The Advisors' Blog

– Broc Romanek, CompensationStandards.com

This op-ed piece in the WSJ from Henry Mintzberg is interesting:

These days, it seems, there is no shortage of recommendations for fixing the way bonuses are paid to executives at big public companies.

Well, I have my own recommendation: Scrap the whole thing. Don’t pay any bonuses.

This may sound extreme. But when you look at the way the compensation game is played–and the assumptions that are made by those who want to reform it–you can come to no other conclusion. The system simply can’t be fixed. Executive bonuses–especially in the form of stock and option grants–represent the most prominent form of legal corruption that has been undermining our large corporations and bringing down the global economy. Get rid of them and we will all be better off for it.

The failings of the current system–and the executives who live by it–are painfully obvious. Although these executives like to think of themselves as leaders, when it comes to their pay practices, many of them haven’t been demonstrating leadership at all. Instead they’ve been acting like gamblers–except that the games they play are hopelessly rigged in their favor.

First, they play with other people’s money–the stockholders’, not to mention the livelihoods of their employees and the sustainability of their institutions.

Henry Mintzberg, a management professor at McGill University, explains to WSJ’s Erin White why executive bonuses are a bad idea and dicusses alternative ways to structure CEO pay.

Second, they collect not when they win so much as when it appears that they are winning–because their company’s stock price has gone up and their bonuses have kicked in. In such a game, you make sure to have your best cards on the table, while you keep the rest hidden in your hand.

Third, they also collect when they lose–it’s called a “golden parachute.” Some gamblers.

Fourth, some even collect just for drawing cards–for example, receiving a special bonus when they have signed a merger, before anyone can know if it will work out. Most mergers don’t.

And fifth, on top of all this, there are chief executives who collect merely for not leaving the table. This little trick is called a “retention bonus”–being paid for staying in the game!

This may be nice work if you can get it, but it is awful work if you care about the sustainability of an enterprise. Who, playing such games, wouldn’t take substantial risks? What’s to lose? If more executives these days were as creative in doing their jobs as they are in getting compensated for them, we would be in a period of boom, not bust.

Faulty Assumptions

Surely, you may be saying, there’s a way to fix this system, to make bonuses work for corporate prosperity and economic security.

Plenty of people think so, as evidenced by all the suggestions for changing it. Even the Federal Reserve has weighed in, announcing a new plan to rein in bank compensation practices that encourage too much risk-taking.

But I believe that all these efforts are doomed to fail as well. That’s because the system, and any proposals to fix it, must inevitably rest on several faulty assumptions. Specifically:

• A company’s health is represented by its financial measures alone–even better, by just the price of its stock.

Come on. Companies are a lot more complicated than that. Their health is significantly represented by what accountants call goodwill, which in its basic sense means a company’s intrinsic value beyond its tangible assets: the quality of its brands, its overall reputation in the marketplace, the depth of its culture, the commitment of its people, and so on.

But how to measure such things? Accountants have always had trouble when they have tried, as have stock-market analysts, investors and even potential purchasers of the company. (That’s one of the reasons so many mergers fail.) No board of directors is going to have much luck finding that elusive measure, either.

This flawed assumption, though, does far more damage than simply distorting CEO compensation. All too often, financial measures are a convenient substitute used by disconnected executives who don’t know what else to do–including how to manage more deeply.

Or worse, such measures encourage abuse from impatient CEOs, who can have a field day cashing in that goodwill by cutting back on maintenance and customer service, “downsizing” experienced employees while others are left to “burn out,” trashing valued brands, and so on. Quickly the measured costs are reduced while slowly the institution deteriorates.

• Performance measures, whether short or long term, represent the true strength of the company.

For years, the idea was that a company’s short-term performance represented its long-term health. The banks and insurance companies have pretty much laid that assumption to rest.

So now there is focus on trying to link bonuses with longer-term measures. Well, I defy anyone to pinpoint and measure such performance in any serious way and attribute it to one or a few executives.

How do you assess the long-term performance of a chief executive? Some proposals look at three years, others as many as 10 years. But can we even be sure of 10 years? Is a decade long enough in the life of a large company, with all its natural momentum? How many years of questionable management did it take to bring General Motors to its knees?

Conversely, if a company’s stock price goes up and stays up for several years, does that signify the definitive success of the current chief executive? What if the previous CEO made some good decisions that later kicked in? Don’t we all talk about the long-term influence of executive decisions? Have we forgotten about that?

• The CEO, with a few other senior executives, is primarily responsible for the company’s performance.

What if the CEO was lucky enough to have been in the right place at the right time? When it comes to a company’s current performance, history matters, culture matters, markets matter, even weather can matter. How many chief executives have succeeded simply by maneuvering themselves into favorable situations and then hanging on while taking credit for all the success? In something as complex as the contemporary large corporation, how can success over three or even 10 years possibly be attributed to a single individual? Where is teamwork and all that talk about people being “our most important asset?”

More important, should any company even try to attribute success to one person? A robust enterprise is not a collection of “human resources”; it’s a community of human beings. All kinds of people are responsible for its performance. Focusing on a few–indeed, only one, who may have parachuted into the most senior post from the outside–just discourages everyone else in the company. Sometimes, there is the impression that a forceful chief executive has turned around a troubled company. But how sure can we be that such a turnaround will be long-lasting? After all, so many of these supposed corporate resurrections eventually go sour.

Bad Signals

Put differently, executive compensation these days reinforces a class structure within the enterprise that is antithetical to its effective functioning. Because of its symbolic nature, executive compensation as currently practiced sends out the worst possible signal to everyone in the enterprise.

One alternative, of course, is to pay bonuses to everyone, perhaps according to their base pay. That solves one problem but not another: how to ensure that the goodwill is not being cashed in by everyone, collectively. Once again, who is to come up with the measures that assess performance correctly?

So, again, there is but one solution: Eliminate bonuses. Period. Pay people, including the CEO, fairly. As an executive, if you want a bonus, buy the stock, like everyone else. Bet on your company for real, personally.

Bonuses as a Screening Tool

Actually, bonuses can serve one purpose. It has been claimed that if you don’t pay them, you don’t get the right person in the CEO chair. I believe that if you do pay bonuses, you get the wrong person in that chair. At the worst, you get a self-centered narcissist. At the best, you get someone who is willing to be singled out from everyone else by virtue of the compensation plan. Is this any way to build community within an enterprise, even to foster the very sense of enterprise that is so fundamental to economic strength?

Accordingly, executive bonuses provide the perfect tool to screen candidates for the CEO job. Anyone who insists on them should be dismissed out of hand, because he or she has demonstrated an absence of the leadership attitude required for a sustainable enterprise.

Of course, this might thin the roster of candidates. Good. Most need to be thinned, in order to be refilled with people who don’t allow their own needs to take precedence over those of the community they wish to lead.

Many Motivations

People pursue the job of chief executive for all kinds of reasons: the prestige of the position, the sheer pleasure of heading up a major company, the chance to make a real difference to an institution they cherish, and, of course, remuneration. When push comes to shove, do you think pay is more consequential to these people than the other factors? All this compensation madness is not about markets or talents or incentives, but rather about insiders hijacking established institutions for their personal benefit.

Too many large corporations today are starved for leadership–true leadership, meaning engaged leadership embedded in concerned management. And the global economy desperately needs renewed enterprise, embedded in the belief that companies are communities. Getting rid of executive bonuses, and the gambling games that accompany them, is the place to start.