What to Do about Executive Compensation

The Washington Times (Washington, DC), October 12, 2008 | Go to article overview

What to Do about Executive Compensation


Byline: Harvey Pitt, SPECIAL TO THE WASHINGTON TIMES

When Lee Iacocca first joined Chrysler in 1978, he lowered his salary to $1 a year. When a shareholder questioned the wisdom of this, Mr. Iacocca responded, Don't worry. I'll spend it carefully. The spend it carefully philosophy is exactly how companies should, but often don't, approach executive compensation.

In 2007, CEOs of S&P 500 companies received, on average, $14.2 million in total compensation, according to preliminary figures from the Corporate Library. That's more than 300 times what the average American worker earned in 2006 and six times what the average CEO would have brought home in 1980.

Some point to statistics like these as evidence that executive compensation is out of control. And Congress reflected similar sentiments in the recently enacted Economic Stabilization Legislation, capping the amount of fees for CEOs of firms whose portfolios are assisted by the new powers given to the secretary of the Treasury.

But, in reality, it's not the amount of compensation that's a problem; it's the rationale and methodology behind initial compensation decisions and the processes that companies use to determine whether they've received a fair day's work for their compensation dollars.

There is, and should be, a strong positive correlation between executive compensation and performance. Productive and successful executives ought to be rewarded handsomely. The key, of course, is to make sure they achieve both standards. It's un-American to lavishly reward someone who performs poorly. The challenge, therefore, is to establish policies and procedures that consistently embrace and further this linkage, as well as corporate and economic reality.

Fortunately, the construction of an effective executive compensation process isn't enormously complex. The following elements can provide a solid foundation:

Compensation should be linked to legitimate, objective, corporate objectives.

Simply put, executive compensation should always align the interests of management and shareholders. Executives should be rewarded for producing fundamental, sustainable, development measured objectively, in market share, markets served, or other appropriate means - not for achieving some arbitrary, fleeting and easily manipulated earnings target.

The elements and amount of compensation should reflect company goals.

Many companies approach compensation as a rote exercise:

comparable companies are identified, and senior executives are paid about 75 percent of the range of compensation paid by the comparables. No wonder there's compensation inflation! Simple mathematical comparables are not, by themselves, a defensible rationale for compensation decisions. It's better to start by defining the company's objectives and the specific goals each executive is expected to achieve. Then, the amount and form of each element of compensation can be related directly to the relevant objectives. …

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