I’ve long been at odds with many of my lean compadres in that I don’t advocate controls or caps on executive pay. Instead I’d like to see more active investors and boards creating compensation systems that match the particular business vision of a particular company in a particular industry. I’m concerned that artificial caps or constraints could actually create the unexpected effects… now where have we heard that before?
There have been some exceptionally egregious examples of incredibly bad compensation plans, with some failed execs getting nine figures just for leaving. But perhaps there’s more at work than meets the eye.
The $700 billion financial-rescue law attempts to curb executive pay by barring incentives for "unnecessary and excessive risks," among other steps. That will be easier said than done, say pay experts. It’s "a very noble thought, but administering it will be very difficult," says Paul Hodgson, senior research associate at governance tracker Corporate Library and a frequent critic of executive-pay excesses. Pay experts say the vague language of the new law will make it hard to implement. The provision doesn’t specify how to determine what "unnecessary and excessive" risk is, says Mr. Hodgson.
The excessive-risk language applies to financial firms in which the government takes a "meaningful" debt or equity stake under the terms of the bailout. Other provisions limit corporate-tax deductions on executive compensation at some firms, bar "golden parachutes" for some executives, and allow companies to recover compensation based on inaccurate results.
What’s the problem with risk?
The excessive-risk provision is aimed at what some consider a contributor to the Wall Street meltdown: pay plans that gave executives outsize rewards for taking big risks.
Few dispute Wall Street firms took too much risk, but there is little consensus on the role of pay packages in encouraging that behavior — or how to prevent it from happening again. Some experts say that banks such as Wells Fargo & Co. avoided the worst of the mortgage mess, even though their compensation plans were similar to those at banks that suffered big losses.
So similar compensation plans, but different results. Hmmm… what’s happening?
Alan Johnson, managing director of pay consultancy Johnson Associates Inc., blames unrealistic performance targets for much of the risky behavior. He says executives of some financial firms he advised had to produce a return on equity of 20% to earn their full annual bonuses. A more realistic goal might have been around 15%, he says.
I could see that. Goals must be tied to acceptable risk levels.
Ira Kay, head of compensation consulting at Watson Wyatt, contends that linking pay to performance, particularly through granting stock, is still the best way to avoid excessive risk-taking. The problem on Wall Street, he says, may have been overly large cash bonuses that made the stock seem like "gravy."
Yep, another good point. Who cares about risk-related goals when you’ll get a boatload of cash even if you miss them?
Others suggest tying more pay to long-term results. Richard Ferlauto, head of corporate governance and pension investment at the American Federation of State, County and Municipal Employees, suggests companies delay paying annual bonuses for a few years — until they are sure that good results will last. Consultants say some companies tried such deferred-bonus plans in the 1990s, but later abandoned them because they were hard to administer. Mr. Ferlauto also wants more companies to require top executives to hold a significant amount of stock until they leave, forcing them to think longer term.
And that’s probably the most important point: distinguish between long-term risk and short-term risk, and reward appropriate long-term results.
How many of you work for companies that focus on monthly or quarterly results, and perhaps tie rewards to those short-term numbers? How many of you work for companies that almost compell you to change jobs every two years if you want to be on "the ladder?" I’ve been there too, and left a Fortune-50 because of it. Ok, I also left because that next assignment would take me to (brrr!) Buffalo… the wrong direction from Salt Lake.
Focus on long term results from appropriate long term risk. It takes real leadership to buck the traditional accounting and demands of the Street, but that’s where the opportunity is.