Fray on Pay

The battle over executive compensation and what it means for you.

Koeppel agrees. “The issue is risk and how to align it with executive reward,” she says. “We lost our way when reward was linked to financial metrics that did not translate into cash flow.”

In Search of Better Metrics
There may be a lesson in that for compensation committees, which are now on a collective hot seat from which they are unlikely to extricate themselves any time soon. “The typically light agenda of summer committee meetings will be a distant memory,” says Myrna Hellerman, senior vice president at Sibson Consulting. “Committees will have to make [vital] decisions about what stays and what goes in 2010 compensation plans.” RiskMetrics’s McGurn agrees, adding that “AIG and other egregious examples of ‘pay-for-failure’ have served as a consciousness-raising exercise for boards and compensation committees.”

“I think that compensation committees should be in the crosshairs on this issue,” says Lester A. Hudson, chairman of the Human Resources Committee of AEP’s board (which also addresses executive-compensation policies), “and not the executives receiving incentive compensation. The problems reside with the directors; many just don’t understand the implications of their plans. It is their responsibility to ensure that incentive compensation doesn’t increase the risk level of the company, and some committees failed to grasp this.”

As for what such committees might do, Bruce Ellig, a compensation adviser and author of the revised and updated Complete Guide to Executive Compensation, echoes Koeppel’s comments on metrics in general and cash flow in particular. “There are a number of ways that boards can address these issues before the government [steps in],” he says. “For example, they may want to use both net income and cash flow as pay-for-performance measures, as opposed to just net income. Cash flow is much harder to fudge — you either have it or you don’t.”

FM Global’s compensation program links incentive compensation to three key metrics: profitability, customer retention (measured as revenues from the existing customer base), and new customers (measured as additional revenues). If profitability falls precipitously and the other two metrics rise, executive compensation suffers — the reverse of the equation used by AIG. “Of the three key metrics, profitability is the one weighted largest, accounting for 50%,” Burchill says. “Customer retention is 40%, and only 10% is new business. You have to have company results before you pay incentive compensation.”

Despite the uncertainty regarding legislation, many companies are addressing compensation issues already. The Watson Wyatt survey found that fully 55% have frozen salaries — 34 percentage points higher than the consultancy’s December 2008 survey recorded. Thirty-eight percent of respondents also are making changes to their annual incentive-plan performance measures and 30% are making changes to their long-term incentive-plan measures. About one-third have already shifted to time-based restricted stock and performance-based shares, and another third have changed or are considering changes to their executive-pay programs to address excessive risk.

Tensions and Checkpoints
Given that companies seem to be taking action, however belatedly, on this hot-button issue, many argue that no government intervention is needed. “I’m a firm believer that the current system is working,” says Mylle Harvey Mangum, chairman and CEO of IBT Holdings, a designer and builder of retail environments for bank branches. Mangum sits on several boards and currently chairs two compensation committees, at Haverty Furniture and Collective Brands (owner of Payless retail shoe stores). “Compensation committees are in the best and most knowledgeable position to address the perceived abuses,” she says. “Directors today are chosen by other board members and voted on by the shareholders. Nobody slips by anymore.”

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