For some time now, CEO pay has been a lightning rod for criticism and debate, but CEOs themselves have stayed pretty quiet on the topic—often because it’s uncomfortable for us to speak out about how others are paid and simpler to leave it to our compensation committees. Our well-intentioned advisers—HR leadership, outside consultants and lawyers, even board members—avoid the subject, fearful of sending the wrong message to a high-performing CEO. So it’s time for CEOs to speak up about unacceptable and inappropriate amounts and forms of compensation—particularly since “say on pay” shareholder votes are on the horizon. If we don’t take the lead, Congress and others will, in ways that may be in no one’s best interest. Here’s what I propose:
This commentary by A.G. Lafley was originally published in the May 2010 issue of the Harvard Business Review.
Reward with equity. Every element of a pay package should strengthen the CEO’s stewardship of the firm, providing incentive to consistently create value over the short, medium, and long term. It should align him with the company not only when he is active but also in retirement, because the surest measure of his contribution is the quality of succession and the business’s performance in the year or two after he hands over the reins. For this reason I strongly believe that equity should make up the lion’s share of a CEO’s retirement package.
Restore integrity to equity grants. Let’s also require that CEOs hold a meaningful portion of their company-awarded equity into retirement. This sets an example by affirming the company’s long-term values and culture for other top executives. It’s painless—many CEOs already do it—but it underscores the importance of the long-term health of the enterprise.
In some cases a CEO may have accumulated so much equity that additional grants provide little incremental motivation. At that point the CEO should ask the compensation committee to put those grants back into the pool for other employees.
Eliminate post-employment provisions not pegged to performance. So-called safety-net provisions such as outsize change-in-control or severance payments and supplemental retirement plans are indefensible—as are “mega equity grants” that are way out of proportion to the CEO’s contributions. Stock options were never intended to be automatic. Their purpose is to recognize extraordinary individual performance, to align the CEO clearly with shareowners, and to encourage longer-term value creation. A CEO who has amassed sufficient wealth to provide for any eventuality needs no security blanket.
Implement more-detailed analyses. A few years ago companies started using tally sheets to ensure that all the components of an executive’s compensation could be seen in one place. We should adopt two additional analyses: walkaway wealth accumulation and internal pay equity. The first pulls together the total wealth an executive will take with him under various termination scenarios. Whereas the tally sheet is a front-end snapshot, the walkaway provides a full picture, including the outcome of all the gains (realized, unrealized, and projected) from all previous (and pending) grants. The internal pay equity analysis adds up all the components of an executive’s compensation going back several years, to determine whether one of them may have distorted pay ratios.
Cynics may say, “Lafley can afford to talk this way because he already got his.” In fact I had no employment contract, no severance, no change-in-control payments, no gross ups, no pension (beyond stock from a modest profit-sharing trust that all P&G employees participate in), and no supplemental retirement plan, and 90% of my pay was at risk in the form of restricted stock and stock options. I truly hope and believe that if we as a group embrace—and implement—the tenets above, we will have come a long way toward restoring public trust in our system of democratic capitalism.
A.G. Lafley is the former chairman and chief executive officer of Procter & Gamble.
As a long time board member of public companies, in my various presentations to board groups over the years I have often held up A.G. Lafley as an example of what a major global corporate CEO should be. It is therefore no surprise for me to read his common sense and eminently sensible review of how CEOs should be compensated. As is his trademark, he leads by example – his own pay package. This article should be required reading for all aspiring CEOs and sitting CEOs as well as board members. America and the world could do with many more CEOs of the caliber of A.G. Lafley.
Brilliant.
This is real leadership.
Let’s hope the majority of corporate leaders flock behind him and it becomes a movement. Let’s hope boards and comp committees insist on the “Lafley Principles.” And the politicians of both parties in Washington and statehouses will take similarly principled stances regarding the huge issues they’ve been dodging for decades. Imagine how quickly this nation and its economy would heal.
Or is his a voice in the wilderness?
Frankly, I am tired of the deification of Mr. Lafley. This is one of the most hypocritical articles I have ever read. It’s a shame Mr. Lafley did not practice these “Lafley Principles” himself.
Case in point: Just before Mr. Lafley retired, he took an unprecedented $3.5 million + bonus. This was above and beyond his normal bonus, restricted stock, options, etc… It was rewarded in RSUs granted as of Feb. 29, 2009, a time at which the share price was at a 10 year low. Ostensibly, it was granted in “recognizing the integral role that he played in the valuation, negotiation and acquisition of Gillette.” My 12-year-old could have negotiated a better deal. In fact, there was no real negotiation or valuation- P&G grossly overpaid. Why do you think Warren Buffet was so happy? Keep in mind this is at the same time GE’s CEO refused to accept his contractually earned bonus for 2008. Immelt showed leadership, not Lafley. If Mr. Lafley did such a great job, why was P&G stock at the same price on July 1, 2009, when he retired, as it was in September 1999? And how exactly was this bonus going to incentivize his future performance when he was retiring soon? This was simply greed.
Moreover, when discussing equity grants, Mr. Lafley states, “A CEO who has amassed sufficient wealth to provide for any eventuality needs no security blanket.” You would think the ~$200 million in amassed wealth over his career would be enough. But, in his last year, he took an almost $14 million grant, half in RSUs and half in options. This was in a year he was retiring. This was in a year when the company’s stock performance was atrocious. This was, again, a case of simple self-enrichment.
He also rails against outsize change-in-control payments. While he, in fact, took none, he paid Jim Kilts $150 million+ when P&G bought Gillette. This included a $10 million+ change-in-control payment. Kilts approached P&G to make a deal. Why would he receive an outsize change-in-control payment when he originated the deal?
Finally, at a time when P&G’s performance was lagging, he delinked his performance-based bonus from the company’s performance and let the board award it independently of the company’s normal bonus criterion. He made the decision to overpay for Gillette (as well as Wella, Clairol and Frederic Fekkai, all terrible investments), which has dragged down P&G’s performance for years; shouldn’t his bonus have been tied directly to the overall company performance? Instead, while the company performance factor was 80%, Mr. Lafley’s STAR bonus paid out at 98%. Why?
I gleaned all this information directly from the company’s proxy statement. I find it bizarre that, given these facts, people and publications continue to allow Mr. Lafley to pontificate on subjects where he clearly has no leg to stand on.