The Economist November 10th 2001
Executive pay
Under water
читать дальшеThe downturn is making companies think anew about how to tie managers' compensation to performance
I HAS been a remarkable experiment. Reward top executives according to the performance of their companies, and their interests will be more closely aligned with those of shareholders. So far has the ex¬periment gone, particularly in America, that William M. Mercer, a pay consultancy, says that only 18% of the compensation of American chief executives (and 40% of that of British chief executives) came from fixed salaries last year. The rest came from variable sources such as stock options and other performance-related bonuses.
As corporate profits and share prices soared in the late 1990s, so did these re¬wards. With the fall in the stockmarket this year, however, many executives' stock op¬tions have become almost worthless. Ira Kay of Watson Wyatt, another pay consul¬tancy, reckons that 90% of American quoted companies have some options "under water"—ie, the share price is below that at which the options were issued. At perhaps half of these companies, he reck-ons, all the options are under water.
At Harvard Business School, Brian Hall and Thomas Knox have done more de¬tailed sums, studying a sample of top exec¬utives in large and small companies at the end of 2000. In some 40% of the compa¬nies they looked at, the top cadre of execu¬tives had near-valueless options.
This is not the only way in which per¬formance-related pay is being whacked. Other measures on which executive bo¬nuses are based, such as hitting budget tar¬gets, are doing badly. Richard Bednarek, a director of the Hay Group, a remuneration consultancy, says that for executive direc¬tors of FTSE 100 companies in Britain last year, the median bonus was 50% of basic salary. Some got well over 100%. These figures will be far lower this year.
Because most bonuses are at least partly related to such fuzzy things as "per¬sonal goals", some companies will (if they so wish) be able to massage them back up a bit. For many industries, though, that will be impossible. Wall Street bankers' bo¬nuses are likely to be down by as much as 70% this year. Several airlines, including Delta, have already ditched bonuses for their top managers; so have Ford, Louisi¬ana-Pacific and Siebel.
For many, this year's bonus is being al¬lowed to keep the same salary. British Air¬ways and CSFB are among a number of companies seeking to cut their executives' nominal salaries. Others, says Steven Hall of Pearl Meyer, a company that monitors top pay, are giving no salary increases but raising possible bonus pay-outs, so that high-fliers have a chance to earn a little more if things go well.
With options drowning and bonuses shredded, how will companies reward their stars? No longer will the likes of En¬ron, a troubled American energy com¬pany, be able to pay less than the industry average by relying heavily on options. "Cash is king," says Charles Wardell of Korn/Ferry International, a big headhunt¬ing firm. The star candidates he sees want a basic salary and a cash bonus. That is bad news for many companies: cash is a scarce commodity these days.
In Silicon Valley, though, people still ask for options—but far more of them than before. Amazon issued 26m employee stock options in the third quarter of this year. New options add to the overhang of allocated but unclaimed corporate equity, something that shareholders dislike. But they hate it more when companies "reprice" options (cancel them and reissue them at a lower, more favourable price). Any company that does this (few now do) must charge the replacement option, unlike the original one, against profits.
Pay consultants therefore sweat through the night to concoct ingenious ways to issue options that will motivate and retain talent without annoying share¬holders. One device that minimises over¬hang, popular on America's west coast, is the "stub option"—a short-term option that "vests" (becomes available for an em¬ployee to exercise) within 12 months but expires after 13. Most options vest within four years and expire after ten.
On both sides of the Atlantic, the fast-growing fad in remuneration packages is "deferred bonuses". A company will, typi¬cally, pay a cash bonus of 40% of salary up-front, and another 40% in shares (not, note, options) which become available only at some future date. "Restricted" stock of this sort has become an increasingly popular part of top executives' pay pack¬ages in America over the past couple of years. When the share price falls, options become worthless—but restricted stock is merely worth much less than before.
The longer-term question, however, is how to link pay better to sound perfor¬mance. Some academics, such as Sendhil Mullainathan of MIT, have criticised stock-related pay on the ground that it re¬wards good luck as much as good perfor¬mance. The rising stockmarket tide of the past few years did wonders for a host of leaky boats (and their top executives).
Now that options are so drenched, even some of the compensation consul-tants who once helped to design them wonder about their worth. "Options were given to too many people," reflects Scott Olsen, who specialises in executive com¬pensation at Towers Perrin. "Many sold as soon as they could. So they did not build a sense of ownership."
Moreover, a relentless focus on some performance measures can skew cor-porate policy. In the latest issue of the Har¬vard Business Review, Michael Jensen, a professor at Harvard Business School, criti¬cises the ties that exist in most companies between a manager's budget and his pay. These, he says, "distort decisions, and turn honest managers into schemers". Mr Jen¬sen argues that compensation should re¬ward actual performance, independent of budget targets.
