09 January 2007
Simplifying Executive Pay
Comment on "It pays to simplify executive compensation" - 4th January 2007 by John Plender (Financial Times) Click here to see the original article (subscription required)
John Plender appears to be unduly sceptical about TSR as a performance measure. It is true that many TSR based remuneration schemes are badly designed and do pay out windfalls that are not attributable to executive performance. However this is not the fault of the performance measure, this is the fault of the scheme design. A well designed scheme will only pay out if performance has been good compared to the performance of a set of comparable companies.Similarly a well designed remuneration scheme will only pay out for genuine long term increases in TSR. Short term changes in TSR are meaningless because of share price volatility, but a well designed scheme can eliminate the effect of volatility.Growth in the TSR index over the long term is what creating shareholder value is all about. All other performance measures (including Economic Value Added) matter only because they are predictors of long term growth in shareholder value. Long term growth in TSR is the one and only performance measure on which directors should receive variable pay.John Plender is quite right to point out that it pays to simplify executive compensation. A single incentive scheme based on long term TSR growth would provide far, far better incentives than the plethora of incentive schemes with which most executives are currently rewarded.
As appeared on ft.com subscription website (9th January 2007):
http://www.ft.com/cms/6c2bf1ce-91b7-11da-bab9-0000779e2340.html?q=y&a=tpc&s=646099322&f=6361039231&m=8361039231
John Plender appears to be unduly sceptical about TSR as a performance measure. It is true that many TSR based remuneration schemes are badly designed and do pay out windfalls that are not attributable to executive performance. However this is not the fault of the performance measure, this is the fault of the scheme design. A well designed scheme will only pay out if performance has been good compared to the performance of a set of comparable companies.Similarly a well designed remuneration scheme will only pay out for genuine long term increases in TSR. Short term changes in TSR are meaningless because of share price volatility, but a well designed scheme can eliminate the effect of volatility.Growth in the TSR index over the long term is what creating shareholder value is all about. All other performance measures (including Economic Value Added) matter only because they are predictors of long term growth in shareholder value. Long term growth in TSR is the one and only performance measure on which directors should receive variable pay.John Plender is quite right to point out that it pays to simplify executive compensation. A single incentive scheme based on long term TSR growth would provide far, far better incentives than the plethora of incentive schemes with which most executives are currently rewarded.
As appeared on ft.com subscription website (9th January 2007):
http://www.ft.com/cms/6c2bf1ce-91b7-11da-bab9-0000779e2340.html?q=y&a=tpc&s=646099322&f=6361039231&m=8361039231
Labels: Complexity, Plender, TSR
03 January 2007
Home Depot & Bob Nardelli
I sent the following letter to the FT on 3rd January 2007. It was not published.
Dear Sir,
I find it ironic that the departure of Bob Nardelli from Home Depot is being described as a victory for shareholder activists, who thought he was overpaid. Your report (Home Depot chief Nardelli steps down – ft.com, 3/1/07) suggests that Mr Nardelli will receive a severance package worth $210m, in addition to the more than $120m that he has received in compensation since joining the company. The problem of overpayment is therefore even greater now that Mr Nardelli is not running the company!
Home Depot’s share price rose 3% on this announcement, suggesting that shareholders value the potential improvements in performance far more than the $210m.
The traditional argument for high executive pay is that shareholders have to pay high to attract the best performers. However, in this case, shareholders are paying even more to get rid of a perceived poor performer, than they were paying to attract a perceived good performer. This is surely conclusive proof of Professor Bebchuk’s contention that high executive pay in the US is far better explained by the power of CEOs than by considerations of markets or performance. (Pay Without Performance by Lucian Bebchuk and Jesse Fried, Harvard University Press, 2004).
Yours faithfully,
Revd. Patrick H Gerard
Dear Sir,
I find it ironic that the departure of Bob Nardelli from Home Depot is being described as a victory for shareholder activists, who thought he was overpaid. Your report (Home Depot chief Nardelli steps down – ft.com, 3/1/07) suggests that Mr Nardelli will receive a severance package worth $210m, in addition to the more than $120m that he has received in compensation since joining the company. The problem of overpayment is therefore even greater now that Mr Nardelli is not running the company!
Home Depot’s share price rose 3% on this announcement, suggesting that shareholders value the potential improvements in performance far more than the $210m.
The traditional argument for high executive pay is that shareholders have to pay high to attract the best performers. However, in this case, shareholders are paying even more to get rid of a perceived poor performer, than they were paying to attract a perceived good performer. This is surely conclusive proof of Professor Bebchuk’s contention that high executive pay in the US is far better explained by the power of CEOs than by considerations of markets or performance. (Pay Without Performance by Lucian Bebchuk and Jesse Fried, Harvard University Press, 2004).
Yours faithfully,
Revd. Patrick H Gerard
Labels: Bebchuk, failure, Nardelli, power
