Category Archives: executive compensation

Paying CEOs to Fail

Scott MacDonald thinks the contract language and hiring processes for chief executive officers need to change. As he sees it, some CEOs are great leaders who deserve their seemingly extravagant salaries, but others are highly paid despite their poor performance. And even when they’re fired, they don’t lose out because they’re given a golden parachute — millions of dollars for failing, he says.

In some back-and-forth with me recently about this, MacDonald — former CEO at the Australian company Investa, who wrote a book about his experience there, Saving Investa: How An Ex-Factory Worker Helped Save One of Australia’s Iconic Companies (here’s his website’s information about the book and here’s the Amazon link) — said this to me:

“Every year, we read stories of corporate boards of directors firing a senior executive for unsatisfactory performance and then paying the executive millions of dollars upon his or her departure.

“Several years ago, for example, the Walt Disney Co. hired Michael Ovitz [as president] and then terminated him 14 months later. Ovitz reportedly received a severance package of $140 million. Recently, Wells Fargo admitted that thousands of their employees opened new accounts in customers’ names without consent to generate bigger fees and commissions. The scandal has damaged the bank and led to many investigations and potential fines. The person in charge of the retail division where the scandal occurred announced her retirement and reportedly received about $125 million upon her departure.”

MacDonald says the real problem stems from the narrow definition of “cause” in current CEO’s employment contracts; specifically, the clause that says the executive may be fired “for cause,” in which case nothing more is owed to him or her.

But the definition of cause is still limited to being found guilty of felony acts, committing fraud or stealing from the company. It almost never includes poor performance.

MacDonald’s had a successful career as a CEO turning around struggling companies, often by addressing performance issues. Through his years of experience, he says,

” … the benefits gained from changing personnel have always outweighed the short-term financial cost … . Once, I fired a talented chief financial officer because he was not a team player, typically promoting himself while disparaging other team members. The cost of his termination was significant because being a bad team member was not defined in his “for cause” contract definition, but the entire company performed much better after his departure.”

So how did “cause” become so narrowly defined and almost unenforceable? It’s unclear, MacDonald says, but he has a theory, based on the past 40 years of business as usual, and it even includes human resources. Here’s how he lays it out:

“Generally, a board retains an employment consultant to help negotiate the contract or provide an opinion that the contract is fair and competitive in the industry. The same consultant will often seek to see human resource-related consulting services to CEOs in the future. If a consultant recommends approval of a CEO’s favorable employment contract, the consultant is more likely to be favorably considered when that CEO approves hiring an HR consultant.

“After one board agrees to a narrow definition of ’cause,’ it quickly becomes cited by other executives and their attorneys as the standard. … When an executive is terminated for poor performance but not ‘for cause’ … he or she is typically entitled to all the compensation and benefits that he or she would have received if he or she had not been terminated. This usually includes salary not yet paid, bonuses not yet earned, stock options not yet vested and various other entitlements. If a terminated executive has three years left on a contract, the company often has to pay three years of full compensation as if the executive had been a stellar executive.”

So what can we do to turn this around? Simple. According to MacDonald, just broaden the definition of “cause.” Successive years underperforming [against] a pier group of companies should be cause for termination. And if a dispute occurs over the performance measures, submit it to an arbitration panel for resolution.

Other items we might consider cause for dismissal could include successive poor results on confidential employee surveys, failure to meet budget targets in successive years, failure to follow written directives from the board … his list goes on.

Companies that provide audit services to another company are generally not permitted to provide other consulting services to avoid influencing the impartiality of the audit. Similarly, says MacDonald, “companies that provide employment-contract services could be forbidden from providing other consulting services to the company involved.”

Finally, he says, when an employee is terminated without cause, he or she should not be paid full bonuses for all the remaining years of their contract. “Clearly,” he says, “the bonuses would not be earned.”

Commander-in-Chief or CEO?

From Truman to Trump, a handful of U.S. presidents have made their way to the Oval Office via the business sector.

If a recent Korn Ferry Institute survey offers any clues, it might be a while before we see another commander-in-chief who’s taken that route.

In a poll of 1,432 corporate executives, an overwhelming majority of respondents showed no signs of aspiring to the highest political office in the land. Given the choice, 85 percent of executives said they would rather be CEO of their own organization than lead the country, according to Korn Ferry.

While recognizing the similar requirements for both roles—the ability to drive growth, manage crises, think strategically and manage finances, for example—most business leaders allow that the president has even more hats to wear.

