16 June 2006
Executive compensation in crisis
The FT is full of executive compensation today (16th June 2006). On page 13 there is a full page of "Comment and Analysis" digesting the effects in the US of the options backdating scandal and the shareholder revolt over executive compensation at Home Depot. On page 16 the Lex column contemplates the inevitable feeling among investors that they have been taken for a ride by executive compensation arrangements.
I am grateful to the Lex column for its timely comments on executive compensation. Now is the time for a complete reconsideration of the way that executive pay is set.
As Lex points out, the traditional defense for high compensation is that this is what it takes to attract talent in a competitive market. If we take this argument seriously then we must question if the market is truly competitive. Lex also notes that executives appear to have very significant protection against real market pressures. Part of this arises because, as appointers of executive directors, company board members are dominant in their own market. Part of it arises from price distorting mechanisms, such as the near universal desire to pay executives at median level or above. These two issues ensure that the market in executive talent is far from truly competitive. It should be investigated by competition authorities. I seek to make the case for a competition law enquiry elsewhere in this blog.
The idea of recruitment in a competitive market can never provide a sound basis for setting executive pay. It implies that executives are selling themselves in a market to maximise their own personal return. This is completely in contradiction with the fiduciary responsibilities to act in the shareholders best interests. It introduces a fundamental conflict of interests in the board as both buyer and provider of executive talent. The executive director can only make sense as a role of service to shareholders. Executive pay has to reflect this and be set at a level which provides confidence in that attitude of service.
And where has this unhelpful idea about a competitive market in executive talent come from? I think we need to look at dynamics behind the remuneration consultancy business. Surely the best way of getting new consultancy business is to approach management with the message "You deserve more pay". Somehow the consultants have to justify that message.
This entry was originally written as a comment on the Lex Live page of ft.com. See:
http://forums.ft.com/2/OpenTopic?q=Y&a=tpc&s=646099322&f=813102159&m=923102159
I am grateful to the Lex column for its timely comments on executive compensation. Now is the time for a complete reconsideration of the way that executive pay is set.
As Lex points out, the traditional defense for high compensation is that this is what it takes to attract talent in a competitive market. If we take this argument seriously then we must question if the market is truly competitive. Lex also notes that executives appear to have very significant protection against real market pressures. Part of this arises because, as appointers of executive directors, company board members are dominant in their own market. Part of it arises from price distorting mechanisms, such as the near universal desire to pay executives at median level or above. These two issues ensure that the market in executive talent is far from truly competitive. It should be investigated by competition authorities. I seek to make the case for a competition law enquiry elsewhere in this blog.
The idea of recruitment in a competitive market can never provide a sound basis for setting executive pay. It implies that executives are selling themselves in a market to maximise their own personal return. This is completely in contradiction with the fiduciary responsibilities to act in the shareholders best interests. It introduces a fundamental conflict of interests in the board as both buyer and provider of executive talent. The executive director can only make sense as a role of service to shareholders. Executive pay has to reflect this and be set at a level which provides confidence in that attitude of service.
And where has this unhelpful idea about a competitive market in executive talent come from? I think we need to look at dynamics behind the remuneration consultancy business. Surely the best way of getting new consultancy business is to approach management with the message "You deserve more pay". Somehow the consultants have to justify that message.
This entry was originally written as a comment on the Lex Live page of ft.com. See:
http://forums.ft.com/2/OpenTopic?q=Y&a=tpc&s=646099322&f=813102159&m=923102159
