Pay for Performance is More than Pay for Shareholder Return

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Expert Perspective by Grahall’s OmniMedia Editorial Board

Several articles were published in the Wall Street Journal drawing from the Journal’s Survey of CEO Compensation conducted by the Hay group.

The articles all tout the fact that CEO pay is up (according to the survey) but so too is shareholder return.  As Joann Lublin writes in her article Paychecks for CEOs Climb, “The chief executives of the largest U.S. public companies enjoyed bigger paydays in their latest fiscal year, as share prices recovered and profits soared amid the country’s slow emergence from recession.”  Is this really “pay for performance” as the articles seem to suggest or is a “rising tide lifting all boats”?

Our experience suggests that “pay for performance” requires looking at executive compensation in three ways:  “looking forward” (i.e., based on forward looking business plans for the organization), “looking back” (i.e., based upon increasing performance over last year’s levels), and “looking around” (i.e., based on performance relative to that of the competition).

A valuable aspect of “look around” is that it provides excellent “checks and balances” in changing economic conditions.  It offers the chance for discretion in addressing 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 that of the 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 that of the competition, the relative performance is down. The incentive should be as well.

A good way to check this approach  is the “1:1” performance payout ratio. Stated simply: a guide for determining relative pay and performance is to review a good survey and determine the performance percentile of the organization on one or 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” basis. If the two percentiles don’t match (either the relative pay is too high or too low given the relative performance), then a review of the executive compensation program is needed.

The Hay Survey covers a very narrow group of companies.  The survey analyzed “… CEO pay from 456 U. S. companies with revenue of at least $4 billion in their most recent fiscal year that filed their proxy statements between October 2009 and Sept. 30, 2010.”

There are 10,000 publically traded companies in the US, and probably another 10,000 or so that are private.  Those in Hay’s list may look nothing like the other 9,500 public companies. It is at best difficult and at worst dangerous to draw broad conclusions from a sample that is clearly skewed by information totally unrelated to pay (such as the date of proxy submission) and tilted toward companies that would deliver CEOs far higher pay than would a typical US company (which is often the situation found in companies with larger revenue).  This approach does not provide intelligent insight into the state of CEO pay.

Grahall has conducted its own research, and we found that executive compensation should be considered within a strategic framework including many factors such as environment, stakeholders, business strategy, and people strategy. Not only does this more expansive approach provide a rational way to evaluate executive pay, but when fully considered as part of a pay strategy, it sends the right messages to shareholders and executives.

Grahall’s Executive Compensation Research Report Series examines the level and mix of executive pay at publically traded companies. Because we wanted to report on the market as a whole, we followed a methodology that would allow us to reflect the true state of executive pay in US publically traded companies.  Compensation information was collected on a managed sample that accurately reflects the majority of publically traded companies in the US.  The result of our selection process is a group of 1,020 companies with median revenue of $1 billion. For more information on our sampling approach, download the first, free report in our series on executive compensation research report.

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

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