How to Fix Executive Pay: A Harvard Business Review Debate

In response to the all the attention on executive pay these days, and with corporate leaders attempting to outrun federal regulators in addressing concerns and issues about how executives are rewarded, Harvard Business Review has createda debate forum on how to fix executive pay.

Is it fair – or useful – to limit executive compensation?

Do limits hurt companies’ competitiveness?

Is CEO pay a moral issue?

What’s the best way to structure executive pay?

HBR has invited a group of experts to lead an online discussion of these and other questions. 

Recent posts include:

How to Help Directors Increase Oversight of Pay by Don Delves, the Delves Group (July 1)

To Fix CEO Pay, Focus on the Big Shareholders by John Mackey, Chairman & CEO of Whole Foods Market (June 30)

On Executive Pay, Simpler is Better by John T. Landry, Business Development Editor at Harvard Business Review (June 25)

How to Tie Equity Pay to Long-Term Performance by Lucian Bebchuk & Jesse Fried, Professors of Law at Harvard and U.C. Berkeley Law Schools, respectively (June 24)

Executive Pay, It's About "How", Not "How Much" by V. G. Narayanan, Professor of Business Administration at Harvard Business School (June 22)

And there's more...

Tune in for an interesting and informative debate on this critical topic from a diverse group of business leaders, academics, researchers and consultants.

 

 

 

Pay Range Secrecy Persists ... and the Approaching Window for Addressing It

I was struck by a particular statistic in a recent WorldatWork research report ("Alignment of Business Strategies, Organizational Structure and Reward Programs" coauthored by Dow Scott, Ph.D. of Loyola University and the Hay Group - members click here to access):  Only 41% of responding organizations indicate that their employees know the pay range for their own position.  This shouldn't surprise me, as it is consistent with findings in earlier research, yet I admit it still does.

As I try to get my head around the persistent nature of pay range secrecy, two questions come to mind:

Why?

For how much longer?

Let's start with the why.  First, know that this can't be written off as an issue of smaller, less sophisticated organizations without formal pay programs or professional HR staff.  The vast majority of participating organizations (86%) have more than 1,000 employees.  More than half of them (54%) have over 5,000.  These are big companies, not emerging businesses or "Mom and Pop shops".

That being the case, I would suggest there are three reasons that pay range secrecy exists in these organizations:

1. Some organizations are simply enshrouded in a culture of secrecy, and pay range secrecy is merely one example of how this plays out. 

2. Management does not believe that pay ranges and pay range assignments are defensible

3. Management does not believe that actual employee pay levels within their assigned salary ranges are defensible

None of these seem like good reasons to you?  I'm hard pressed to disagree, but I also appreciate that this (particularly #2 and #3) is the reality many organizations are faced with at present ... and there aren't currently a lot of discretionary pay budget dollars floating around which can be used to fix problems.

How much longer? 

As the recession bottoms out and the labor market begins to turn, which it will (particularly in critical skill areas), employee expectations and demands will rise accordingly.  In this age of information and transparency, and given the increased pressure and regulation around pay discrimination, it is difficult for me to believe that pay range secrecy is a tactic that employers can hold onto in the long run.

But as the economy turns, we will see plenty of churn and adjustment as the labor market (and market pay values) adapt to the reality of the other side.  This presents all of us with opportunity and (frankly) cover for getting our pay houses in order.

If you are one of the 59% of employers who does not reveal personal pay ranges to employees and the reason is a lack of confidence in your pay program and practices, you have a distinct window for addressing this approaching on the horizon.

I hope you take advantage of it.

Image:  Creative Commons Photo "Secrets" by stevendepolo

Most Furloughs to Go Away - But Will Their Impact Linger?

In a post last week, I explored the question of whether the furloughs of '09 would trigger a fundamental and irrevocable shift in the employment relationship.

It appears, based on the latest research from Watson Wyatt (conducted in June and reflecting 179 U.S. based employers) that most of the companies who implemented mandatory furloughs or shortened work weeks plan to reverse or eliminate them in the next 12 months.

From the survey:

Of those companies who implemented a reduced work week ...

• 29% plan to reverse the practice in the next 6 months

• 39% plan to reverse the practice in the next 12 months

• 10% do not expect to reverse the practice

• 23% do not know

And of those employers who put a mandatory furlough in place ...

• 20% plan to eliminate the furlough in the next 6 months

• 45% plan to eliminate the furlough in the next 12 months

• 10% plan to eliminate the furlough in the next 18 months

• 10% do not expect to eliminate the furlough

• 15% do not know

So most employers hope to put the reduced work weeks and mandatory furloughs behind them in the next 12 months.  The question remains ... while they may move to reinstate full work weeks, will they ever recapture the sense of employee dedication and 24-hour-a-day-availability that they may have counted on before the recession. 