Indeed, 81 percent of the executives polled said they think the U.S. president has a more complex job than they do.

“In a way, you could consider the U.S. president [to be] the national CEO,” says Rick Lash, senior partner at Korn Ferry Hay Group, in a press release summarizing the findings. “While serving as a corporate CEO is generally considered a very challenging role, executives acknowledge the U.S. president faces hurdles that are much higher than those faced by a leader in corporate America.”

In addition to complexity, you can put compensation on the list of reasons why your CEO isn’t likely interested in leading the free world.

Seventy-one percent of executives, for example, reported feeling that the U.S. president—at $400,000 annually, as determined by Congress—is underpaid. Nearly half (48 percent) said the president should receive at least $10.4 million per year; the current average compensation for a CEO at an S&P 500 company. And exactly 0 percent cited salary/compensation as the top reason someone would want the job of U.S. president. But money, or a lack thereof, isn’t the only thing deterring executives from someday pursuing a presidential run.

The position of U.S. president “comes with extra scrutiny as well,” according to Korn Ferry.

Donald Trump, for example, “has been president for less than a week and he’s been questioned about his every action, from the serious (the words he used during his inaugural speech and his choice of cabinet members) to the silly (whether the dance with his wife, Melania, at an inaugural ball was ‘awkward’),” notes the aforementioned release.

“A corporate CEO may be questioned on his or her firm’s stock price and business strategy, but usually isn’t scrutinized for dancing ability.”

Benchmarking and Executive Comp

Executive-pay packages often don’t include a comparison of company performance and its competitors are regularly approved by boards of directors, and many have wondered why.

New research by University of Michigan professor Martin Schmalz and co-authors Miguel Anton and Mireia Gine of the IESE Business School and Florian Ederer of the Yale School of Management helps explain why—and why benchmarking happens more in some industries than in others.

They found that when companies in an industry are owned by the same shareholders, the executives tend to be rewarded relatively more for industry performance and less for their own company’s performance.

“Many people have been puzzled why shareholders approve pay packages that lead to high pay without much benchmarking,” said Schmalz, the NBD Bancorp Assistant Professor of Business Administration and an assistant professor of finance. “But it’s actually not that puzzling once you analyze these shareholders’ economic incentives.”

Schmalz, Anton, Ederer and Gine examined 20 years’ worth of data from ExecuComp, which measures the compensation of top executives of the largest 2,000 U.S. companies.

The more a company’s institutional shareholders own big stakes in rival companies, the less pay managers receive for company performance and the more pay they receive in response to rivals’ performance.

The logic is easy to understand, the author contends:

If you benchmark performance against rival companies, that gives managers an incentive to compete aggressively. If you own a number of companies in the same industry, you don’t want that to happen,” Schmalz said. “If anything, you want them to cooperate more, because you want to improve the value of your entire portfolio, not just one company. Our findings suggest managerial contracts give managers economic reasons to act in their shareholders’ interests—it’s as simple as that.

The Motherhood Tax at Work

New research out of the United Kingdom shows the gender-pay gap widens significantly after the birth of a child, otherwise known as the “motherhood tax.”

According to a new report from the Institute for Fiscal Studies, 12 years after giving birth for the first time, women are making 33 percent less per hour than men.

On average, women in work receive about 18 percent less per hour than men, down from 23 percent in 2003.

While the wider gap for mothers is not because women see an immediate cut in hourly pay after childbirth.

Possible explanations include mothers missing out on promotions or accumulating less labor market experience, the authors said.

“Comparing women who had the same hourly wage before leaving paid work, wages when they return are on average 2 percent lower for each year spent out of paid work in the interim,” the IFS wrote.

(Tip of the hat to CNN Money.)

Do CEO Stock Options Mean Trouble?

It’s the season for fretting about chief executive compensation. Annual proxy statements for most public companies are in. The numbers have been crunched. Now it’s time for the hand-wringing.

200401764-001But there are some surprises this year. The New York Times, using data compiled by Equilar, reports that average compensation for the 200 best-paid CEOs last year was $19.3 million, down 15 percent from 2014.

This follows an analysis by Equilar and the Associated Press of a larger group of CEOs that found pay was up, but at a slower rate compared to past years. The AP story noted that public companies are increasingly relying on performance-based compensation such as stock grants or options.

The theory, of course, is that CEO pay should be aligned with the interest of company shareholders. But there’s an active debate over whether stock options — a very common part of CEO compensation packages — are the best way to do that.

