 |
 |
|
|
Home | Contact | Subscribe | Login | Previews | Newsletter | Caselaw | Service | Shop |
|
 |
|
|
||||||
|
||||||
|
Executive Compensation: Pay Without Performance* By Mallory Stark who can be contacted at Working Knowledge at http://signup4.c.topica.com/maacYiYabcxz0bnFRwGb/ ---------------------------------------------------------------------- 1. Introduction In the new book Pay Without Performance: The Unfulfilled Promise of Executive Compensation, Lucian Bebchuk and Jesse Fried make the case that the executive compensation system in the U.S. is fundamentally broken. We like to think that executive pay is the product of arm's-length negotiation, that the executive bargains in his or her own best interest, while the board of directors bargains for the best interests of the shareholders. Bebchuk and Fried argue that, in fact, soaring executive pay is the result of management power. "Compensation arrangements have often deviated from arm's-length contracting because directors have been influenced by management, sympathetic to executives, insufficiently motivated to bargain over compensation, or simply ineffectual in overseeing compensation," the authors write. "Executives' influence over directors has enabled them to obtain "rents"-benefits greater than those obtainable under true arm's-length bargaining." The book opens with a quote from Harvard Business School Dean Kim Clark asking the fundamental question about executive scandals: "Is it a problem of bad apples, or is it the barrel?" For Bebchuk and Fried, the problem is in the barrel, and to an extent, well underplayed. In this interview, Bebchuk and Fried discuss their book and their ideas for how executive pay and corporate governance could improve. Bebchuk is Friedman Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School. Fried is professor of law at the University of California at Berkeley. Q: MALLORY STARK: WHY DID YOU WRITE PAY WITHOUT PERFORMANCE? Lucian Bebchuk: Although there is now widespread recognition that many boards approved executive pay packages that did not serve shareholder interests, there is still insufficient understanding of the scope, source, and severity of the problems. We wanted to provide a full account of the widespread flaws in compensation arrangements and the resulting costs to shareholders. Studying pay arrangements also enabled us to identify some more basic problems with our system of corporate governance. Finally, we wanted not only to improve recognition of existing problems, but also to contribute to solving them. The book puts forward proposals for improving both executive compensation and corporate governance more generally. Q: HOW IMPORTANT ARE EXECUTIVE PAY PROBLEMS IN THE GRAND SCHEME OF THINGS? Bebchuk: The problems of executive pay are of real practical significance for investors and the economy. The amounts paid to executives are significant even relative to the large market capitalization of public firms. In a recent study with Yaniv Grinstein, we find that the aggregate compensation paid by public firms to their top-five executives during 1993-2002 was about $250 billion. Aggregate top-five compensation was equal to 10 percent of aggregate corporate earnings in 1998-2002, up from 6 percent of aggregate corporate earnings during 1993-1997. Thus, if compensation could be cut without weakening managerial incentives, which we show it could, the direct gains to investors would have real practical significance. Moreover, the excess pay obtained by executives is not the only, and probably not even the primary, cost of flawed pay arrangements. Executives' influence has produced pay arrangements that provide diluted and sometimes perverse incentives. These distortions might well have been the biggest costs arising from executives' influence on their own pay; eliminating them could produce substantial benefits. Q: IN WHAT WAYS HAVE THE PROBLEMS OF EXECUTIVE PAY BEEN UNDER APPRECIATED? Jesse Fried: There are many who believe that concerns about executive pay have been exaggerated. Some hold the "rotten apples" view that flawed compensation arrangements have been limited to a small number of firms. In contrast, we conclude that problems have been widespread, persistent, and systemic. We conclude that problems have been widespread, persistent, and systemic. - Jesse Fried There are also those who accept that flaws in compensation arrangements have been common but maintain that these flaws have resulted from honest mistakes and misperceptions on the part of loyal boards that can be expected to fix the problems on their own. But the problems we identify have stemmed not from transient lapses that boards can be expected to self-correct; rather, they have stemmed from basic defects in the