5 Reasons We Can’t Fix Executive Compensation

Executive compensation, especially at larger companies, continues to soar ever upward. Headlines in local newspapers and websites around the US are reporting record years, once again. While there are valid arguments for many huge CEO pay packages, there are at least as many that defy explanation. Why can’t we get our arms around this issue?

1. No one wants to admit they have below-average executives. Boards don’t want to tell shareholders that the goal is to have an executive team designed to perform below the middle of the market. Shareholders don’t want to invest in a company with a below-average executive team. Executives don’t want to be told (or admit) that they are “less than.”
2. Shame is not an effective deterrent. Our country is currently built on crowing about how much money you have. People at the top know that there is always someone who makes more. Many middle and lower-level employees celebrate and aspire to be like the high paid executives at their employer.
3. We have allowed a system to be built that cannot be sustained. In the early 1990s, executive pay began its rapid movement from cash and perquisites to a heavy dose of equity. In many industries equity was poured over every employee with the goal being a singularly aligned workforce. As executive pay has increased it has eaten more and more of the available equity (shareholders frown on 100% dilution). This means there is less and less available for the rank and file. More importantly, equity (while amazing) is a limited commodity. The current growth cannot be sustained without shareholders accepting significantly more dilution AND employee getting far less equity. My guess is that the current approach has 5-10 more years before it begins to cannibalize executive pay.
4. Executives are increasingly portable. Not so long ago most executives stayed in one industry and often at one or two companies for their entire career. The lack of movement worked to inhibit outsized pay increases. It also served to slow the need for expensive outside hires to replace the people who left. This is just like free agency wildly increased the pay of athletes. This will not, and should not, go away, but its impact cannot be underestimated.
5. The stock market has been redesigned to grow for longer periods and fall for shorter, albeit more dramatic, periods. This means that stock-based compensation grows more aggressively and more predictably than it did twenty or forty years ago. When crashes occur the reset period is short and the low prices provide for stacking even more equity onto the pile.

So, what should we do? All of our prior efforts have been the equivalent of pouring gasoline on a fire. Perhaps it is time to reassess whether the “scorecard” of executive pay disclosure is doing more than simply providing the foundation for next year’s big increases. Maybe a little less data will result in a little more control. I’d love the hear the thoughts of compensation professionals, whether or not they are focused on executive pay.

Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. He is passionately committed to aligning pay with company strategy and culture. Dan is also a leading expert on equity compensation issues and has written several industry resources including the one-of-a-kind Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @DanFutureSense.

Comments

[Joe]

I don't think free agency is a bad thing, Dan.

I haven't heard a comp pros take on the recent Michael Lewis podcast, which was great. He frames comp consultants as referees. There are governing bodies with their compensation philosophies and goals on one side and there is compensation data/practice on the other. As referee/consultants we have a responsibility to make sure the comp decisions align with the philosophies.

Governing bodies = sports team owners
Executives = athletes
Consultants = referees

Keep the game clean--that's our job.

I'm not 100% on board with this, but it's an interesting way to think about it.

[E. James (Jim) Brennan]

Not all rewards jingle.

The public, unions, politicians and MSM all count dollars to "keep score". They want "fairness", which means... well... MORE (for themselves, typically).

As long as comp people keep endorsing schemes which enrich the 1% in extremely transparent ways that show cash values (yeah, I know... potential, but still...), those who approve the deposits of THEIR money into already-bulging pockets will earn ire, resentment and hatred.

Competition is the culprit. Since the 1980s, the statistically significant positive correlation of industry/size-specific Exec Comp amounts published in the major commercial surveys has skyrocketed. The moment one firm edges ahead, "I want what HE got!" resounds. The ratchet effect rules. Since board directors tend to overlap, private CEOs get cash-equivalent packages matching the openly reported corporate CEOs.

Thus we experience an uncontrolled mad rush towards economic/political insanity.

Can't we get the enabling attorneys out of "our biz"? Why don't we actively promote some less conspicuous non-"countable" rewards that would satisfy Great Leaders without outraging the rest of the world?

Otherwise, some profession will pay a hard and bitter price... and we know which group will end up in the cross-hairs.

[Dan Walter]

pretty well stated

[Dan Walter]

Thanks for the comment Joe.
I also think free agency is generally a good thing. I will have to give the recent Michael Lewis thing a listen. I will guess that I will have an opinion. I often feel that Comp pros are less like referees and more like scorekeepers. The decisions seem pre-made with comp pros left to justify them.

[Paul Pittman]

Hey Dan

As always good thoughts.

As you rightly suggest equity has been the cause and because of the way we communicate its value has created an impression that this is cash money. Anyone who has ever reconciled realised value of LTI awards at settlement with booked value will know there is often a significant difference because of a number of factors.

This value chasing is fuelled by an industry of consultants who have bet the farm on data including inclusion of this funny money that perpetuates the annual review and fee cycle and stokes the fear of being "less than" .

Management do not invest Capital as investors do but we encourage an inflated degree of leverage (and return) return that is protected (through employment law and contract) - why did we never settle on "if you want the same return buy the stock too".

Pay equity, gender equity et al are suppressing pay at lower levels but no fairness tests are applied at senior levels other than market rate which may or may not bear any reference to lower levels of pay in the organization.

Why not give employees, like shareholders an opportunity to comment on the reasonableness of their leader's pay. Whether we like to admit (yet!) or not it does have a meaningful impact on engagement and collaboration. My guess is that establishing that linkage will have a beneficial effect on leadership, engagement and collaboration - it worked in the forces! We have tried everything else; taxes, shareholder approval (say on pay), disclosure and the CEO pay ratio - all failed.

If one extends the concept of Companies as communities then CEO's like elected officials have to have the approval of all stakeholders to get the job - so why not include employees. And why not have a term; say three to five years for a fixed fee plus bonuses with the CEO seeking re-election at the end.

We examined this in a blog a few years ago
https://thehumanwell.com/a-peek-into-the-future/

There would be a break clause and penalty for premature termination - giving the workforce reasonable comfort that their leader was not going to be poached away.

Shareholders will need to will these changes and maybe our friends at the proxy advisory groups should be taking on a higher calling :-)

A good and endless discussion - thnx for rekindling it.

[Dan Walter]

Thanks for the comment Paul. Very interesting ideas (and very entertaining blog article). One thing I have always found surprising is that the majority of employees at the companies with the highest-paid executives believe that executive compensation at their company is just fine. I have seen survey results from multiple sources over the years. I do not think giving employees the ability to have a "say on pay" would do much more than create an additional administrative burden.

[Lisa Williams SPHR]

I thought your number 5 was true but funny. "The stock market has been redesigned to grow for longer periods and fall for shorter, albeit more dramatic, periods." Remember when there was all the talk of underwater stock values and what we needed to do to fix it? How we had to fix it? Execs want quick fixes now in their favor (everyone does).

I agree with you about the pitfalls of the current system, however, the genie is out of the bottle now. It will be tough to put it back without the crash you are predicting in 5 to 10 years.

[Dan Walter]

Thanks for the comment Lisa. It's funny but sad. Equity works best when the markets are both rational and follow fundamentals. Repricings and option exchanges will come back with a vengeance when the market falls again ... and will once again allow for spring loading of equity for the wrong crowd.

[paul pittman]

Hey Dan very good. That's the point :-) Does leadership correlate with high pay - maybe that makes them worth it?

[Dan Walter]

Thanks Paul.

[Joe]

For those interested, the episode that references exec comp consulting is titled The Hand of Leonardo. But the entire series in on the same theme.

Michael Lewis does interview Pearl Lewis as part of the conversation.