a prescriptive list like this to so large an issue as executive compensation, whether they are preparing for Dodd-Frank or not. Better they should read Michael Graham’s book “Effective Executive Compensation” so they can identify ways “to reward both organizational and individual performance in such a way that the company is the absolute best it can be… the mutual benefit of all stakeholders, shareholders, employees, customers, and partners is a major consideration for the executive reward program.”
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