On Executive Pay, Simpler Is Better - How To Fix Executive Pay - Harvard Business Review

On Executive Pay, Simpler Is Better - How To Fix Executive Pay - Harvard Business Review


On Executive Pay, Simpler Is Better
4:15 PM Thursday June 25, 2009
by John T. Landry
Tags:Leadership, Leadership development, Talent management

Excerpts:

Back in 1990, Michael Jensen wrote a landmark HBR article arguing that "It's Not How Much You Pay CEOs, But How." He wanted boards to adjust pay according to company performance as shown by stock price. V.G. Narayanan's recent post in this debate goes a step further, arguing that executive pay should be tied aggressively to a company's specific strategy.

The Jensen article was cogent, but it led to an explosion in supercharged stock-option grants in the 1990s. Jensen initially favored restricted stock (full shares made available only years after being awarded). As he saw to his dismay, boards heard only part of his message, the part about tying compensation to stock. Issuing stock options allowed boards to respond to the market pressures they felt to boost executive pay. And in those heady days, options grants had no immediate impact on the company's books. Executives responded--rationally--by managing earnings long enough to prop up stock prices, regardless of long-term consequences. In Jensen's words, they became hooked on stock price like addicts on heroin.

In a separate post in this debate, Lucian Bebchuk and Jesse Fried offer a complex timing scheme of vesting and cashing stock options. They're trying to retain the intense incentives of stock options while preventing gamesmanship. It's hard to see boards going along, once the outcry over executive compensation fades.

That's why restricted stock is worth a new look. These grants would still give CEOs some incentive to focus on long term corporate performance. Yet the upside potential would not be great enough to tempt executives into earnings management and other manipulation. The simplicity of relying on restricted stock would also free up board time for more direct oversight of executives. Restricted stock also allows companies to pay executives handsomely, which is what boards mainly care about.

Read Full Article: http://blogs.harvardbusiness.org/hbr/how-to-fix-executive-pay/2009/06/on-executive-pay-simpler-is-be.html

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This posting was made my Jim Jacobs, President & CEO of Jacobs Executive Advisors. Jim also serves as Leader of Jacobs Advisors' Insurance Practice.