Pay for Performance

More and more companies are seeking to bridge the gap between executive pay and company performance

Nov 13, 2003  

by Michael O'Toole

with additional research by Kim Tannas

Executive Compensation has changed dramatically over the past two decades for both public and private companies. Now, with compensation and performance results being severely scrutinized by the public, by employees and by regulators, corporations are seeking a balance between appropriate rewards and the desired retention of their key employees.

The issue came to a head with the spectacular announcement in August 2003 of former New York Stock Exchange chairman Dick Grasso’s $140-million benefits payout. Many consider Grasso to be the last gasp of the extravagant era that has so outraged shareholders. In general, pay packages have been moderated for executives in the past two years, reflecting both the softened economy and a more temperate corporate attitude. South of the border, the New York Times has calculated that average CEO pay rose by about 6% in 2002, approximately 3% more than inflation. Mid-range CEO salary plus bonus clocked in at an average of $1.8 million US, according to a survey of 350 public companies conducted by Mercer Human Resources Consulting.

In the end, changing compensation trends – and the instances of corporate fraud that have come about as a result – have cast executives, and particularly CEOs, in a rather negative light. But the issue is not as simple as CEOs being overpaid. Gary Frey, a consultant in the Banff area who advises on topics such as finance, control and board governance, insists that high-achieving senior managers should be well-compensated, and in some cases significantly so. “Notwithstanding conventional wisdom, successful leaders are a rare breed, in any field,” he says. “But you should only reward the ones who are truly successful, not the ones managing things only in their own interests and really not in the shareholders’ interests.” He points out that some of the compensation and incentive plans that have been developed over the years no longer bear much relation to actual performance in terms of shareholder value. “I don’t believe that the only objective of a corporation is to increase shareholder value, but it’s certainly one of the primary responsibilities of senior management. In the absence of that, it’s very hard to understand why some of these compensation packages are still being applied – in some cases where the companies have suffered tremendous losses,” he says.

It’s a theme enthusiastically taken up by compensation consultant Nadine Winter, president of the Winter Consulting Group, who galvanized more than a few minds with her forthright presentation “Moving Beyond the Outrage” at the 2003 WorldatWork conference in San Diego.

“I don’t think the issue is the level of pay for CEOs,” she says, “but rather the gap between pay and performance.”

It’s a common struggle for many companies today: how do you reconcile the disconnect between pay and performance and achieve a level of compensation that adequately motivates and rewards executives? In its simplest manifestation, compensation can take three forms: as a base salary, as a bonus payment based on some measure of performance or as stock options in which value depends on the current price of the firm’s stock.

“Stock options and other forms of equity-based compensation have been associated with recent corporate scandals where executives hid losses in order to cash in their shares before the declining fortunes of their company became public. Because of this association, some companies are throwing the proverbial ‘baby out with the bathwater’ by focusing on cash compensation. I believe this is a serious error,” says Winter.

Equity-based compensation, she argues, is key to tying together the long-term interests of executives and shareholders. But only if it is treated as a long-term reward for long-term, sustained company performance – not if they can be cashed in quickly simply because they are in-the-money (i.e., are trading at a level higher than their original price).

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