That’s where we find this proxy season’s most interesting news about CEO pay. In the latest issue of the Harvard Business Review, Dylan B. Minor offers evidence that stock options not only encourage CEOs to pursue bold innovation, but also to take dangerous risks.

Minor, a visiting assistant professor in Harvard’s business school,  summarizes in his article the results of a recent research paper. Minor compared two kinds of CEOs, divided by what kind of equity-based compensation they received. His conclusion: those who got stock options were more likely to get their companies in trouble than those who got straight shares.

Others have made the case that stock options create a perverse incentive. Shares reward a CEO for success, just like options. But unlike options, shares also penalize the CEO for failure. Some argue that shares therefore provide a better incentive for CEOs to pursue long-term benefits.

Minor offers some hard data to back up this argument. He compared the two groups of CEOs against two measures of risk-taking.

The first analysis looked at whether companies were linked to an environmental disaster or brokeThinkstockPhotos-466936217 environmental laws. He found that those with CEOs getting options were 65 percent more likely to get in trouble than companies with CEOs receiving shares.

Minor then looked at whether companies ran into financial irregularities. He found that those with CEOs receiving options were 50 percent more likely to be investigated by the SEC for an earnings restatement than were companies with CEOs receiving shares.

“In sum, higher powered incentives can increase both good and bad risk-taking,” Minor writes. It’s a good lesson for companies of all sizes: In providing incentives to top executives, think carefully about the behavior you’re encouraging.

Employers Worry About Pay-Ratio Perceptions

Results of a recent poll by New York-based Towers Watson show it’s not the mechanics of complying with the new CEO pay-ratio-101366398 -- money on scaledisclosure rule — such as data gathering, getting the right sampling, identifying the median employee and the like — that worries employers the most.

It’s how they’re going to explain the pay-setting process to their employees and how their pay ratio will look compared to other companies’ ratios. This according to the almost 600 corporate compensation professionals who weighed in on the Towers Watson Webcast Poll on CEO Pay Ratio Disclosure Rule.

The communication issues loom especially large. Half the respondents cite that issue among their top concerns. Also, how employees will react when they start comparing their compensation to their CEO’s and to the median employees’ is keeping many a top business leader up at night.

For a refresher, this New York Times piece offers some pretty complete details, history and analysis of the 3-to-2 vote on Aug. 5 by the Securities and Exchange Commission that will require most public companies, starting in 2017, to regularly reveal the ratio of their chief executive’s pay to that of employees.

Some of the controversy is also spelled out in the piece:

“Representatives of corporations were quick to assail the new rule … saying that it was misleading, costly to put into practice and intended to shame companies into paying executives less.

“But the ratio, cropping up every year in audited financial statements, could stoke and perhaps even inform a debate over income inequality that has intensified in recent years as the wages of top earners have grown far more quickly than anyone else’s.”

What’s disconcerting at this point isn’t just how this ratio will be perceived, but how few employers really know what they need to do to comply. In the poll mentioned above, only 17 percent of employers agree they understand all of the costs, effort and data that will be needed while almost two-thirds (65 percent) disagree.

In an earlier Towers Watson survey of 170 U.S. compensation professionals, Towers Watson Talent Management and Rewards Pulse Survey, only 48 percent agree that their companies had identified the data they’ll need and know how they will capture it to calculate the pay ratio, while even fewer (41 percent) say they’re prepared for how the disclosure will affect employee perceptions of their pay.

And if you think time is on your side and you’ll get it right with many months to spare, think again, says Steve Seelig, senior regulatory adviser for executive compensation at Towers Watson.

It’s “not too early for HR to begin thinking about how well its company communicates with employees, and to then set a strategy for improving its message,” he says, adding to:

“Keep in mind that, when the disclosure comes out, workers below the median will [immediately start to] wonder what it takes to get them to that level, and why their company is not paying them more. Those employees at or above the median will naturally wonder whether their pay levels are determined fairly, or how the level of CEO pay might be hindering their pay increases. Workers also will be looking at companies across the street and pondering if their median pay is higher, and whether it might be a good idea to look around.

“Human resource executives should [be proactive and] view the pay ratio disclosure as a chance to make sure their employees understand [their company’s] pay-value proposition. Companies that get this communication effort right will find they actually have strengthened their relationship with the workforce, with better productivity and reduced turnover as likely outcomes.”

Those that don’t get it right shouldn’t be surprised when the opposite occurs.

