Stop Incenting Executives to Act Badly!

We are all aware of the uproar caused by the $175 million in bonus payments made to AIG executives. It has been the straw that has broken the public’s back unleashing frustration and anger. Journalists and pundits have detailed the absolute travesty of the individuals receiving them who are no longer with the company and who were also at the heart of foisting credit default swaps into the marketplace. And with the almost-unanimous wrath of Congress bearing down on the bonus recipients, with the 90% taxation clawback measure passed by the House of Representatives, executive compensation has once again moved into the spotlight and illuminated two very different perspectives.

Driven by obscene greed, regardless of the long-term impact on their companies or the economy, executive comp has been vilified as one of the more blatant symptoms that something is terribly wrong. This perspective has led to the comp limits recently written into law as part of the Stimulus bill, the tax clawbacks passed by the House, and without a doubt will result in additional compensation changes demanded by the Senate. However, there is another dialogue to acknowledge: the potential deleterious effect these policies could have on the ability of any company receiving TARP funds, to retain and hire the real leadership necessary to help us out of this mess. Somehow these two perspectives that are at odds with each other need to be rectified!

On March 24th, Secretary of the Treasury Tim Geithner said, "This issue of excessive compensation extends beyond AIG, and requires reform of the system of incentives and compensation throughout the financial sector." Well, I’m all for reforming compensation on Wall Street, and wherever else it makes sense, but as we move down this path we need to look at this from a holistic perspective to make certain we get it right.

These comp plans were not created in a vacuum, folks. They have the stamp of approval of boards of directors, and were constructed under the watchful eyes of the top compensation consulting firms in the country. With all of this high-powered intellect and experience, what went wrong? The problem is that most plans do not meaningfully account for "how" the results are achieved. So there is no connection to people’s behavior.

While compensation is one of the strongest drivers of behavior, most companies fail to take advantage of this truth and acknowledge the profound relationship between compensation, behavior, culture and values. This means that if you have a clear set of values that are defined behaviorally, and compensation is tied equally to the results and "how" the results are achieved, people will most certainly be compelled to behave in a manner that creates the desired culture while reaching the stated goals.

Here is AIG’s value set as an example:

People Develop diverse talent. Reward excellence.
Customer Focus Anticipate their priorities. Exceed their expectations.
Performance Be accountable. Manage risks. Deliver AIG’s strength
Integrity Work honestly. Enhance AIG’s reputation.
Respect Value all colleagues. Collaborate with one another.
Entrepreneurship Seize opportunities. Innovate for and with customers

Source: AIG’s Code of Conduct

Looking at this in the context of the recent bonus payout is laughable at best. Most certainly these values have not been clearly defined behaviorally within AIG, and to whatever degree they were, they were not significantly tied to compensation. If values-representative behavior had been significantly tied to compensation, the most egregious of the bonus payments would not have even been on the table, nor would they have occurred.

Bottom line, until Wall Street and other companies begin to define values-representative behavior which is tied to the achievement of results, and significant compensation is at stake, we will be doomed to repeat the same mistakes.

Wake up people, the secret is in tying values representative behavior to compensation!

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