Expert Perspective by Grahall’s OmniMedia Editorial Board
In their October 24, 2009 article in the Wall Street Journal (Range of Firms Alter Executive-Pay Policies) , authors Erin White, Joann S. Lublin and Cari Tuna share: “Companies…. are adopting executive-pay plans that echo principles laid out by government regulators, potentially signaling a broad shift in compensation practices… The recession, more than government regulation, is driving some of the moves.”
Certainly the recession has raised awareness of executive pay and resurrected the mantras of pay for performance, long term incentives and risk management as guideposts in today’s business environment. As the authors mention: “… companies for a while have been seeking ways to reward executives’ long-term performance and limit excessive risk-taking, according to compensation consultants.”
Interestingly though, experts quoted in the article suggest that “longer term” compensation approaches might increase vesting periods from 3 to 4 years or might extend a performance period from 1 to 2 years. Certainly that is longer (by a year in each case), but does it represent “a broad shift in compensation practices”? And, is it enough to limit excessive risk taking? Grahall thinks NOT. Adding a year is less a real change and more a symptom of Cainotophobia – a fear of change.
Grahall’s Michael Graham says: “Companies and their Boards need to match the rewards payout with the ‘time span of discretion’, an idea originated by Elliot Jacques which helps in understanding the issue of linking pay to events”. (See Grahall Blog “Don’t be Fooled”).
Essentially, the time span of discretion is the longest span of time that an employee spends working on a task, which steadily increases with the position of an employee in the company hierarchy. An hourly worker may have a time span of discretion of one hour, a middle manager of one year, and a chief executive of a large company of 20 years. (Paraphrased from www.dictionary.bnet.com).
So Graham asks the essential question. “If we don’t know the outcome of a decision (or “task” in Elliot’s language) for perhaps 2 or even 20 years, should the executive be paid for those decisions before the outcomes are known?”
Today compensation includes salary paid monthly, annual incentives paid at year end, and “long term incentives” that generally vest within four years, and might be 50% vested in two. Ownership of incentive pay may therefore be granted very far forward of the time when these decisions (i.e. “tasks”) can be judged as appropriate or not.
Certainly CEOs and other senior executives might be unwilling to accept a job without any pay for years to come. But there are ways to structure pay to address the executive’s current contributions while managing risk through delayed payment for long term decisions. Structuring executive compensation to include base pay, coupled with short-, medium-, long, and CAREER-term incentives is a mechanism to appropriately deliver compensation while managing risk.
The arguments against longer term payouts have all focused around retention: “If we don’t pay sooner, they won’t stay.” We believe the best managed companies and the most effective boards will not succumb to “fear of executive resignation,” or more broadly, a fear of meaningful change on the executive compensation landscape. Rather, they will structure compensation programs for a new age, which address business strategy while appropriately managing risk according to realistic time frames.
Contact Grahall’s OmniMedia Editorial Board at firstname.lastname@example.org