Why the Executive Compensation Debate is Fundamentally Flawed

I sat through a very interesting presentation on the problems with executive pay and the associated comp plans being used in today’s corporations.  As I listened to the presenters very eloquent arguments, it dawned on me we are having the wrong conversation.  The whole underlying hypothesis that frames the conversation is flawed.

His opening remark was that executive pay plans should be designed to align the interests of the CEO and other executives with those of the shareholders.  A premise that underlies all conversations on executive pay and one I certainly have agreed with, that is up till now.

I don’t know what made me all of sudden see the fallacy in that premise, but as the presenter said those words I realized that is the problem.

Here is how the reasoning goes.  We are interested in aligning the interests of the CEO with that of the Shareholders.  We believe that the best way to do that is to incentivize the CEO through his pay package.  This assumes another belief that the CEOs behavior is driven by his self serving interest in maximizing his pay.  Therefore with the properly designed pay plan and the CEO innate desire to maximize his pay, he will behave in ways that create long term shareholder value.

Here is the fallacy.  A CEO maximizing his pay can perform in a myriad of ways that are not in the shareholders value creating interests.  In fact the whole focus on pay as the key objective for a CEO to attain sends the very opposite message that we as board members want the CEO to have.

Let me explain a little further.  When I was an executive hiring managers and other employees I sought out people who would communicate a real interest, even a passion, for the job I needed to have performed.  It is an age old belief that if anyone came seeking a position based on how much they can earn, they were not the type of person we would hire.

Why, because we knew that salary followed performance and performance was driven as much by their interest and passion for the job as well as their skills and abilities.  And anyone who was in it just for the money was not in it for the long term and would leave as soon as a better offer came along.

Yet in the current discussion on CEO pay we take as a given that CEOs are in it for the money and we have to pay them to get them and keep them.  Yet these very same people would not take this position with their own organizations.  Or if they do is this the kind of culture or tone at the top you want for your company.

Let’s bring the conversation on executive pay back on track.  How do we recruit and retain CEOs who have a true passion for the Soulful Purpose of the organization they are being asked to lead.  How do we as board members ensure they are behaving in the best interest of the corporation and the realization of its fullest potential The Living Organization™ that is.  And then after all that is done, how can we ensure they are receiving the proper remuneration for their efforts.

For more discussion on this topic visit my other blog, www.quantumleadersblog.com

 

Norman Wolfe | President/CEO | Quantum Leaders, Inc

nwolfe@quantumleaders.com

www.quantumleadersblog.com

http://twitter.com/normanwolfe

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10 Comments

  • davinder singh

    Norman,I agree with your views. There is quite a disconnect in most of management terms between position of CEO and other senior management.I will not blame CEO for all the wrong doing as that person sticks out their neck in case of failure.
    There is a pressure from stakeholder for returns and that at times decided their survival.Incentive system need to be reworked and the market failure at present might be a stepping stone in that direction.

  • Norman Wolfe

    I want to thank all of you who have commened onmy blog. IT is my hope that we can continue this dialogue to see if a "true" solution can be found for the question of CEO or for that matter any execcutive) pay.

    I am going to continue posting a series of blogs to help frame the conversation some more. Please visit the other blogs and keep posting.

    Thank you and together perhaps we can bring some effective guidance to this critical issue

  • Jonathan Fry

    These are all great comments. I hope we are able to continue this discussion as we slowly start to exit the current financial crisis. It's far too easy to be outraged at outlandish executive pay when the chips are down and the company is imploding. I find it hard, if not impossible, to justify such pay packages even when a company is performing well. What sort of messages does it send to employees, when the executive team makes hundreds of times more than the average salaried worker? At the end of the day, the company needs each and every one of those averaged salaried workers performing their jobs at an optimal level, for the company to succeed. I hope that companies and current business leaders are cognizant of this issue and the damaging effects it can have on their organizations in the long-run. I hope to see a new breed of business leaders emerge from our current crisis that has the courage and the conviction to say "enough is enough.” Better yet, if fortunate enough to have the opportunity to serve in an executive capacity, I hope I have the courage and conviction to follow through with my own advice.

  • Lee Mitchem

    Would you want to invest millions of dollars on a future employee only to have them walk away four years later with several millions with nothing to show for it, or worse, with a devalued company on your hands? Golden parachutes, if poorly structure, may permit just such behavior by CEOs and other top tier executives. While the board may want the flexibility to hire and fire at their pleasure, this “flexibility” may result in a severe curtailment of the executive’s responsibility in financial stewardship for the company. Wolfe’s comments on the importance of hiring executives for the right reasons are sound. Why incorporate a “get out of jail free” card into the benefit structure that could be self-defeating for the company? Why hire someone who knowingly can do a poor job and still get paid? For all of the risk taking that executives are rewarded for via the variable component of their compensation, it is surprising that they require such insurance on the back end, unless they are taking risks beyond reason. Golden parachutes and exit packages could well be at the root of the financial crisis that we are all facing today. Executives were well compensated via the variable component of their pay, driving the risky behavior, knowing that when the party was over, as long as they didn’t mess up too badly, there was a pot of gold at the end of the rainbow and someone else could deal with the floods of storm. Golden parachutes could be removing the very risk management breaking mechanism that the executive compensation vehicles need.

