Executive Compensation: Programs That Should Be Avoided

There are programs that do not stand up under scrutiny and that will breed suspicion that the playing field has been tilted in favor of executives. These “third rail” programs should be avoided. They can be recognized by their characteristics:

High Upside Potential; No Downside Risk:

Adverse reaction is inevitable when certain types of programs are used. High base salaries, incentive programs with low thresholds, stock plans that do not require sustained ownership, repricing stock options and programs that are modified when they do not pay out; these are sure to attract criticism. High base salaries enable recipients to live well even when other employees do less well. One abuse is to guarantee some portion of an incentive reward, which removes the performance threshold altogether. But the two ultimate high-risk practices are repricing stock options and lowering incentive plan performance requirements during the year to ensure a plan pays out when it otherwise would not have. Lowering incentive plan performance standards during the year may be acceptable if there is a viable expectation that if uncontrollable external conditions were to improve during the year that the performance threshold would be raised. In today’s environment unexpected and uncontrollable events may render incentive plan standards unreasonable – either unachievable or impossible not to make. Each organization must decide if it responds by modifying the standards so that the plan is still viable. Some do while others acknowledge that external factors prevailed and accept the reality that forecasts do not always work out. If such occurrences happen frequently it is time to reevaluate the plan design, which may be inappropriate for the context within which it operates.

“Elitist” Programs:

Perquisites that are not business-related are apt to be challenged the shareholders and to other employees. If they discover that a CEO purchased an $ 8,000 shower curtain with company funds they should insist that person be prosecuted and terminated. But they should also investigate the governance structure to find out why well-compensated executives felt they could obtain reimbursement for personal expenses. Personal and family use of planes, expense accounts and other company resources should also carefully examined, since abuse can lead to the erosion of trust on the part of those who must contribute in order for the organization to succeed. Even when perquisites are technically legal and within established policy they send a message that there are different rules and principles for different people, which can erode the social capital within the organization and impact employee motivation.

Programs That Reward Something Other Than Performance:

“Golden parachutes” programs that protect executives in the case of a change in control have their place. But excessive termination/severance arrangements that pay out no matter what the circumstances can easily increase the cynicism of the public about executive compensation. A well-respected corporation paid newly hired #2 huge sums to leave because the CEO could not get along with this person. Why the selection process did not discover this chemistry problem and why the shareholders should have to sacrifice their capital to rectify the mistake are questions that were indeed asked. Too often total failure on the part of senior executives is rewarded, with the shareholders providing the funding when their investment is probably diminished in value.

Poorly Communicated Programs:

Bypassing shareholder approval, even if approval is technically not mandated by law, is common but not recommended. Many inappropriate decisions can be avoided if shareholders are able to review the compensation strategy of the Board and to approve the specific programs being adopted. When executive compensation is managed out of the sight of shareholders and other employees it becomes easy to slide down the slippery slope through excess to out of control behavior. And when stockholders must be consulted too many organizations use “legalize” to obfuscate the intent of programs and/or their potential cost. The SEC disclosure guidelines still leave room for incomplete or misleading communication, such as burying key facts in footnotes, projecting future costs using unlikely assumptions and reporting payouts only after they are made, but they do provide the basis for challenging what is done.

An excerpt from:“Executive Compensation: The Optics Are Critical” by Robert J. Greene, PhD
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