In their joint article published in the Wall Street Journal on June 15, 2009 titled “Risk vs. Executive Reward”, Cari Tuna and Joann S. Lublin share that: “Federal officials hope to curb excessive executive compensation by controlling the incentives for risk-taking built into pay packages. But experts can’t agree on how — or whether — pay plans encourage such risks.” Tuna and Lublin base their article on a recent paper from Harvard Law School and a study by Watson Wyatt, a human resourses consulting firm.
We are not at all surprised that in this case “ivory tower academics” and the consultants can’t agree on how or if compensation impacts risk-taking particularly since the information and approaches used to draw their conclusions is dissimilar. Taking an initial read of The Harvard Law School article (it deserves a more thorough and careful review and commentary which will be coming in a future blog) we find that the comments and conclusions are based on a generalized view of executive compensation structures in Financial Services companies. Only two firms, Bank of America and Citigroup, are mentioned in the paper with specific compensation and financial data reported. And that data is from 2006.
Watson Wyatt, on the other hand, “conducted an empirical analysis of the executive compensation architecture at more than 1,000 firms from the S&P 1500 from 2005 to 2007.” Therefore, Watson Wyatt’s study is cross industry and does not focus only on financial service firms.
While we aren’t shocked that the Harvard Law School and Watson Wyatt came up with different conclusions, it’s not just because of the dissimilar approaches and study groups. We firmly believe that effective executive compensation cannot be structured with a “one size fits all” approach. The fact that different input to the quoted reports and papers resulted in different conclusions supports our opinion.
Further we believe that compensation is a great motivator and the components of compensation can motivate appropriate behaviors as well as inappropriate behaviors. Well thought out rewards structures linked to appropriate business strategies (that incorporate reasonable risk considerations) is the way to ensure that compensation drives the right behaviors.
But focusing solely on compensation alone will not address the problem of risk management – it is the tail wagging the dog. Companies need to start at the beginning. They need to review the external environment, general business strategy, risk considerations and people strategy and then create a rewards strategy that is effective, and drives appropriate behaviors (be they related to risk or not). Over the past 35 years, Grahall consultants have codified the Conceptual Model, Process Steps, and Tools used to design a system that addresses all of the factors and influences on Total Rewards design. We invite you to review our conceptual model.
Risk is an important and emerging concept in the arena of executive compensation that will, no doubt, lead to further discussion and new tools and techniques to calibrate and assess the impact of compensation on behaviors that increase or decrease enterprise, industry and broader economic risk. As the government, the media, the academics and the experts continue to “scratch the surface” of this issue we plan to provide you with a deeper perspective on their findings and hope to lift the veil of inconsistent analysis and unintentional bias to provide you with a more complete understanding of these issues.
Email Grahall’s OmniMedia Editor at Edie.Kingston@grahall.com