Time will tell, I guess.

Salary Freezes and Reductions... Is the End in Sight?

In the latest update to their ongoing research on the impact of the economic crisis (this round conducted in June and reflecting 179 U.S. based employers), Watson Wyatt finds that many - but not all - companies are planning the reversal of recent cost cutting actions.  While there will be reinstatements in some areas, survey responses also suggest that some changes (staff size being chief among them) that are expected to be longer-term in nature.

Some findings from the salary side of things:

Salary Freezes

Of those companies that have implemented salary freezes ...

• 17% plan to eliminate the freeze in the next 6 months

• 52% plan to eliminate the freeze in the next 12 months

• 7% plan to eliminate the freeze in the next 18 months

• 2% believe that it will be more than 18 months until the freeze is eliminated

• 4% do not expect to eliminate the salary freeze

• 18% don't know

Of those stating plans to eliminate a salary freeze, 78% will eliminate all salary freezes.

Salary Reductions

Of those companies that have implemented salary reductions ...

• 30% plan to reverse the salary reductions in the next 6 months

• 25% plan to reverse the salary reductions in the next 12 months

• 5% plan to reverse the salary reductions in the next 18 months

• 20% do not expect to reverse the salary reductions

• 20% do not know

Of those planning to reverse salary reductions, 78% will restore salaries to their original levels.

Merit Increase Budgets

Responding companies report their actual 2009 and planned 2010 merit increase budgets to be as follows, on average...

• 2009 Actual:  2.0%

• 2010 Planned:  3.0%

Note that of those companies that reduced salaries, about half do not yet know if their next merit increases will build upon current reduced salary levels or the former salary levels.

While it is heartening to hear that we may have the worst behind us in terms of salary freezes and reductions, this data also suggests that salary plans and levels will likely be in flux for at least the next 12 months.

Image: Creative Commons Photo "The End" by Ewen Roberts

Will the Furloughs of '09 Trigger a Fundamental Shift in the Employment Relationship?

In her post The Slippery Slope of This Recession's Talent Management Practices, Harvard Business blogger Tammy Erickson talks about how recessions prompt changes in the way we do things - but that this rarely happens in a deliberate manner or with a full appreciation of the consequences.

As Erickson points out, the recession of 1981 brought the concept of a "layoff" into widespread use.  The 1991 recession drove many individuals into contract employment - a status many hung on to even after "permanent" jobs became plentiful again.  Now, our current recession has ushered in the return to furloughs.

Consider the following statistics:

• A Towers Perrin study, conducted earlier this year, found that 40% of employers had either implemented or were considering a mandatory furlough, 32% a reduced workweek.

• A Hewitt Associates survey, conducted in April 2009, found that 44% of employers had either implemented or were considering a reduced workweek or involuntary furlough.

• A Watson Wyatt study, also completed in April 2009, found that 21% had implemented or were expecting to implement a mandatory furlough, 26% a reduced workweek.

Erickson's point: That this practice, though it may inflict less pain and hardship than would have occurred with a layoff, is irrevocably changing the relationship between employers and employees.  From her post:

But the idea of furloughs, particularly for managers and professionals, is planting the seed of a new way of looking at work in our minds. Suddenly companies have asked us to work, say, 32 hours a week rather than 40. Hmmm. What does that really mean? Most of us were never working 40 hours - we might have been working 50 or maybe even 60. We were answering emails at odd hours, writing in the early hours, calling Singapore at night. Does this mean that we should now work 20% less than we were before . . . or does it mean we should work literally 32 hours?

For many, I believe the conclusion will be that we should work the hours specified by the company and perhaps do other things - start new businesses on the side perhaps, sell stuff on eBay, take another job, go back to school, whatever - with the other time.

In this shift, companies will lose far more than the number of hours they think they've cut back. Companies will lose that sense of total dedication - the sense that what I produce on my own time is theirs, that I have a responsibility to answer emails whenever they arrive or participate in odd-hour phone calls.

I agree.  As was true with its predecessors, the consequences of this recession and the actions it has prompted by employers will be with us long into the future ... and in ways we may not appreciate for some time to come.

The Perils of Allowing Popular Opinion & Conventional Wisdom to Drive Executive Pay

Last week's appointment of a Federal Compensation Czar represents one of a number of steps the federal government is taking to insert itself into executive compensation - initially at companies receiving federal bailout funds, but potentially much beyond.

One aspect of executive pay that is drawing particularly acute attention is its relationship to institutional risk.  As a result, we are seeing a lot of pressure and attention from government officials not only on the levels of executive pay but also on the steps taken - in pay design and structure - to mitigate risk.