underlying governance structures that enable executives to exert considerable influence over their own pay. Finally, there are some who maintain that recent reforms, which strengthen director independence, would fully address past problems. We show, however, that the problems are ones that cannot be expected to go away merely by strengthening the independence of directors. Directors, we argue, must be made not only independent of insiders, but also more dependent on shareholders. Q: WHAT ARE THE PROBLEMS YOU IDENTIFY IN THE PAY-SETTING PROCESS? Fried: We show that directors have persistently failed to negotiate at arm's length with the executives whose pay they set. We identify a myriad of factors that lead directors to go along with pay arrangements favorable to executives. Executives' influence on pay setting can explain a wide range of compensation practices and patterns, including ones that have long been viewed as puzzles by economists assuming arm's-length contracting. The role of managerial influence also explains why pay is higher and less sensitive to performance in firms in which executives are more entrenched or have more power vis-à-vis the board. The flaws in the pay-setting process have resulted in substantively flawed outcomes. Pay has been insufficiently linked to performance. And pay schemes have been designed in ways that camouflage both the amount of compensation and its insensitivity to performance. Q: DO YOU AGREE WITH THE VIEW THAT INCREASING PAY LEVELS IS NECESSARY TO PROVIDE MANAGERS WITH POWERFUL INCENTIVES TO ENHANCE SHAREHOLDER VALUE? Bebchuk: No, we don't. Pay schemes fail to provide incentives in a cost-effective way, and shareholders have been receiving much less bang for their buck than possible. Indeed, pay is far less sensitive to performance than is commonly recognized. To begin, there is evidence that cash compensation, including the large amounts paid in bonuses, is little correlated with managers' own performance. In addition, much value is delivered to executives through what we call "stealth compensation"-forms of pay whose dollar amount is not included in publicly filed compensation tables-and this stealth compensation also isn't tightly linked to performance. Even with respect to equity-based pay, the link between pay and performance is much weaker than possible. Most of the payoffs from executives' equity-based compensation come from market-wide and industry-wide movements, as well as from short-term fluctuations in stock prices, rather than from managers' own long-term performance. Furthermore, compensation contracts and provisions provide executives with substantial downside protection that further decouples pay from performance. Compared with other employees, executives receive an unusually large fraction of their full-term compensation in the event they leave due to under-performance. Finally, current compensation arrangements not only fail to provide incentives to enhance shareholder value in a cost-effective way, but also provide perverse incentives. For example, broad freedom to unload options and shares has provided executives with incentives to produce short-term stock price increases that come at the expense of long-term value. Q: YOU TALKED ABOUT THE CAMOUFLAGING OF PAY. CAN YOU GIVE AN EXAMPLE OF HOW PAY HAS BEEN CAMOUFLAGED? Fried: Firms have used retirement benefits, for example, to provide executives with substantial amounts of stealth compensation. Given the lack of tax subsidy, firms' substantial use of nonqualified pension and deferred compensation arrangements is difficult to explain on efficiency grounds. But such arrangements can serve an effective camouflage role, providing executives with large amounts of performance-insensitive pay below investors' radar screen. Under current disclosure requirements, firms do not have to place a monetary value on retirement benefits and include it in the compensation tables that companies file and outsiders follow. Indeed, the executive compensation figures used by the media and researchers, as well as the figures of aggregate compensation Lucian noted earlier, do not include these retirement benefits. Q: HOW CAN PAY ARRANGEMENTS BE IMPROVED? |
| Home | Contact | Subscribe | Service | Email | Copyright | Privacy | PAIA Manual | BBBEE Certificate | Directions |
| © 1998, 2008 Workplace
Performance Technologies (Pty) Ltd PO Box 925 Lanseria Gauteng South Africa 1748 Kent Place, 332 Kent Avenue, Randburg, Gauteng South Africa Facsimile: +27 (0)86 869 7862 (Office) Telephone: +27 (0)11 781 4228 (Office) | +27 (0)82 416 7712 (After Hours) Cellular: +27 (0)82 416 7712 Email: info@workinfo.com Domains www.workinfo.com | www.caselaw.co.za | www.workinfo.co.za Gloria in Excelsis Deo |
Member
Content 
