WASHINGTON, May 5
/PRNewswire-FirstCall/ -- A majority of directors who serve on
corporate boards believe that the executive pay programs of U.S.
companies need to change as a result of the financial crisis, according
to a new survey by Watson Wyatt, a leading global consulting firm.
Nearly two-thirds (63 percent) of outside directors said they
believe American companies should modify their executive compensation
programs to adapt to new economic realities, according to the survey.
Additionally, most directors (68 percent) are not concerned or only
slightly to moderately concerned about the retention of high-performing
executives. Further reinforcing this point, 70 percent of directors
expect executive pay opportunity to decline over the next two years.
More than a third (34 percent) of directors said their companies had
already reduced salary, target bonus and/or long-term incentive award
levels. Six percent plan to make those changes in the next six months
and another 48 percent are considering making them. Furthermore, these
pay changes will not be temporary for a significant number of
companies. And, although underwater options are at historically high
levels, 58 percent of respondents whose companies grant options do not
think it is appropriate to take action such as repricing or exchanging
them for new shares.
Watson Wyatt's survey was conducted in March and April 2009 and includes responses from 85 outside directors.
"Shareholders and the general public will support that directors are
looking to change their executive pay programs to reflect the economic
crisis," said
Ira Kay, global director of executive
compensation consulting at Watson Wyatt. "We are confident that boards
will continue to hold management directly accountable for their
company's performance."
Companies are beginning to address the issue of excessive risk in
executive compensation. Twenty-three percent of directors are
moderately to greatly concerned that legislation addressing "excessive
risk" will have an effect on their executive pay programs. Roughly one
quarter (24 percent) are concerned to the same extent about expanded
clawback
Here's a related article titled "Pay Dirt: The Executive Pay System is Broken."
http://finance.yahoo.com/banking-budgeting/article/107070/pay-dirt-the-executive-pay-system-is-broken
This article advocates eliminating CEO severance, making no annual equity awards to CEOs and forcing executives to hold share-based compensation through retirement. While I like holding periods and am no fan of large parachutes or pay for failure, I am a believer in the value of annual grants. Generally, I am not in favor of option exchange programs or repricing,
though I understand the impact an underwater grant can have on
employees. I believe that well-planned annual grants and performance
vesting criteria will overcome the impact of underwater options.
Executive compensation, and in some cases other levels of equity compensation, have sometimes seemed excessive. Rather than seeing a system that is broken beyond repair, however, I see improvement occurring across the board with migration to performance-based compensation. Logically, performance criteria will work to improve performance so long as the measures are honest and meaningful. The amount of compensation to grant is still an issue for debate and that's probably the main issue at hand.
When it comes to the excessive size of equity compensation awards, I see two factors. One is that companies see a need to keep up in sheer compensation size with the most successful companies across the board. They try to do this by making larger and larger grants, making up for stock price growth in sheer grant size. This is a losing proposition. The other factor is that phenomenal stock price growth itself results in seemingly excessive pay.
For those who believe the compensation itself has grown out of hand, it is possible to design plans and grants that cap and/or index the value of such compensation. Indexed options deal fairly with market downturns by comparing company vs. peer performance making repricing and exchanges less "necessary." Why such arrangements are not used more frequently is a question I continue to asking myself. Two answers come quickly to mind. They are valuation and administrative challenges.
While unique plan provisions and capping arrangements create a challenge for those of us administering plans and valuing grants, they also limit the amount of pay one person might receive. From a compensation perspective, the role of an award is to encourage performance and still retain the employee. At some point, these two complementary objectives collide and excessive gains actually provide employees with the financial freedom to leave the company. Limiting gains is a double-edged sword, however, since limits on the possible compensation may diminish individual incentive. Any cap would have to be sufficiently high to create at least initial incentive. Personally, I believe innovative solutions are out there that allow for some sort of "unlikely cap" with further capability for modest growth annually once that cap has been reached. For key executives, perhaps that cap should be lower than for rank and file employees.
A number of years ago, I found myself in the midst of a compensation discussion where the topic was annual option grants. The discussion centered on making new grants sizable enough to handcuff employees who already had sizable if not excessive vested grant values. Rather than trying to grant fairly, the goal was retention at all costs. This is one mindset that Compensation Committees need to discard. There is a point in terms of shareholder value where it's time to let someone go. A logical place to draw this line is by letting the employee make the decision. This occurs naturally when a company is making reasonable annual grants instead of trying to handcuff the employee with excessive compensation.
Rather than eliminating annual grants, a better approach to fixing executive compensation in my opinion is making annual performance-based grants with indexes or caps acting as moderators on the top-end value. Some sort of additional reasonable growth should be allowed beyond the initial cap as an incentive for continuing to hold the grant. With modest grant sizes, I believe upper limits on maximum gains would continue to make annual grants feasible and keep executive compensation reasonable. Rather than seeking a windfall, executives would seek sustained growth, especially if satisfactory performance in the previous year was a pre-requisite for receiving new annual grants.
If we do begin capping the realized values from grants on a regular basis, we might even be able to tie new annual incentives to raising these caps and extending vesting and expiration periods rather than making new outright grants of shares. By making use of grants that are already there, we should be able to limit overhang and enforce executive holding periods. Hopefully this topic can inspire some additional discussion on how we could be more innovative.
Mike,
Thanks for the excellent comments. I hope other ECE member will take the time to read this post and provide their input.
Dan
Mike Cranor makes some excellent points. I also believe that non-excessive annual grants is a better way of dealing with the negative morale effects of market down-turns than option exchanges.
One thing I would add to Mike's list of suggestions is an educational component. In additional to annual grants, participants should receive an annual "Equity Compensation Benefit Statement" that specifies their "Forfeit Value". This value is more than just the in-the-money value of their unvested options and the fair market value of any restricted stock. Their true Forfeit Value should include the remaining time value of their vested options unvested options. Consequently, options grants don't have to excessive to have a substantial retention and motivation effect.
For more information on Forfeit Value visit: www.stockopter.com/University