When it comes to compensation, it should first be “why” and lastly be “how much.”
Human nature being what it is, however, everyone focuses on the size of the paycheck—usually other people’s, not their own. (As a CEO of a publicly traded company, I’ve never had any of my peers tell me they are overpaid.) But pay is also relative. New York Yankee Alex Rodriguez makes $100,000 in less than six swings of the bat, while Pittsburgh Steeler Ben Roethlisberger gets that in only four snaps of the ball. The average S&P 500 CEO makes 300 times the average U.S. worker. For sure, all of these are headline grabbers.
Far more troubling is the fact that such examples can easily become distractions in a much bigger and more complex discussion that needs to take place around compensation, a re-focusing on the “why” and not just the “how much” endpoint of compensation.
CEO pay is an emotionally and politically charged topic.
It has become very fashionable to look askance at executive compensation with a preconceived bias, which has been substantially heightened since the near collapse of the global banking system. Biases around compensation can lead to an undue focus on form rather than substance. Add to that a “check the box” attitude that puts more emphasis on rationalizing pay and being in the middle of the pack of what comparable, “peer group” companies are paying—safe and out of public scrutiny, as long as the peers you select are the right ones.
Several weeks ago I attended a meeting of the compensation committee of a publicly traded company during which the newly hired compensation consulting firm was presenting its initial report on the company’s executive compensation plan. I was aghast that the discussion, which lasted a full hour, only focused on the absolute pay and the merits of companies that should be included in the peer group for benchmarking compensation purposes. The discussion never once touched on the alignment between compensation to the company’s strategic plan, something that’s common in companies lower down in the organization.
Unfortunately, I’m afraid that this may be the norm and not the exception at many companies. Instead of getting caught up in connecting the dots that shift with the breeze, companies and their boards should first re-examine whether their compensations plans fit their strategy. The primary objective: create the levers of behavior that will drive desired outcomes.
This should include not only the leadership team, but all employees to ensure alignment with the company’s strategy. The form of compensation, mix of pay and incentives (short term versus long term, cash versus equity), and payment period (“lock-ups”) should be considered. Next, a careful review of possible unintended consequences – or outright gaming the system –should be undertaken, such as inadvertently encouraging too much risk-taking or cutting R&D investment to improve margins. In other words, the pay plans need to carry incentives for the right kinds of behaviors with regard to risk-taking, growth, and sustainable performance.
After all, shouldn’t the aim of CEO compensation be to benefit the company and improve its results?
Finally, the absolute size should be transparently evaluated not only in relation to peer companies (the talent landscape) but also to other external factors such as the stage of the economic cycle or company lifecycle.
"In most things in life, excess is never healthy. Compensation is no exception.""
One size does not fit all in compensation.
What works best to incentivize people in one company culture may not be effective or appropriate in another - a startup is different from a more mature organization. Similarly, the leadership characteristics and behaviors required to execute a strategy will vary between companies, including possibly those in the same industry. One company might be driving an innovation strategy whereas another may be exploiting a geographic opportunity. One may be organic, another could be acquisitive.
Compensation also moves in cycles.
During economic expansion or in emerging economies, companies pay up for talent; during retractions or in more mature markets, they scale back or have more talent to choose from. The current cycle is one of innovation and consolidation, Western market saturation and emerging global consumerism. Underlying all of this is tremendous scrutiny – by politicians, regulators and shareholders.
The compensation whiplash from the great economic train wreck has been “say on pay” and calls for greater transparency. Who could argue against transparency? But transparency should not be replaced with a false sense of security – a focus on form and not substance.
Take “pay for performance” – it’s a popular term these days. The underlying principle is straightforward, but its interpretation is less than clear. What performance? Internal benchmarks? Stock price? Shareholder returns? Then over what timeframe? Who are the shareholders? It’s been reported that the average holding period of a U.S. stock is currently seven months. On the other side, the average tenure of an S&P 500 CEO is five years. Both are remarkably short and, unfortunately, reflect today’s culture of instant gratification and an inherently short-term view.
In most things in life, excess is never healthy.
Compensation is no exception. Balance is needed. No matter what the economic or competitive climate, compensation needs to be grounded in a framework that is aligned with the company’s strategy. That framework must include specific targets for growth, profitability, and achievement of objectives. Metrics and measurements must be established to determine if targets have been reached or even exceeded.
Lastly, compensation is a process—it should neither be episodic nor change with the wind. It should allow for subjectivity and always be grounded in substance rather than form. Compensation like a company’s strategy must evolve over time.
The constant is to focus first on the why and then to consider how much.
Gary D. Burnison is CEO of Korn/Ferry International , headquartered in the Firm’s Los Angeles office. He is also a member of the Firm’s Board of Directors.