Expert Perspective by Grahall’s OmniMedia Editorial Board
Recently, The Kellogg School of Management at Northwestern University’s Camelia Kuhnen addressed several pressing issues in executive compensation. Grahall’s editorial Board thought it would be interesting to canvas our team of Top Consultants to provide our thoughts in addressing the same questions posed by Bloomberg BusinessWeek.com’s Patricia O’Connell on the subject of “Executive Compensation and Public Outrage” (Business Week February 24, 2009).
The questions below have been selected from O’Connell’s interview with Ms. Kuhnen, but the answers are from Grahall consultants with a total of combined experience of more than 200 years designing executive compensation programs for literally thousands of public and private U.S. companies in various stages of development.
Q – “What do you think about the state of exec comp? It was a big issue a year ago, and people were expecting a lot of reform.”
In our authoritative research of top named officers in 1,000 public companies there is a significant correlation of pay to the size of the company and to performance measured over seven different variables in 95% of companies. This strongly suggests what we’ve long suspected – that typically, executive compensation programs are generally very effective and appropriately linked to financial performance.
However, like many issues that engender popular outrage and stimulate media attention, heightened concerns often result from hyper focus on the most egregious examples of poor pay practices, perpetrated by a small number of evil doers. While it is both appropriate for the media to disclose these problems and reasonable for Americans to be angry about them, they are by no means illustrative of the broader market. We agree that there have been too many (i.e. more than zero) examples of excessive and inappropriate executive compensation at large companies with entrenched Boards of Directors who also exhibit a serious lack of checks and balances over executive compensation decision making. However, it is not reasonable to extend those observations to conclude that the entire system is broken. Our quantitative and qualitative analysis illustrates that in over 90% of U.S. based companies analyzed by Grahall, pay programs are operating fairly effectively, and that the three keystones of well designed compensation – which we call the 3 “M”s “money” (amount), mix (components) and messages (behaviors) vary appropriately.
In short, while improvement is necessary and desirable, – particularly in certain industries – the sky is NOT falling and Compensation Committees are operating much more effectively than they were even 5 years ago.
Q – “Is exec compensation out of line?”
As we said above, NO, in most cases, executive compensation is NOT out of line. In some large organizations, significant problems do exist, and those problems are appropriately vetted in the media.. But it is also our opinion that neither criticism from nor an angry public will do much to change behaviors when executives, Boards or their consultants use poor judgment when making decision on executive pay. A sense of entitlement to enormous compensation, entrenched Boards who have lost touch with the expectation of shareholders and conflicted consultants is a recipe for bad decisions in the arena of executive compensation.
The egregious problems that capture the attention of the media and the fury of the pubic is not representative of the vast majority of US companies.
But maybe it’s not executive compensation that is the problem. At least according to Goldman Sachs. In a March 1, 2009 article in The New York Times (Goldman Discloses a New Risk: Bad Publicity) author Michelle Leder shares that “…in the 10-K financial statement that Goldman filed on Monday, it included a new risk factor related to the problems of negative publicity.” It seems that Goldman is proposing that negative publicity, and not the firms generous pay programs, that may create serious risks that need to be considered by investors who own or are considering purchasing GS stock. And, to that we say: “WHAT!?”
Q – “Is it really about individual shareholders? And last year we saw a lot of outrage that wasn’t even coming from shareholders.”
The individual shareholder doesn’t have any chance to influence any item on the proxy. Institutional shareholders might have some influence but as we have shared in earlier blogs, there is little that they speak out on and rarely if ever show concern over executive compensation.
In our blog “Shareholder Lawsuits Won’t Rebalance the Boardroom” we said: “Over the past few decades the ownership structure of public companies has changed dramatically. Where individual shareholders once had substantial ownership – and therefore a voice in the boardrooms of public companies – that ownership position has become highly diluted. Today the tilt in the power coalition greatly favors management because management selects board candidates and determines the issues put before the boards.
Individual shareholders today have dwindling influence… Some might hope that institutional shareholders – pension funds, mutual funds, endowments and the like – who own substantial shares will help to influence management decisions. But research shows that institutional shareholders vote with management more often than not, in fact as much as 90% of the time.”
Q – “What do you think we will see from now on?”
At Grahall, we steadfastly believe that no one solution is the right one for every company, and that “best approach” or practice is not universal, but varies depending on what stage the company is in (from start up to growth to decline to turnaround) and the firm’s business strategy.
For example, at a mature company with a goal of generating free cash flow and reduce investment, using restricted stock as a primary component of pay is a reasonable approach. However, this may represent perhaps 25% of companies in the U.S. Conversely, a start-up company with goals of market share and sales revenue may more appropriately structure compensation in line with what we see in many technology companies – liberal use of stock options, since they are more leveraged and promote higher rewards and incentives for executives to take the appropriate risks necessary to achieve early market domination that will generate the above average to spectacular returns that investors expect.
Don’t do what everyone else is doing, do what is right for your company and your shareholders.
Contact Grahall’s OmniMedia Editorial Board at firstname.lastname@example.org