New Year’s Resolutions – Executive Compensation Style
Upper Saddle River, NJ – January 4, 2006 – We all succumb to the annual ritual of making a bunch of resolutions about how we will change our lives with the start of the New Year: eat better and healthier foods, exercise more, reorganize our rather hectic and stressful lives in order to live longer, and learn to enjoy what we have. In most instances, regardless of how dedicated we are to these resolutions, most of our good intentions give way to the realities and pressures of everyday living, and before we know it, we are pretty much back to where we were on December 31.
Executive compensation is, in many ways, treated very much the same way. Boards and their Compensation Committees set forth their resolutions on how they will tighten up the criteria for governing and determining executive compensation going forward. Some of this idealism is internally generated based on reasonableness and a strong sense of responsibility on the Board’s part. Unfortunately, this desire to tighten up the decision-making process emanates from external pressures, namely the shareholders, investors and their “watchdog groups”, and various governmental agencies and their “knee jerk” regulations, including recent changes in accounting and tax rules. After all, the basic premises behind executive compensation has always been to maximize the value to the individual while minimizing the taxes to the executive and company, along with minimizing any negative accounting issues for the corporation. These are over and above the basic objectives of any compensation program, which are four-fold:
1. To provide the competitive package necessary to attract qualified talent;
2. To assist in retention of that talent, the proverbial “golden handcuff”;
3. To provide the motivation needed to achieve desired results, in effect, the “golden ring”; and lastly,
4. To focus the employee’s attention on specific business objectives, so that what is achieved is consistent with the business strategy.
Just as New Year’s resolutions are all too often sidestepped when realities of every day pressures are confronted, the Board’s resolve to “do the right thing” is sometimes forgotten when undue pressures, whether competitive or self-induced, are encountered. For example, in the case of long-term incentives, we have seen the Compensation Committee give in and provide an award, such as stock options, even though the performance goals were not met and no incentive award was warranted. The explanation often given is that “it was out of the hands of the executives, and we can’t afford to lose our top people”. In reality, the Board’s actions have weakened their own policies, and ignored the reality that there may be more capable individuals available in the marketplace that could achieve the stated business objectives, despite the costs involved in recruiting them. Similarly, a recent example where a Compensation Committee probably did not fulfill its duties to the shareholders, Board or itself, was one in which the Committee provided a severance payment in excess of $5 million to an executive who was forced out for poor performance. Not only did the Committee fail in its duty as the arbitrator of fair and justifiable compensation, but it also set a precedent for others. The mixed message is that the executives will be rewarded, regardless of whether or not they achieve the company’s business objectives.
How, then, can the Board and Compensation Committee ensure that their “resolutions” result in real and lasting changes? As with personal resolutions, changes should be realistic and within the Board’s capabilities to accomplish. Incremental steps are much more palatable and more easily achieved than dramatic changes. Don’t resolve to overhaul the entire executive compensation program in one all-encompassing action; rather, evaluate each portion of the package in a logical sequence over a period of months. Some other thoughts for making resolutions stick:
· Look at the roadmap: Review the organization’s compensation philosophy to ensure it is consistent with the business strategy and driving the appropriate performance.
· Don’t fix what isn’t broken: If a plan is achieving the goals of the organization and is motivating executives to perform optimally, don’t change it.
· Prioritize needs starting with the most critically challenged areas: Don’t focus on annual incentives if long-term programs are suffering.
· Seek the guidance of outside advisors: Professional service firms can be utilized to assist in making resolutions happen, allowing the Board and Compensation Committee to focus on its most important responsibilities.
· Don’t expect changes to happen overnight: Lasting changes, especially behavioral ones, should happen slowly, giving time for adjustment and refocus.
Ultimately, change should begin at the source. The Board and Compensation Committee should evaluate the Committee’s charter to ensure that responsibilities are clearly defined, so that the document can serve as the baseline for how it will conduct its duties relative to executive compensation.
Contact: Paul R. Dorf, Ph.D., APD
877-934-0505 · Fax: 201-934-0737