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Upper Saddle River, NJ - February 24, 2010 - I had a discussion recently with a reporter on the background issues related to Executive Compensation, and, in particular, why it continues to be such a hot topic. The reasons that it continues to garner so much front page attention is easy to understand: there are approximately 12.5 million people who are out of work, and as Robert Reisch, the former Secretary of Labor under the Clinton Administration said, "They are mad as hell!" Many highly visible financial service and insurance companies appear to be pouring gasoline on the fire – by continuing to pay executives extremely large, and, as many perceive, unjustified amounts of compensation. The perceived insensitivity is even more evident among companies that received huge financial TARP bailouts. The reporter then asked who should make the changes necessary to control Executive Compensation. Clearly, those changes have to be made by the Board of Directors and their Compensation Committees. However, their effectiveness has been somewhat diminished either because they don’t know how to go about making the necessary changes, or because they are afraid to make changes that will alienate their management. The government has stepped in by enacting confusing and inconsistent legislation, and by creating the Pay Czar. These "fixes" appear short-sighted and to totally ignore the "Law of Unintended Consequences". The government just doesn't understand the complexities of Executive Compensation or the real dynamics of "Pay for Performance". Assuming that the Boards actually take control of the Executive Compensation decision-making process; what should they do? There is no single or easy answer, since each organization is different; cookie-cutter answers don’t work in the complex Executive Compensation arena. However, there are things that can be done which we believe will greatly improve the current pay programs. These include: • Move from discretionary bonuses to results oriented incentives; this requires appropriate and realistic goal setting that balance both quantitative and qualitative measures. • Clearly define expectations, and hold executives accountable for their successful completion. • Balance short-and long-term decision-making by introducing complementary plans, so that "all eggs are not in one basket". • Add sufficient checks and balances to incentive plans to ensure awards are justifiable. • Include circuit breakers to all plans that prohibit any payments under certain circumstances. • Institute Clawback provisions in the event problems are uncovered after the fact. • Communicate effectively to avoid "mixed messages". The government’s best way to help is two-fold; the first would be to enact legislation to level the playing field between companies so that the small, privately owned companies are subject to the same regulations as big, publicly traded organizations. This would remove the opportunity for key executives to avoid the pay restrictions by merely moving across the street. The second answer may be more difficult to enact: add specific penalties for granting or receiving excessive compensation. This would certainly get a Board's attention and should curtail some questionable practices. (Note: there are regulations that actually prescribe some very punitive penalties for excessive compensation, but these rules only cover not-for-profit organizations, which is not where most of the problems lie.) As I indicated to the reporter, Executive Compensation is an extremely complex issue which needs to be addressed with careful thought and research. The sooner we can get this done, the better, so we can get back to focusing on repairing the economy and getting people working again.
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