Pay For Performance
March 1 1989 by Robert W. Lear
It’s getting to be that time of year again. The first blossoming of proxy statements is already out, revealing new levels of executive compensation. Before long, the business magazines will let fly with their Big Bucks listings, and all of the newspapers will gleefully interpret and misinterpret the 1988 earnings of their leading corporate citizens.
The dominant theme of most, if not all, of these reports will be an expression of shock at the altitude of the highest earners and particularly for those whose company stock prices are lagging behind expectations. Indeed, Fortune has already jumped the gun with its November 7, 1988, indictment, “American Bosses Are Overpaid…”
Critics like to talk of executive compensation by using a neat little phrase, “Pay for Performance.” When your company, your division, or your profit center makes a lot of money, you in turn, should get some money for making it happen. When you’ve had a bad year and didn’t live up to your promises, no bonus should be paid. It sounds logical. Or is it?
One of the problems with proxy statements is that, while being much more revealing than in prior years, they still leave much to be desired. Cash compensation will be shown for 1988 only; but a bonus paid in that year is based against 1987 results. Gains coming from options exercised in 1988 may have come from grants made as far back as 1978.
Some pundits suggest that proxies should be expanded to show salary, bonus, long-term incentives and option gains for each of the last three years, thus evening out the distortions. This might make it better for the statisticians, but it still doesn’t answer the question of performance correlation. A definition of good or poor performance can vary enormously between industries, companies, CEOs, years and circumstances. A straight match-up between CEO compensation and earnings per share is much too simplistic, even when shown over a three year period.
David Meredith, chairman and CEO, Personnel Corporation of America, is a professional observer of the executive compensation scene and comes as close as anyone I know to making a valid “pay for performance” analysis. For two years running, he has recalculated, for Chief Executive, the pay of some 225 CEOs in 14 major industry groups in a complicated, but most interesting way.
In addition to all cash compensation, Meredith calculates the value added to (or lost from) the CEO’s outstanding stock options during the year. He measures company performance on the basis of stock price improvement and dividends paid. He then compares both the CEO and the company with industry peers to derive competitive pay and performance factors. His resulting scatter-diagram charts are most provocative. I applaud his effort, for it does focus attention on those companies that are compensating their CEOs in significant variance to shareholder results.
Despite the help that comes from comparative analyses such as Meredith’s, compensation committee chairmen and CEOs are a long way from figuring out the best way to handle their incentive needs for the future. Just about every company I know thinks that they have a unique set of problems and opportunities to cope with in the years ahead. Their perception is that, to make their company better, they need to spend time and money to clean up past messes and invest in future hopes. Many of the things that appear appropriate to do, may well depress earnings-for a while. In time (unless the raiders come), the ultimate earnings achieved from these moves (if done correctly) will produce higher stock prices and thus options will pay off. Meanwhile, however, it is difficult to justify the type of salary and bonus plan that is needed to attract and hold talent required to make it all happen.
Last fall, I sat in on a working seminar run by Sibson and Company-another leading executive compensation consultant. None of us who were there felt fully comfortable in judging the performance of a CEO with purely quantitative measures. Many of the most important things a CEO does-management succession and strategic planning, for example take time away from direct operational activities that enhance quantitative showings.
As panelist observers, most of us would like to include a high qualitative content in the CEO’s performance measurement. We would prefer to have less of the CEO’s incentive compensation come from an annual bonus and more from long-term performance.
A number of companies seem to feel that the use of restricted stock grants can be a partial answer. Instead of making standard grants which then vest over a number of years, it is possible to have portions of the stock vest in accordance with the accomplishment of specific targets.
These targets may be qualitative and could range from items such as improving market share to increasing export volume. They could be based on dates to complete tasks such as a spin-off, a reorganization or management appointment. They could be several in number and weighted for priority and importance. For a variation on theme, instead of restricted shares, phantom stock could be issued and the award based strictly upon the price improvement achieved.
Programs like these are exceptionally difficult to administer fairly; it needs both a strong compensation committee and a confident, competent CEO to make them work. But the importance of the task is worth the time it takes. This is now a high profile area with heavy impact on the overall image of American business executives. It’s time to start doing it right.
Robert W. Lear is former CEO of F.&M. Schaefer (19721977). He currently teaches at Columbia Business School where he is an Executive-in-Residence, in addition to his role as an independent general partner of Equitable Capital Partners.