At root, though, badly designed re¬wards often reflect bad corporate gover-nance. Board remuneration committees too often indulge in a form of high-level back-scratching. Nell Minow, an expert on corporate governance, says that decisions on pay are "best made by capable, expert, vitally involved directors, and until our boards meet that standard, companies and their shareholders will break out with bad pay the way that sufferers of poison ivy break out in an itchy rash." The rash de¬veloped in the 1990s has not yet subsided; it has merely changed colour a bit. ■
Executive pay
Under water
читать дальшеThe downturn is making companies think anew about how to tie managers' compensation to performance
I HAS been a remarkable experiment. Reward top executives according to the performance of their companies, and their interests will be more closely aligned with those of shareholders. So far has the ex¬periment gone, particularly in America, that William M. Mercer, a pay consultancy, says that only 18% of the compensation of American chief executives (and 40% of that of British chief executives) came from fixed salaries last year. The rest came from variable sources such as stock options and other performance-related bonuses.
As corporate profits and share prices soared in the late 1990s, so did these re¬wards. With the fall in the stockmarket this year, however, many executives' stock op¬tions have become almost worthless. Ira Kay of Watson Wyatt, another pay consul¬tancy, reckons that 90% of American quoted companies have some options "under water"—ie, the share price is below that at which the options were issued. At perhaps half of these companies, he reck-ons, all the options are under water.
At Harvard Business School, Brian Hall and Thomas Knox have done more de¬tailed sums, studying a sample of top exec¬utives in large and small companies at the end of 2000. In some 40% of the compa¬nies they looked at, the top cadre of execu¬tives had near-valueless options.
This is not the only way in which per¬formance-related pay is being whacked. Other measures on which executive bo¬nuses are based, such as hitting budget tar¬gets, are doing badly. Richard Bednarek, a director of the Hay Group, a remuneration consultancy, says that for executive direc¬tors of FTSE 100 companies in Britain last year, the median bonus was 50% of basic salary. Some got well over 100%. These figures will be far lower this year.
Because most bonuses are at least partly related to such fuzzy things as "per¬sonal goals", some companies will (if they so wish) be able to massage them back up a bit. For many industries, though, that will be impossible. Wall Street bankers' bo¬nuses are likely to be down by as much as 70% this year. Several airlines, including Delta, have already ditched bonuses for their top managers; so have Ford, Louisi¬ana-Pacific and Siebel.
For many, this year's bonus is being al¬lowed to keep the same salary. British Air¬ways and CSFB are among a number of companies seeking to cut their executives' nominal salaries. Others, says Steven Hall of Pearl Meyer, a company that monitors top pay, are giving no salary increases but raising possible bonus pay-outs, so that high-fliers have a chance to earn a little more if things go well.
With options drowning and bonuses shredded, how will companies reward their stars? No longer will the likes of En¬ron, a troubled American energy com¬pany, be able to pay less than the industry average by relying heavily on options. "Cash is king," says Charles Wardell of Korn/Ferry International, a big headhunt¬ing firm. The star candidates he sees want a basic salary and a cash bonus. That is bad news for many companies: cash is a scarce commodity these days.
In Silicon Valley, though, people still ask for options—but far more of them than before. Amazon issued 26m employee stock options in the third quarter of this year. New options add to the overhang of allocated but unclaimed corporate equity, something that shareholders dislike. But they hate it more when companies "reprice" options (cancel them and reissue them at a lower, more favourable price). Any company that does this (few now do) must charge the replacement option, unlike the original one, against profits.
Pay consultants therefore sweat through the night to concoct ingenious ways to issue options that will motivate and retain talent without annoying share¬holders. One device that minimises over¬hang, popular on America's west coast, is the "stub option"—a short-term option that "vests" (becomes available for an em¬ployee to exercise) within 12 months but expires after 13. Most options vest within four years and expire after ten.
On both sides of the Atlantic, the fast-growing fad in remuneration packages is "deferred bonuses". A company will, typi¬cally, pay a cash bonus of 40% of salary up-front, and another 40% in shares (not, note, options) which become available only at some future date. "Restricted" stock of this sort has become an increasingly popular part of top executives' pay pack¬ages in America over the past couple of years. When the share price falls, options become worthless—but restricted stock is merely worth much less than before.
The longer-term question, however, is how to link pay better to sound perfor¬mance. Some academics, such as Sendhil Mullainathan of MIT, have criticised stock-related pay on the ground that it re¬wards good luck as much as good perfor¬mance. The rising stockmarket tide of the past few years did wonders for a host of leaky boats (and their top executives).
Now that options are so drenched, even some of the compensation consul-tants who once helped to design them wonder about their worth. "Options were given to too many people," reflects Scott Olsen, who specialises in executive com¬pensation at Towers Perrin. "Many sold as soon as they could. So they did not build a sense of ownership."
Moreover, a relentless focus on some performance measures can skew cor-porate policy. In the latest issue of the Har¬vard Business Review, Michael Jensen, a professor at Harvard Business School, criti¬cises the ties that exist in most companies between a manager's budget and his pay. These, he says, "distort decisions, and turn honest managers into schemers". Mr Jen¬sen argues that compensation should re¬ward actual performance, independent of budget targets.
At root, though, badly designed re¬wards often reflect bad corporate gover-nance. Board remuneration committees too often indulge in a form of high-level back-scratching. Nell Minow, an expert on corporate governance, says that decisions on pay are "best made by capable, expert, vitally involved directors, and until our boards meet that standard, companies and their shareholders will break out with bad pay the way that sufferers of poison ivy break out in an itchy rash." The rash de¬veloped in the 1990s has not yet subsided; it has merely changed colour a bit. ■