A Closer Look at Executive Compensation

moneyThe U.S. Securities and Exchange Commission wants the link between executive pay and a company’s financial performance to be clearer.

The SEC hopes it took a step in that direction this week, when it proposed rules that would implement a requirement mandated by the Dodd-Frank Act, obliging companies to disclose that relationship.

According to an SEC statement announcing the proposal, the rules “would provide greater transparency and allow shareholders to be better informed when they vote to elect directors and in connection with advisory votes on executive compensation.”

Firms would be obligated to disclose executive pay and performance information in a table, for themselves as well as a “peer group” of companies, and tag the information in an interactive data format. The table would include data such as:

  • Executive compensation actually paid for the principal executive officer, which would be the total compensation as disclosed in the summary compensation table already required in the proxy statement, with adjustments to the amounts included for pensions and equity awards.
  • The total executive compensation reported in the summary compensation table for the principle executive officer and an average of the reported amounts for the remaining named executive officers.
  • The company’s total shareholder return on an annual basis.

On the heels of the SEC announcement, National Public Radio’s Jim Zarroli summed up the proposal more succinctly.

“The rule grew out of the 2010 Dodd-Frank financial overhaul bill,” said Zarroli, a business reporter with NPR. “And it simply says that companies have to disclose whether executive pay is in line with their financial performance.”

This information “is already available for people who want to pore through financial reports,” he added. “The new law would simply require companies to put it in a form that’s easier for shareholders to digest.”

Zarroli called the rule “the latest attempt by regulators to address soaring corporate pay,” but also noted some compensation consultants’ skepticism toward the proposal, and said it’s unclear what if any bearing the law would have if approved.

SEC Chairwoman Mary Jo White, meanwhile, seems optimistic about the rule’s potential impact.

“These proposed rules would better inform shareholders,” said White, in the aforementioned statement, “and give them a new metric for assessing a company’s executive compensation relative to its financial performance.”

CEOs Pay the Price for Scandal

CEO payWhether it’s a companywide pattern of unseemly actions or one rogue employee’s dirty deeds, corporate misconduct happens.

And, when it does, the chief executive has to answer for it.

Theoretically, anyway. But how do you hold CEOs accountable for ethical breaches—and deter future lapses—that occur on their watch?

One way is to hit them in the wallet, in the form of reduced salaries or forfeited bonuses, for example.

Earlier this week, the Wall Street Journal suggested that more boards are taking that route, in a piece highlighting a few prominent examples of CEOs who have recently seen their compensation cut in the wake of scandal (subscription required).

For instance:

  • The board of directors at GlaxoSmithKline cited the settlement of bribery charges in China (and the company’s sinking profits) when it slashed CEO Andrew Witty’s pay nearly in half.
  • Rolls-Royce Holdings chief executive John Rishton saw his salary cut last year amidst a series of bribery and corruption scandals that continue to plague the company.
  • Faced with sliding profits and a spate of compliance issues, soon-to-be former Standard Chartered CEO Peter Sands recently announced he would forego a bonus reportedly in the neighborhood of $6 million.

Richard Leblanc, an associate professor of governance, law and ethics at York University, told the Journal that affecting executives’ pay incentives is “the best way to control management” in terms of preventing bad behavior and unsavory business practices.

In the same piece, Leblanc says boards are taking an increasingly unforgiving stance on such transgressions, withholding CEO pay and vesting of equity as part of a broader trend of “risk-adjusted” compensation.

In some cases, chief executives may be forced to fall on their swords even if untoward behavior took place before he or she took over the top spot.

In fact, CEOs should be prepared to do just that, according to Alan Johnson, managing director of compensation consulting firm Johnson Associates.

“It may not be your fault,” Johnson told the Journal. But “the lesson for executives is to expect it.”

Johnson urges CEOs to “get out ahead of the board” and actually volunteer to have their pay cut or to waive a bonus in such a situation.

“It’s probably going to happen anyway,” he said, “so why go through the pain of [the board] having to agonize over it?”

GM Takes Care of its Hourlies

blue collarGeneral Motors is still digging out from the onslaught of legal bills, settlements and recall costs of its faulty ignition-switch debacle that’s been directly linked to at least 51 deaths so far. Costs for the nation’s largest automaker stand at nearly $3 billion and counting.

That has not, however, stopped GM from awarding its unionized hourly workers record bonuses of up to $9,000 apiece based on the company’s performance last year. Excluding settlements and other costs linked to the recalls, GM’s North American division would have seen a whopping $9 billion in pretax earnings last year, reports the New York Times. Recall costs whittled that down to $6.6 billion. GM’s strong financial position was partly enabled, of course, by its $49 billion bailout by the federal government.

