An executive compensation model that makes sense

Both candidates for President have publicly acknowledged that executive pay is out of line. In today's NY Times comes a blog post that speaks to a unique compensation model that isn't too far off what the hedgies already receive.

The novel elements include paying bonuses based strictly on accounting performance (rather than stock performance), benchmarking of executives against the performance of rival firms. and the "high water mark" concept of hedge fund managers.

Read the entire article here.

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Comment by Joshua Letourneau on November 4, 2008 at 2:29pm
Good article - this a hugely debated issue, at least it was enough to get people throwing things at one another even before our recent meltdown!

While it's manily 'bank-focused', we'd definitely have a trickle-down effect where other industries are affected. What I do like here is Rajan's proposal of what you might call a rolling compensation model. Instead of Execs making decisions to only improve the balance sheet on a short-term basis (thereby gaming numbers instead of making better long-term plays), it looks as if he's recommending a "rolling-performance" model.

The question I think we'd run into here involves the cyclical nature of many industries. Many move in highly predictable/cyclical fashion, and the typical economic cycle is ~7 years long. If we asked the Exec to remain around (i.e. not making his "rolling comp" available until the end of the 7th year), I imagine it would be tough to fire 'em . . . but then again, this happens many times with sports teams. They fire a coach, but wind up having to front the bill for the entire contract nonetheless.

Steve, this is what I think might happen if the government were to get more involved in regulating exec compensation (keep in mind this isn't true for banks since they were bailed out): More and more companies will move to buy back their shares and go back private. If you and I were used to making $50M USD a year as a publicly traded company, and Uncle Sam then said we were capped . . . we'd probably say "The hell with that!" and do whatever we had to do to convert from shareholder equity to debt!

This is quite a maze and I bet it will be interesting to see how this unfolds. Although I am a capitalist at heart, I admit there are some greedy bastards out there :) I mean, if you're making $50M USD a year, and you lay off 50% of your middle-class blue collar workforce each December 1st to make your numbers and boost your bonus, I have no love for you.
Comment by Joshua Letourneau on November 4, 2008 at 2:33pm
P.S. Just for a laugh, let's say Billy-Bob is hired as CEO for a 4 or 7 year period. Then the economy goes south or there is some other development that leads BB to conclude he made the wrong move and wants out. From that point, he starts making dumb move after dumb move, trying to get fired . . . because he knows he has more to gain by getting fired today than waiting for a bonus he isn't going to get at the end of year 4 or year 7 :) Or . . . how prone would a CEO in a 'long-term' contract be to a buyout . . . if that buyout were to alter his original arrangement? I know - I'm playing around here . . . but these issues are worth thinking about (if just for comedy's sake) :)
Comment by Steve Levy on November 5, 2008 at 11:16am
Josh, wonderful points. Some thoughts:

Re:cyclical businesses, year-over-year "should" be higher for "successful" executives.

Long-term contracts are typically "reviewed" by the comp committee of the Board. While what I'm about to write is easier said than done, companies need to hire better - and dare I say smarter - people for their boards. Giving away the farm in a contract may not be one of the best business practices seen to date - lol.

FASB "regulates" finance; perhaps its time for those strategic business partners out there to flex their strategic business partner muscle and establish an ERASE - Employee Relations Accounting Standards Entity (had to change the B, I just had to).

Re:buybacks...possibly. Part of FASB would be to specify the framework for buyback scenarios. Buybacks take place because the short term implications on the stock price are typically positive, allowing management to see the most immediate results to their compensation. And any dividend cut reflects poorly on management. So a BB allows management to pass cash to the shareholders without raising dividends - everyone leaves happy. Bottom-line: FASB could address this if they wanted to and develop standards. If they wanted to... More about buybacks here.

Again, great points Josh. Anyone else interested?

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