With the intense criticism CEOs suffer today, especially for their compensation, it is tempting to ask if they still matter. The easiest way to understand why they do, and should be compensated appropriately, is to envision a public company with a weak leader.
Executives competing for capital to run their divisions would remain at loggerheads because no one would set priorities or make decisions. Infighting and politics would hamper hiring new executives. Selling non-performing or non-strategic units would be nearly impossible. Changing company direction in the face of new and strong competition would not happen. Rewarding winning managers while weeding out losers would sink in the quicksand of politicking. Understanding the opportunities and risks of the total company would be lost among managers focused on their own units.
Today’s tumultuous environment- from the credit crisis and its ripple effects to climbing energy and commodity costs-underscores the importance of leadership.
In recent years, outstanding CEOs demonstrated great leadership. A.G. Lafley turned around a stumbling Procter & Gamble. Ed Breen stabilized Tyco and regained its credibility with Wall Street, employees and customers. Jim McNerney, Jr. provided leadership and ethical credibility to Boeing after its previous CEOs were dismissed. John Mack at Morgan Stanley brought direction after internal revolt. Jeff Immelt took the baton from Jack Welch days before 9/11, and devised a strategy to transform GE.
Highly publicized failures also demonstrate the power of the role. CEO Kenneth Lay at Enron admitted that he did not understand the financial fraud occurring at the company. Bernard Ebbers at WorldCom allowed manipulation of the books, and Dennis Kozlowski of Tyco used company funds to enhance his lifestyle. More recently, financial services industry CEOs failed to foresee the sub-prime mortgage meltdown or understand the risks of collateralized debt obligations.
In other words, leadership matters, character counts and judgment has consequences, both positive and negative. With so much failure today, heightened by the credit crisis, shouldn’t all CEOs be held more accountable? Yes, and the passage of Sarbanes Oxley tightened accounting standards and reporting and increased the power of boards and aggressive shareholders, not to mention the scrutiny of the media. That increased accountability makes the CEO job more difficult and blanket criticism of CEO pay less valid. In 1980, CEOs in the S&P 500 averaged eight years in office. Today they average five. That doesn’t leave much time to effect change.
Regulators and activists should avoid constraining CEOs to the point that the job becomes impossible or unattractive. One area of change should be demand for quarterly guidance. It is difficult, if not impossible, for CEOs to manage revenue and earnings growth from quarter to quarter. CEOs should provide annual guidance only. It is more realistic and still provides accountability.
If all boards dealt wisely with CEO pay, criticism would diminish. Compensation committees need to determine shareholder-friendly pay based on performance, while balancing risk and reward. If CEOs don’t deliver, their compensation should reflect that. It is a board’s job to provide goals and incentives for CEOs and their teams and then hold them accountable. Any other approach will keep CEOs and boards in the headlines with criticism that has been earned.
Thomas J. Neff is chairman of Spencer Stuart U.S., a global executive recruiting firm.