The complexity of executive compensation

Executive pay is a hard problem; no wonder shareholders are hesitant to second-guess.

 
(Photo: Getty Images)

Many jurisdictions have moved recently to give shareholders a “say on pay,” which typically means that companies are required to hold advisory (i.e., non-binding) shareholder votes on compensation. In other words, establishing executive pay remains the responsibility of the Board of Directors, but shareholders are given an opportunity to voice their approval or disapproval.

The Wall Street Journal recently reported that when given their say, shareholders at a resounding 98.5% of American companies have said “yes.” So it seems that, thus far, shareholders are hesitant to challenge Boards in their compensation decision-making.

This is not surprising, given the complexity of the decision that Boards face in setting executive pay. Setting executive pay is a task typically delegated to a Board’s “Compensation Committee.” Now consider the task faced by a Compensation Committee in establishing the total pay-and-incentive package offered to their CEO.

The question facing a Compensation Committee is this: what combination of cash, bonuses, equity, and perks should we put on the table in order to inspire our CEO to perform optimally? In practice, this is a pretty complex question, one not admitting of cookie-cutter solutions. A Comp Committee needs to consider, just for starters:

  • pressures from shareholder (and other stakeholders),
  • pressures from proxy advisory firms and various think-tanks,
  • human psychology, including their particular CEO’s character and motivational levers,
  • the managerial experience and expertise of Committee members,
  • corporate objectives (profit, market share, sales, social responsibility, etc.),
  • their company’s ‘risk appetite’ (roughly speaking, are they trying to incentivize their CEO to be bold, or conservative?),
  • expert opinion about optimal compensation structures (which is deeply divided, to say the least).

The problem here is as much one of epistemology as it is one of ethics. Compensation Committees need to take an enormous amount of information and opinion and distill it into a decision that will work and that will be defensible in the face of enormous scrutiny.

Of course, there is no shortage of compensation consultants, ready and willing to help Compensation Committees with this task. But recent (not-yet-published) research at the Clarkson Centre suggests that many corporate directors are skeptical about the value of compensation consultants.

Given this complexity, it’s not surprising that shareholders — even sophisticated institutional shareholders — are so far pretty hesitant to do much second-guessing. Whether or not that’s a good thing is a separate issue.

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