CEO Pay is Up! Is that Good?

Such is the question posed in the lead editorial of the July/August 2011 edition of Harvard Business Review. It comes on the heels of a report by Equilar, an organization that tracks executive compensation, total pay packages for CEOs at S&P 500 companies. According to its data, CEO pay rose 28% in 2010, to a median of $9 million. This brings it back to pre-recession levels.

HBR Editor in Chief, Adi Ignatius, offers some interesting observations in response to this report. Here, in part, is what he says:

"It’s hard to know exactly how to take this news. On the one hand, it’s a positive economic indicator of sorts, in that a CEO’s compensation tends to be linked to the company’s stock price. The markets saw a strong recovery in 2010; the S&P 500 index, for example, rose 13%. On the other hand, there’s something unsettling about this development. In the immediate wake of the financial crisis, nearly everyone agreed that we had gotten into trouble partly because tying compensation to short-term performance had enriched individuals while putting institutions—and the overall system—at risk. In an interview that begins on page 112, Disney CEO Robert Iger addresses the problem. He made $28 million last year in salary, bonus, and stock options. But Iger concedes that there is too much emphasis, in his and other CEOs’ pay packages, on short-term stock results, and he urges compensation committees to rethink their approach."

I tend to agree with Ignatius's thinking on this issue. The 2010 results certainly reveal that executive pay is a kind of double-edged sword in what it reflects. At a minimum they demonstrate that any executive pay strategy that doesn't take a balanced approach to compensation (tempering short-term earnings capacity for key people by placing some long-term compensation at risk) can ultimately be considered "unfair" by some constituency. Public companies have a harder time with this than private organizations, primarily because of the need to focus on quarterly results. Meeting the expectations of the analysts is almost their sole focus.

Both public and private companies need a compensation philosophy and strategy that is consistent with building both short and long-term value. As I have discussed previously in these blog pages, such an approach keeps a business focused on good profits instead of bad profits. The latter are earnings that come at the ultimate expense of both the customer and shareholders. Good profits sustain value and multiply wealth for all stakeholders.

In our approach to compensation design, we recommend companies place a substantial amount of executive pay "at risk" through well designed incentives. We encourage growth oriented-organizations to offer top tier employees as much as 80 to 100% of salary in incentive earning capacity. The key is to have approximately half of that amount paid out in short-term incentives (pay for results generated in 12 months or less) and the other half in long-term incentives (pay for results generated past the one year mark, and usually three years or more later). Salaries should be modest by market standards--usually between the 40th and 50th percentile of market pay.

Such an approach creates a truer sense of partnership between company ownership, key employees, customers and the market in general. When each of those stakeholders' interests are represented in the way employees are compensated, greater balance is realized and the compensation wars can subside if not be eliminated.

For more information on the role of compensation in driving shareholder value, view our webinar entitled: "Does Your Compensation Strategy Drive or Hinder Growth?"

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