  • John Rudzis

    Thank you for an enlightening discussion in your article, as well as to those in the subsequent postings. It is often amusing to hear or read of executives’ justifications for their obscenely high pay packages. Add to your example of aligning executive to shareholder interests, that shallow and over-used excuse, “to attract and retain the best and the brightest”.
    No doubt effective leaders should be fairly compensated for the value they bring to their organization, community and the marketplace. Unfortunately, many pay packages include provisions which have little to do with value of service. Examples include those excessive golden parachutes, to be awarded regardless of performance. I suppose these are to entice, said “best and brightest”, to go away when things don’t turn out so well. Where is the value there?
    In the big picture, as a fraction of our 14 trillion GDP, the total executive compensation is a pimple. However, as the government becomes more directly involved in shoring up our economy, it is more important than ever to scrutinize the accountability of business leaders and the value they bring to the marketplace. Industries must police their executive payouts or surely the government will step in with blunt instruments do the job.

  • Anatoliy Neymark

    Thank you for the thoughtful and interesting article, Norman. The only issue that I respectfully disagree with is the timeframe used to evaluate executives' intentions and compensation. I think that quite a number of us, humans, are prone to selfish actions given the right circumstances. CEO might apply for and take a job sincerely having the shareholders' interests in mind. However, once in the position to implement far-reaching strategies, that same CEO might make self-serving decisions at shareholders' expense.
    The analogy could be drawn to Utopian Communistic idea founded on overestimation of human virtue: "from each according to his ability, to each according to his needs." As Soviet Bloc's experiences showed, the latter, unfortunately, does not hold with majority of population and greed takes over conscientiousness once that very same proponent of "freedom, equality, and brotherhood" assumes position of power.
    Thus, I am convinced that strong legal control over executive compensation is as important as security cameras in large stores. Constant monitoring does not imply that everyone steals, but identifies the few actual thieves and nips in the bud bad temptations in so many of us.

  • Jonathan Fry

    Great article Norman. With the news outlets constantly keeping us informed of the meltdown on Wall Street, the topic of executive compensation has once again taken center stage. I recently took part in a brief presentation looking into executive compensation. At the end of our presentation we posed the question, "Should executive pay be capped?" The questions spawned a heated debate amongst the 30 MBA students in the class with no clear answer satisfying all sides.

    So many on “Main Street” think the government should impose a cap on executive compensation. They point to the executives of recently failed companies pulling down hundreds of millions of dollars this past year. Unbeknownst to many on “Main Street” prior to the meltdown is, that most executive compensation packages contain a number of secured payouts, regardless of company performance. From accelerated pension accruals to golden parachutes most executives walk away from a failing company and still make a killing.

    My advice to companies who survive the recent turndown is not only hire someone who is passionate for your business, but hire someone who also understands the moral and ethical ramifications of making X times what the average worker makes. Of the 7 deadly sins, it is very likely that greed played a biggest role in bringing us to our current situation.

  • Ronald Ronny

    I propose the leader or leaders of a firm BID FOR THAT POSITION. In Formula One and other types of racing, the well-heeled people who dream of being in the 'drivers seat' pay for the privilege.
    That eliminates all those seeking enrichment. Let's face it, the best leaders are usually heard of taking $1 a year in salary.

  • Sampath Srivatsan

    I do agree with Norman that executive pay compensation of CEO needs to be based on his/her performance. Executive pay compensations are decided by the board of directors of the company. They need to be morally responsible of employing the right leader for the company based on the past performance records. Most of the times the CEO presides as chairman of the corporation too. It is difficult to evaluate the performance of CEO when he holds dual positions. It takes the money reaching the shareholders if the executives are paid excessive compensation. I think the board of directors should hold full time positions to understand the operation of the business and monitor the performance of CEO’s. How can they do justice to the job if they are in the board of several corporations at the same time? I also strongly feel the CEO should not have any influence in picking the board members.

  • Alice Korngold

    Norman, I entirely agree with you. What's worse is that some nonprofit boards are considering adopting such "incentive" systems for the CEOs of nonprofits. Although there are good practices that nonprofits can learn from for-profits, bonus systems are often counter-productive. The best CEOs are driven to achieve when they have a passion for the mission and have a solid working relationship with the board (a responsibility on both parts to accomplish success in this collaboration). And yes, CEOs in both for-profits and nonprofits should be compensated suitably; but incentive systems can be treacherous, potentially encouraging short-term wins - and even perverting business practices - to the detriment of longer-term or more meaningful success for the organization - and hence the shareholders (or community, in the case of a nonprofit). We have seen this happen in many companies. Alice