Problem is, this is neither as simple or straightforward as it looks.  New research from Watson Wyatt brings us an appropriate cautionary note here, as it demonstrates how some compensation elements conventionally believed to aggravate risk may actually do the opposite ... and vice versa.

Watson Wyatt conducted an empirical analysis of the executive compensation architecture at more than 1,000 firms from the S&P 1500 from 2005 to 2007, examining each individual program element in view of the relationship between the executive's realizable pay and the Z-score (a measure available through S&P or Blooomberg which has been historically used to measure credit risk, and which has been shown to be predictive of bankruptcy).  The purpose of this exercise was to identify which executive compensation elements acted as "risk mitigators" (i.e., strengthened the relationship between pay and risk reduction, encouraging executives to manage risk more effectively) and which as "risk aggravators" (i.e., weakened the relationship between pay and risk reduction, potentially encouraging executives to take excessive risks).  For the most part, the study results contradict widely held beliefs, as the chart below illustrates:

 

Image Source:  Watson Wyatt

Note, by way of example, that one of the design changes which has been pushed by government representatives recently - increasing the proportion of fixed (salary) versus variable (incentive) pay in the overall mix - turns out to be the one least related to high credit risk. 

The upshot?  I don't know all the details and particulars of the Watson Wyatt research, and there may even be elements of its methodology that are open to challenge.  I do believe, however, that it brings home some very important points, not the least of which are:

• That executive compensation design is a complex process full of subtleties and unknowns, which demand rigorous study and deep understanding in order to grasp the consequences of different structural actions and restraints, and

• That, therefore, there is peril in letting popular opinion - much less political whim - drive mandates on the level and architecture of executive pay. There may also be peril in appointing otherwise intelligent and capable people without deep expertise in executive compensation (and who will, as a result, be forced to rely on their "common sense") to positions of broad oversight in this matter.

The Watson Wyatt study, and the article in yesterday's Wall Street Journal on this topic, also sound a note of caution with respect to the efforts at stamping out risk.  Economic recovery requires that companies, whether they have accepted bailout funds or not, produce returns on shareholder investments.  Too much emphasis on avoiding risk may eliminate the prudent risk taking that goes hand-in-hand with the kind of growth and innovation that will be necessary to turn these organizations - and the economy at large - around. 

More on this to come tomorrow, when the Obama administration releases its proposal for overhaul of financial system regulation.

The Next Frontier for Variable Pay: Independent Contractors & "Free Agents"?

Last week, I posted on the (predicted) end of the merit increase (?) and the conclusion by most of the compensation experts presenting at last week's WorldatWork conference that the future of pay for performance lies in variable pay.

In his conference presentation "Projecting the Future of Variable Pay", Ken Abosch of Hewitt Associates also offered the prediction that variable pay would begin making significant inroads in the remuneration of independent contractors and "free agents".  Goodbye straight hourly rate, hello combination of fixed plus incentive pay tied to results.

I find this to be a very interesting forecast.  I imagine that it is already happening out there, and may even be the norm in certain pockets.  (And I'm not talking consultants, or at least those who run or work for ongoing consulting firms - but rather those who market their skills as an independent agent.  And I do realize that the difference can sometimes be a little fuzzy...)  But I haven't run across this practice much in my own travels.

I believe this potential trend, if in fact it comes to be (and I have every reason to think Mr. Abosch is on the money here), has a range of implications and raises a number of questions.  Here are a few that come immediately to mind for me:

• Incentive design for independent contractors will/must be different than for employees; we should not assume we can simply lift the plans used for one population and apply them to the other.  What aspects of this different work relationship must come to bear on incentive plan design?

• If we begin shifting the mix of compensation for independent contractors to a more "leveraged" model (versus straight salary), will we risk running afoul of the legal definition of independent contractor in any way?  Are there particular legal guideposts we need to be aware of?

• Will this trend, if it comes to pass, impact the "independent" talent pool?  In other words, will certain people opt in or out of "free agency" as a result - will this make that particular form of work less attractive to some, more attractive to others?

• Same question as above for employers; will this trend make the use of "free agents" more attractive to some organizations, less attractive to others?

Any with experience in incentive design for independents want to weigh in here? 

What questions does this potential trend raise for you?

Social Media as a Reward & Recognition Tool

As social media takes an increasingly predominant place in our personal and work lives, it also raises questions about potential connections to employee motivation, performance and rewards.  I chronicled this trend in a recent post, noting the challenges employers face in encouraging productive use of social networks by their employees.

