Executive and senior management pay:  Shareholder value is not enough

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Print this page By Andrew L. Klein

Company directors say they pay CEOs based on performance. The data support this claim. More than half of the compensation awarded to 51 CEOs last year was tied to their companies' financial or stock-market performance, according to a review of proxy statements by consulting firm Hay Group and The Wall Street Journal   In most cases, the companies must hit specified targets for the CEO to receive promised money or equity.

The irony is that “say on pay”, a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act, empowers shareholders to approve or disapprove executive pay. This means shareholders have an exceptionally strong hand in defining what performance is “valued” ” ('Pay for Performance' No Longer a Punchline: Shift Highlights Growing Role of Investors in Shaping Compensation;’ Scott Thurm. Wall Street Journal, March 20, 2013).  But, this power may be undermining companies because shareholders, for the most part, vote for executive performance-based pay based on their self-interest. This self-interest has a name; it is called “shareholder value.”

One point of view, espoused some time ago by people like T. Boone Pickens, is that company management needs to care about company owners — the shareholders. Pickens believes this is primary (http://www.boonepickens.com/).

But a burgeoning movement is afoot, advocating for a different view of what executives should focus on. Lynne Stout of Cornell University Law School, author of the book “Shareholder Value Myth;” Rana Foroohar, assistant managing editor of Time magazine; and Warren Buffet, widely considered the most successful investor of the 20th century, all speak to the destructive consequences of an overemphasized and often single-metric view of company and executive performance. They represent just a few of the voices speaking to this issue. A shareholder view has its limitations.

• Shareholder value is often short term, driving business actions that actually are dysfunctional because all they do is drive short-term value while sacrificing all else that might make the company really successful over time.

• Shareholders are not necessarily trained, experienced or savvy in how to make a company successful over time — they want their payoff now, and then they will move on, leaving the company to try an survive the hit-and-run approach of those who seek out only quick and large returns on their short-term investments.

• Short-term value changes (e.g. layoffs, selloffs, mergers, etc.) are not done in the context of long-term success. Companies that last, invest in the future, sacrificing some short-term value maximization for research and development, innovation, and well-anchored business growth.

• Return-to-investors is not the only role of business. Innovative, quality goods and services to customers, providing employment, paying taxes and being part of the fabric of the communities that surround them are part of why companies exist. Shareholder value is often at odds with this socio-economic view of business.

• Leveraging capital to high levels makes a short-term splash, creating proven risk that this places a company on a path to unsustainable debt and, ultimately, extinction.

The emphasis — almost exclusively — on shareholder value is a likely part of why job growth is so slow although company profits and stock price are so high (up 200 percent since 2008). American business investment in research and development — investments that do not pay off for years — has fallen to levels far below our global competitors and is far below our own historic levels…times when the American quality and innovation was the global gold standard. It can be argued that new products and innovative ways of serving customers better is what underlie rock solid and not financially contrived shareholder value. (“Down with Shareholder Value;” Joe Nocera, New York Times, Aug. 10, 2013).

As a consultant to public and private corporations, it is my experience that private corporations — especially family/founder owned — take a longer, generational view of how they invest in their business. In 2010 there were 27.9 million small businesses. There are only 3,164 U.S. companies on the NYSE, but they represent almost half of the workforce. The short-term shareholder view may not impact too many companies, but the impact on the economy and people is huge.

This author advocates for a more broad-based view of executive rewards. Shareholder value has an important place and should be part of the executive performance equation.  But a broader foundation for performance should be defined, measured and rewarded. The executive success formula should include creation of good jobs to support a vibrant society, research and development investments to create the distinctive and breakthrough products and services that are the true competitive edge, investments in new enterprises and new facilities and technology to add to that competitive edge, and supporting the communities in which the company “lives”. With our executives focused more broadly, American business success is more assured over time.

Investors will be winners if they are in for the longer term and not the quick-hit. And, American pre-eminence in the world of business, science, innovation, quality of life will continue. If your executive plan needs revision, see your compensation adviser — one who thinks beyond just the shareholder.

Andrew L. Klein, Ph.D, is a principal with the Titan Group, a Richmond-based human resources consulting firm.

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