Pay for Performance
More and more companies are seeking to bridge the gap between executive pay and company performance
by Michael O'Toole
Her recommendations include requiring executives to hold stock options for a minimum of three years and not allowing executives to cash in any more than 20% of one’s options at any given point in time. In addition, an executive should not be able to exercise options in a year when company performance is poor.
“It is critical that the granting, vesting and exercising of options be tied to company performance on a wide range of measures; for example ROE (return on equity), RONA (return on net assets), profit, market share and so on, and not just share value.” Executives should also be required to hold on to the majority of their shares until they leave the company or their position as an executive of the company, Winter adds.
Some progress is being made in this direction as a growing number of organizations in Canada and the U.S. are taking small steps to more directly link executive pay to performance and, more specifically, to long-term performance.
For example, at the Bank of Montreal, performance hurdles must be met before executive stock options can be exercised. At Nortel Networks, options vest more quickly if the company meets its operating targets. Executives at RBC Royal Bank are required to hold shares that they have obtained from exercising options for at least one year.
Indeed, a recent survey of Canadian companies by Watson Wyatt Worldwide reveals that there is an overall trend in which companies are increasingly using both short- and long-term incentive plans to effectively link pay with performance. “Such plans not only tie pay to results, but ensure that key talent is retained for the long run and help motivate senior-level employees to accomplish business goals to the benefit of all parties, including shareholders,” says Graham Dodd, a national director for Watson Wyatt.
Nadine Winter sees significance, too in a recent Booz Allen Hamilton study, which indicates that involuntary, performance-related executive termination has become the new norm as corporate boards, acting on behalf of angry shareholders, enforce a “deliver or depart” philosophy.
“If we want executives to take a long-term view in managing the business, then investment experts, shareholders, and company boards need to stop focusing on quarterly results and look at long-term business results. In the context of the ‘deliver or depart’ approach to executive retention, executives are not being given the time necessary to build a sound foundation for future performance based on business fundamentals.”
But what happens when times are tough and company performance is poor? How do you apply a pay-for-performance model at a time when an executive’s expertise is needed more than ever?
Stanford Business School accounting professor Richard Lambert, who has done extensive research on executive compensation, questions the concept of connecting executive pay to shareholder wealth. What happens when the company’s stock market value falls by $300 million? No executive could absorb that kind of loss, he says.
He argues that because true pay-for-performance is so hard to execute, it has only served to make a lot of CEOs richer. “People have simply taken existing compensation packages and added in some more stock and stock options,” says Lambert. “That makes the executive’s pay more sensitive to shareholder performance, but never results in any penalties. Stock and stock options can only add to an executive’s wealth.”
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