Today, Paul Hebert of Incentive Intelligence introduces an intriguing new twist on the topic.  Taking the psychological principle of social proof as a stepping-off point, Paul uses a study done to determine the most effective way to influence hotel guests to reuse their towels in order to illustrate the power of social influence in impacting behavior.

From Paul's post:

Social networks allow information to surface and let's people see what others LIKE THEM are doing - making it more likely they will follow that lead.  If a salesperson can see that other salespeople like them are making sales and finding leads - they are more likely to work a bit harder.  If your employees see others working outside their job descriptions to help the company - they will want to do the same.

Using social networks isn't just posting the top performers at the end of the program - that's still necessary.  Leveraging social networks in your program is about having a continuous stream of information that shows people are hitting targets, trying new ideas, helping other departments - reinforcing those behaviors and communicating that these behaviors are common and are standard operating procedures.

The question is whether employers, many of whom are still wrestling with the risks and control issues surrounding employee social media use, will recognize the enormous opportunity they have to leverage these tools to make a positive difference in employee - and organizational - performance.

What about you?  How can you use the concept of social influence to augment your reward programs and practices?

Sign of the Times: Moribund IPO Market Drives Equity & Compensation Changes

Not only is the IPO (initial public offerings) market suffering from a severe case of the doldrums, it appears that tough times have forced some changes in financial and compensation strategies for IPO companies, according to new research from Presidio Pay Advisors.

Data from Presidio's newly released IPO Pay Reporter^TM reveals that over the past seven years founder CEO equity holdings have plunged, with median (founder CEO) ownership falling from a high of over 10% of total shares outstanding in 2002 to under 3% in 2008.

From the WSJ blog post on the research:

“Today, very few companies go public with limited revenue and nonexistent net income,” says Brandon Cherry, a principal at Presidio. “The prevailing IPO profile has shifted to a company with healthy revenue and positive net income, which is significantly affecting how compensation is delivered.”

That is a marked shift from earlier in the decade, when an Internet and technology start-up’s IPO highlighted the prospect of profits and even revenue in lieu of actual results. That approach worked in the early days of the commercial Internet, when just about any Web site could be semiplausibly touted as the next Wal-Mart Stores Inc. or AT&T Corp.

According to Cherry, companies are taking an additional two to three years to file for IPO in an effort to meet a more sustainable financial profile.  The most pronounced result of this is the dilution of founder CEO ownership; he sees this as likely due to less favorable term sheets or additional rounds of financing required to reach IPO.

Other key findings from the research:

• Companies in 2008 awarded and reserved fewer shares for grants to employees; median stock option overhang was at its lowest level in seven years.

• Since 2005, a 24 percent rise in median CEO base salary has been offset by a 25 percent decrease in annual cash bonuses, leaving total cash compensation essentially unchanged for both founder and non-founder CEOs.

• The mix between options and common stock ownership among all executives has undergone a transformation.  In 2002, executive officers had a stronger link to investor success, with over 85 percent of their ownership in the form of common stock and less than 15 percent in stock options.  By 2008, nearly 40 percent of executive officer ownership was stock options, which have no downside risk for executives, creating a potential disconnect between the financial interests of executives and company investors.  <Note from Ann:  I wonder if the current climate in public company executive compensation will impact and reverse this trend.>

And Now ... A Federal Compensation Czar

By now, many of you have heard that the Obama administration has appointed a Compensation Czar whose responsibility it will be to set salaries and bonuses for 175 top executives at seven of the nation's largest companies - companies who have received federal bailout funds.

The new official, Washington lawyer Kenneth Feinberg (recommended for the post by Connecticut Senator Chris Dodd) is best known for having served as Special Master of the Federal September 11th Victim Compensation Fund, a role in which he spent several years overseeing payouts totaling $7 billion to victims of the September 11 attacks.  In this capacity, he was responsible for investigating claims and ultimately putting a value on the lives of the victims in order to determine government benefits to be paid out.  An overwhelming challenge, at which - it appears by most accounts- Mr. Feinberg did an extraordinary job.  He captured his experiences in a 2005 book "What is Life Worth?".

While Mr. Feinberg appears to be an individual of exceptional capability, I see his selection for this new role as both interesting and revealing. 

The fact that administration officials and Senator Dodd chose a Washington attorney and gifted arbitrator/negotiator rather than a private sector business leader, corporate governance expert or even (gasp) someone seasoned in executive compensation design/administration says a lot about their perspectives on the structuring and administration of executive rewards.

At least that's what I think.  Your take?

More in the articles noted below...

New York Times:  Obama Names Overseer to Set Pay at Rescued Companies

Time.com: Kenneth Feinberg, Compensation Czar

Wall Street Journal:  White House Set to Appoint a Pay Czar