Executive Pay: It's About "How," Not "How Much" - 22 June 2009

It seems we are moving from an era
when "greed was good" to one in which "jealousy is justified"--the
executive-compensation regulations being considered now by the
government and advocated by shareholder activists aren't very
thoughtful, and I believe they're born out of jealousy and
misinformation.

But "How much should CEOs be paid?" is the wrong question to be
asking right now. The right questions are: "How should they be paid?"
and, just as important: "Should changes in the way CEOs are paid be
mandatory or voluntary?"

Pay must be structured to attract the right executives and give
executives effective incentives to lead their companies to great
performance. The poor showing of too many firms, despite ample CEO
salaries and equity packages, and excessive compensation at times of
poor performance shows that pay typically isn't structured correctly
and that executive compensation practices need serious reform.

All too often, executive incentives are based mostly on short-term
financial metrics and shareholder returns. Financial results are the
consequence of a firm's strategy formulation and implementation.
Effective incentive systems should focus on effective organizational
learning and growth, process improvements, and customer-related metrics
and milestones. In addition, companies should design compensation
packages to attract the right people for implementing the company's
strategy. For instance, below market salaries coupled with aggressive
incentive pay linked to individual performance is likely to attract
self-motivated entrepreneurial individuals.

Companies also need to assure their executives longer tenure and
horizons. A CEO who is afraid of being fired for not making short-term
financials will not focus on the long term. A board that is actively
engaged in strategy formulation and implementation and compensates a
CEO for strategy implementation milestones and monitoring long-term
performance is more likely to understand, appreciate, and encourage a
CEO's efforts even if they yield short-term financial results that are
below expectations. Thus there is an urgent need for boards to evaluate
their executives' performance annually to determine their progress on
long-term goals. Simultaneously, boards should engage in active
succession planning so that they do not find themselves looking for a
superstar CEO to rescue them from their financial problems. It is
precisely in those situations that CEOs are able to negotiate
outrageous compensation packages.

Simultaneously,
companies should get rid of egregious practices such as over the top
severance packages (more than two times annual compensation), grossing
up taxes, defined-benefits plans, guaranteed returns on deferred
compensation, accelerated vesting in the event of change in control,
and time-based vesting of restricted stock. On the stock question,
companies should require that equity pay vest on the basis of company
performance relative to their peer group over five to ten years.

It would be highly unfortunate if, as now seems possible, massive amounts of regulation

For more information on The How of Executive Compensation.