“I thought the recalls were going to kill us,” GM worker George McGregor, president of the United Automobile Workers local at GM’s Detroit-Hamtramck plant, told the Times. “We had the big check coming. We shouldn’t have to pay for their defects.”

GM’s unionized hourly workers are to be given annual bonuses based on the company’s financial performance, as per its current contract with the UAW. A spokesman told the Times that CEO Mary T. Barra decided that the workers had done their part to help the company meet its performance goals and should not be penalized because of the failures and mistakes made by others in leadership positions.

GM may also have had its eye on upcoming contract negotiations with the UAW this summer. “General Motors’ announcement today leaves no doubt about the strong, stable environment the G.M.-UAW collective-bargaining agreement created,” UAW President Dennis Williams said in a statement yesterday.

And what about GM’s salaried, white-collar workers? They, too, will get bonuses that will be unaffected by the automaker’s recall costs, two sources told Bloomberg News. Those bonuses are based on a blend of regional and global results, they said.

Barra and her top team will, however, see the recall costs eat into their own compensation, the sources said.

“The optics of not reflecting the recall costs into executive bonuses would be really bad,” Maryann Keller, an independent consultant, told Bloomberg. “In this case, the recall was precipitated by past management, but that’s just the way it is.”

Top Five Top Executive Career Mistakes

We all receive hordes of lists at the end of one year and the start of the next. Top 10 this of 2014. Top 5 that. So on first take, I was 185784831 -- executive interviewprone to ignore a release from JMJ Phillip Executive Search on the top five career mistakes executives made in 2014 when pursuing a career move.

Mind you, these “mistakes” aren’t even confined to HR executives. All the more reason to disregard.

But on second read, I decided to share it because every executive, HR or otherwise, could use pointers on what not to do to get where he or she wants to go. And these were put together by an executive search firm — “the top five mistakes our search consultants witnessed in 2014,” as its release states — so they’re not exactly being pulled from thin air.

The first no-no is to focus too heavily on a hypothetical bonus that may or may not come from your current, soon-to-be-previous, employer. As one “high-level executive” told Phillip’s researchers:

“You cannot keep looking backwards. Your future is in the hands of your new employer. So I lost some bonus money, not every step is forward and career growth certainly isn’t linear. If the job is worth taking, it’s worth taking whether you get your bonus from the old company or not.”

As Phillip’s release puts it, “one thing to think about before you sit down to talk compensation, if you’re flinging out wild numbers about a bonus that ‘may come,’ your chances of getting the job are going to go down.”

Second, the consultants found, was what they list as “relocation bi-polarism.” While executives “know the game [and] how to make a career change …,” they write, “we witnessed something in 2014 that was a bit disturbing. Companies often complained about candidates, be it from a firm or their own internally sourced, backing out in the 25th hour because of relocation.” They go on:

“If you don’t want to move, you need to figure that out early on in your career search, ideally before the first interview and absolutely no later than after the first interview. If you fly out somewhere three or four times only to back out, wasting people’s time may not go well for your reputation.”

Third is playing “hide the compensation.” In short, the release says, “nothing seems to stop an offer in its tracks faster than withholding what you are currently earning.” It continues:

“We know it’s a point of leverage and you don’t want them to lowball you, but we look at it from a different light. If the company see’s your value, [it’s] going to pay you what you are worth. Likewise if you are trying to get a 30 percent-to-40 percent raise by playing the hide the compensation game, the company can equally say you’re just looking for a pay day, not a career. Be honest with the company about your compensation, tell them where you would like to be AND WHY, then let the chips fall where they may.”

Fourth, be careful who you’re tempted to say you know in the company you’re interviewing with. Their opinion of you may not align with your perception and they might not even want you working there “because you have dirt on them,” the researchers write.

Lastly, they say, make sure your social-media profile aligns with your resume. As they put it,

“It seems everyone in their life took a position or two that didn’t work out. Maybe they only lasted three months because it was a bad cultural fit or the company wasn’t what they expected. So what do you do? You leave it off your resume but it’s listed on your LinkedIn profile or some other lead gathering site has your information listed and you cannot have it removed. So it only takes one simple Google search for someone to find that discrepancy and question your integrity.”

There you have it. Forgive me if I’m stating the obvious, but these weren’t exactly obvious to me.