Executive Compensation – Is It Out of Line? Part #2

Monday, June 28, 2010

So who or what determines, sets, approves, and authorizes executive compensation?

In the case of publicly held organizations, those companies whose stock is publicly available for sale through one or more of the stock exchanges, generally there is a subcommittee (Compensation Committee) of the board of directors who reviews and sets pay for the “officers” of the corporation. Typical officers include the Chief Executive Officer, the Chief Financial Officer, the Chief Operations Officer, and may include other “chiefs” in areas of IT/IS, HR, Marketing, Legal … etc. This subcommittee is composed of anywhere from 3 to 7 board members whose job it is to review current executive pay and make recommendations to the full board on what, if any, actions to take. When new “chiefs” are hired, it is also their job to formulate an offer and get it approved by the board.

The Compensation Committee is often advised by internal and external consultants in the areas of executive pay and legal practices. In the case of hiring a new executive, the candidate may even have their own executive pay and legal consultants advising them on how to negotiate pay and benefits. If the Compensation Committee is reviewing current executive’s, they may also employ consultants in executive pay, and legal practices to advise them what can and cannot be done. It is common for the organization to have a compensation philosophy stating how executive pay is to be set, e.g., “the 50th percentile of similarly sized companies in the same industry”. The determination of what constitutes the 50th percentile of similarly sized companies in the same industry often falls to an executive compensation consultant who has access to detailed information on the pay and benefits of executives in other organizations.

Executive compensation packages may include pay, benefits, retirement plans, stock options, performance bonuses, non-performance bonuses, severance packages (Golden Parachutes), personal vehicle(s), use of the company plane(s), boat, apartment(s), first class travel, miscellaneous reimbursement accounts, … etc. This, you will remember, may be the strategic leader of a worldwide organization with billions in sales, thousands of employees, and hundreds of operational locations. Some executives have the ability to turn a failing company into an industry leader, saving the company, shareholders, and yes, even employee jobs. I once worked with an executive who was hired to turn around large organization. In return, he was rewarded for his efforts; however, he had to demonstrate that the turnaround was real so his reward was deferred for 10 years. Most employees I know would not wait 10 years for their bonus check!

Executive compensation has outpaced compensation for rank and file employees of the last two decades. Equilar, a provider of executive compensation data and research, reported on January 20, 2010 that executive salary reinstatements are on the rise, incentive compensation is changing, and companies are getting creative with equity compensation. The full report is available by contacting Equilar.

A special report published on October 13, 2009, by Bloomberg Businessweek quotes Don Delves and Hewitt Associates’ head of the North American compensation consulting practice Ken Abosch on executive compensation trends in the midst of the Great Recession.

While I am a firm believer in paying an employee for what they are worth and for what they can produce, it does beg the question how Michael Jefferies, CEO of Abercrombie and Fitch, can take home more, when their business is under performing, their stock is down, and they laid off employees?

Part #3, tomorrow.