Managing Leadership^®

In the midst of the recent discussion, prompted in particular by the HP scandal, of corporate governance and the role of boards, the issue of senior executive pay is receiving sporadic commentary. Inasmuch as runaway CEO compensation has attracted such negative attention over the past decade and more, many wonder why it not only continues, but increases. The Wall Street Journal has stepped in with an excellent review of the history of this issue, revealing where in that history are to be found the seeds of current exorbitant levels of executive pay – and, perhaps, some of the attendant scandals, as well, such as options back-dating.

A survey article in a recent Economist points out that the issue is most prominent in the US, and underscores the evidence that it is growing more so. Some of it comes from executives packing their boards with colleagues, who then vote each other generous pay packages. Some of it comes from the free market in talent in the US, unconstrained either by legislation or culture, resulting in CEOs who create prodigious value for shareholders being awarded equally prodigious compensation.

On the other hand, the piece also points to the increasing phenomenon of rapid turnover in these ranks. It concludes that this acts to reduce the overall level of pay for these individuals. The point, however, isn’t the compensation the individuals aren’t receiving when they leave the position, but the pay the organization continues to dole out to the next occupant. There is no avoiding the fact that these levels continue to rise.

But, is that a problem? What are the elements of the question? It seems to me that one is: how much does executive pay reflect the value they bring to the organization? Attempts to answer this question properly are behind much of the non-traditional schemes that make up much of executive pay, these days. Salary is flattening out, but bonuses and other contingent payments – such as award of stock or options – is increasing. The hope is to align the interests of managers with those of owners, and promote managerial behavior that is healthy in the long term for the organization, thus increasing its value and therefore its reward for both owners and managers.

This leads to a second element of the question: do such measures actually work to align manager/owner interests, or does Murphy’s Law conspire to frustrate these efforts? The recent spate of scandals regarding options back-dating suggests that these may simply have provided another vehicle for managers to pry short-term personal gain from owners’ capital.

And there, perhaps, is the most impenetrable aspect of the issue: do these scandals – indeed, do other elements of the corporate governance issues we face today – really arise fundamentally from a diversion of interests between managers and owners, or from a divergence of behavior on the part of both resulting from the varying pressures to pursue short- or long-term interests? This is perhaps the key issue we need to examine before we rush into this or that prescription for aligning the motivations of these groups.

It must be acknowledged that the interests of managers are not naturally in conformance with those of owners. These two groups have very different types of investments in the organization and interests in its performance. Indeed, it is not unfair to suspect that management might have a bias to get what financial return it can while the getting is good, driving it to a short-term perspective.

But the hard part comes, really, when we try to understand the interests of owners, especially in a publicly held company. What do owners, or shareholders, really want? Do they want steady, healthy, long-term development and growth? Or, do they want a short-term monster profit? It must be said, many investors still believe, years after the dot-com bust, that they ought to have both. How are directors supposed to assess this, sort out the diverging and conflicting demands of increasingly activist shareholders, and, on the basis of however they resolve those questions, structure their relationship with management?