Pay Plans That Drive Performance

The topic of executive compensation continues to be “radioactive.” Yet the good news for directors, according to Jannice L. Koors, the Chicago-based managing director of Pearl Meyer & Partners, is that “with good planning and the right protections you can survive it.”

Koors and fellow managing director in PM&P’s Chicago office Matt Turner led a Directorship Roundtable on current trends in compensation that included an impressive roster of directors and current and former chief executives.

The prevailing sentiment was that compensation as a focal point for shareholders, the media, and the public won’t go away anytime soon. The panel agreed corporate directors are best served by creating a transparent process that rewards success and focuses on delivering long-term value to shareholders.

Why is compensation such a difficult subject? Richard W. Gochnauer, CEO of United Stationers, a leading office-supplies wholesaler, said it is because the interests of the board, management, and shareholders aren’t always aligned on the topic: “You have shareholders who want performance and you have a board that needs to protect itself. And then you have the key interests of management. Those interests are not always the same. So you have to get everyone to agree. That’s never an easy task.”

“Compensation drives performance,” said John F. Sandner, former chairman of the CME Group who sits on the E*Trade Futures board. That was a lesson he acknowledged learning the hard way as a former director of the Chicago Mercantile, which became the first publicly traded exchange in 2002. It’s a common worry in compensation circles that a stock could shoot the moon, opening the board up to criticism for what in hindsight looks like an exorbitant executive pay package. “We were thinking conventionally when it came to stock options. It never dawned on anyone we’d go out at $35 [a share] and three years later the stock would be at $300,” Sandner said. Now, he pointed out, the most common theme around executive compensation is the inclusion of a pay-for-performance factor.

Of course, when the stock is going up, shareholders don’t complain as much as when it goes down. “We saw a lot of blowback for financial institutions in the wake of the subprime crisis, so there has been some recent pushback where historically there has not been very much,” said Robin Josephs, a former senior executive at Goldman Sachs and now a lead director at iStar Financial. “Management has a lot of latitude when the stock price is going up, but they lose when the stock is going down.”

More leadership on compensation needs to come from the CEO based on long-term performance, said some panelists. “Too many incentives have been focused on the short term…and the materialization of rewards isn’t in sync with company performance,” said Fred G. Steingraber, chairman of Board Advisors, a management consultancy.

Peer-Group Pressure

How should boards determine the appropriate level of executive pay, and what role do peer groups play in setting the appropriate targets?

Usually, companies will look to benchmark executive pay to a peer group, but it’s no easy undertaking. Koors points out that often companies think they don’t fit into any molds. “The one thing that all companies have in common is that they don’t think there’s anybody like them. That’s what I hear most often and it’s something that everyone shares,” Koors said. “The bottom line is executive retention, which relates to the affordability issue. We hear a lot, particularly around the general counsel position, that if soand- so were a partner in a big law firm then he would be making millions. On the flip side, the general counsel has chosen his job for many reasons, not entirely compensation driven, and the value of his job at the company is x-amount of money.

“To some extent, you have to accommodate the individual, but typically when we’re doing market analysis, we usually start with looking at what the position is worth,” said Koors. “Then it’s the comp committee and management’s job to decide where they want to place an individual based on his or her experience, expertise, and how concerned they are from a retention perspective. That’s the rationale for pushing that person to the higher end of the market data. It’s not the rationale for moving the data.”

Quantitatively, there are tools directors can use to measure performance, most of which are correlated to shareholder return for the company and an industry. Those metrics, however, must be balanced because, as Koors notes, “the stock market isn’t perfectly efficient, and good performance doesn’t always translate into an increase in the stock price. What you need is more of a motivational effect than to merely tie a pay package to something that management may only have an indirect influence over.”