Rotman Dean on CEO Pay: Drop Stock Compensation

Posted by: Jena McGregor on July 13, 2009

Perhaps all the people currently trying to redesign executive compensation should consult just that: Design. Well-known design thinker and University of Toronto’s Rotman School of Management dean Roger Martin wrote recently over at the Harvard Business Review about restructuring executive compensation.

His fundamental idea: scrap stock-based compensation. Just like utilities can’t control the weather (even though hotter summers and colder winters would equal more profits), CEOs can’t really control their stock price, Martin argues. Far too much compensation, he says, is built around options and share prices. Martin’s solution: pay CEOs based on “real measures,” such as earnings per share, return on invested capital, and market share.

While these and similar factors are sometimes considered in determining executive compensation, it’s often just portion of the formula, with stock options they must keep above water making up a big chunk, too. Technically, tying pay to share prices may be performance based pay. But is it really performance executives can control?

Reader Comments

BusMan

July 13, 2009 1:20 PM

This is a great idea.

CEOs, and in fact other company executives from the lowest level of management, should be paid based on their controllable performance.

This could include measures of quality, budget/cost control, innovation, earnings, RIO and market share.

Stock options are simply an easy way to executives to earn outsized paychecks without a direct tie to the performance of the company. The only exception to this might be company founders, where options are more appropriate.

bean counter

July 13, 2009 6:50 PM

If we did follow such a sensible approach to exec and especially CEO compensation (and not just for the NY Banks), then who'd buy all those trophy homes and memberships to exclusive country clubs and line the pockets of politicians?

One thing is for sure - THE PRIVATE SECTOR has proven itself incapable of managing exec. compensation. Those of us on the finance playing fields in industry know all the reasons - and we realize this is going to be near impossible to fix. The CEO's have the boards stacked - and it's pure fiction to think stock holders can do anything about it.

It's very fashionable to analyze US worker costs Vs foreign workers.....but don't ever think about measuring US CEO costs Vs CEO costs in China or India.

Look at the highly over paid CEO Kevin Johnson at Juniper Networks - pulling down $ 55 M to lead a flat to negative $ 4 B a year company. (a large chunk being stock options of course) But Kevin and Juniper are NOT atypical - makes the situation even sadder. And we all know that Juniper is increasing their operations in India by 30% over the next 2 years......while laying off workers in the US. The Indian workers cost less - maybe Juniper should layoff Kevin Johnson and replace with a CEO in India - or China.

While we're at it - let's replace all those talking heads on CNBC with talking heads in India or China at 50% of their cost. It's amzing to hear some of those CNBC stock cheerleaders defending CEO compensation - but then we ask where do they earn their advertising $'s.

We have a system of reference errors.

Thomas Huynh

July 13, 2009 7:15 PM

I agree with BusMan. Although the idea of stock options was based on good intentions -- if the owners get richer from stock price increases, why not tie them to managers' performance and pay? -- the experiment has been largely a failure. There are too many uncontrollable factors, such as fluctuations in industries and the overall national economy. The company may be managed well or poorly but one can't tell by the stock price, at least without lingering doubts.

Don't get me wrong. I still think stock prices reflect companies' values better than any other valuation method (what better way to determine if owners are "happy"?) but we need to be careful how much we can rely on it for compensation of hired managers.

If today the board still wants to tie employee compensation to the stock price or even continue to offer a generous stock option plan to attract talent, reward only for price increases above and beyond the sector or industry moving average, not simply on a fixed price. Therefore you can pull intelligence from the market and also reward extraordinary managers for their extra effort. If the job candidate balk at that idea, then I suggest the board should conclude this manager won't -- or perhaps, can't -- perform better than his or her peers. Makes the decision easier for all concerned, including the shareholders.

Sincerely, Thomas, founder, Sonshi.com

Anonymous

September 16, 2009 2:24 PM

I totally agree. Stock compensation ruins the incentives for employees and causes too much dilution.

Website devoted to eliminated stock compensation.

http://vote-against-stock-compensation.webs.com/

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