The question over how best to link CEO compensation to company performance defies an easy answer. But in the current financial crisis, the atmospherics of CEOs raking it in even as their companies go south virtually ensures that there will be changes soon in how companies reward and incentivize their top executives.
U.S. President Barack Obama has articulated the popular discontent over big payouts in the financial sector. He criticized Wall Street just yesterday for handing out a reported $18 billion in bonuses during a horrendous 2008. And during the campaign he criticized how companies reward their top execs. “This isn’t just about expressing outrage,” he said, “it’s about changing a system where bad behavior is rewarded, so that we can hold CEOs accountable.”
At the ongoing World Economic Forum in Davos, Switzerland, where business and political leaders gather each year to discuss global issues, CEO pay has been raised frequently as an issue that needs to be dealt with soon.
An open session, “How to Answer the Compensation Question,” was tasked with reporting back to the Forum with proposals on how to address the challenge. After a spirited discussion (the ground rules prohibit my reporting the names and company affiliations of the attendees), several ideas emerged that may be included in the report:
– Act now. The current crisis almost requires companies to review their compensation structure. Now is the time to ensure that the approach is in line with company and stakeholder values.
– Stay ahead of the regulators. The private sector should voluntarily try to come up with a set of broad, principle-based guidelines on what appropriate compensation practices and ratios should be. If the private sector doesn’t do so, government regulators may well step in and do it for them.
– Watch the consultants. When outside consultants are brought in to advise on compensation, it inevitably feeds into an upward pay spiral. One approach would require that anyone who advises the board on compensation must be fully independent–that is, in no way beholden to the CEO (say for contracts to do other work for the company).
– Be transparent. Publish the earnings not just of the top few execs at the company but of, say, the top 20. And along with that publish the list of bottom 20 (with names omitted, of course). Media reports on the discrepancy might lead to self regulation to narrow the gap.
– Reputation matters. In determining compensation, boards should find ways to look at a wide range of behaviors, and not just stock price. One idea is to link pay somehow to the reputation of the company, to help eliminate “bad behavior” by CEOs.
– Create leaders. Companies should remind CEOs that leadership is not simply a matter of having some subordinates and making a lot of money. It’s about giving employees a sense that they’re part of something important. Compensation could be linked in part somehow to an evaluation of whether that goal is met.
– Steal that model. Many private equity firms compensate their CEOs with a combination of short-term and long-term incentives. Part of any annual bonus payout goes into a pot. After several years, if the company has met its performance goals, the money is paid out. If not it is ”clawed back ”to the company. This could be adopted more broadly for CEOs of publicly traded companies, to get beyond the short-term perspective that now tends to dominate.
– Change the board. It may be time to overhaul how boards are elected. A preponderance of outside directors, for example, may add up to a group that’s afraid to challenge the CEO on such tough issues.
