Tuesday, October 30, 2007

Bwaa-hah-hah-hah! Truly Scary Compensation Stories

Bwaa-hah-hah-hah! Truly Scary Compensation Stories
Fred Whittlesey
Compensation Venture Group, Inc.

Yes, Halloween is a favorite holiday of mine and what a gift to have a couple of frightening stories appear in the media in the last few days.

Now, I think it’s important that compensation experts continually explore data, testing relationships between executive pay and shareholder value. I also think it’s important that so-called experts have some modicum of ability to interpret data and, more importantly, not be inclined to reverse-engineer their analysis to support a predetermined point. But unfortunately what I think about that and what continues to happen are quite different. (Costume idea: Pollyanna)

The first story: “Companies using compensation consultants pay CEOs more with no shareholder benefit, says study.” Oh, the horror, the horror. This “study” is filled with so many flaws, non sequiturs, and misinterpretations that I don’t know where to begin. It scares me that such flawed research, conducted by The Corporate Library (whose well-known axe grinding about executive pay is notoriously one-sided despite their claim of being the "independent and objective") can make the headlines in a fine publication like Financial Week. I have not seen the study itself, however, (because I wouldn’t pay good money for something like that) so perhaps it is the writer’s interpretation of the data that is the problem. That’s scary in its own right as few will read the study but many will repeat the headline they read. (Costume idea: parrot)

The study’s key conclusion according to Financial Week: That companies using compensation consultants did not have any better shareholder returns than companies not using (or at least not disclosing the use of) compensation consultants. I didn’t know, as a compensation consultant, that I was personally responsible for shareholder return but if it turns out that I am, boy will my hourly rate go up tomorrow. Either that or I ask for a percentage of the increase in shareholder value. Kind of like those private equity firms that get 20% of the gains, and 1% regardless of gains. To think I've been charging by the hour all these years. (Costume idea: Private equity guy with bulging pockets and cigar)

The scary comment directly from the source of the study: “Consultants do not increase the effectiveness of incentive plans.” “We did see some patterns” said Alexandra Higgins of the Corporate Library. I see some patterns, too, Alexandra. Bizarre patterns of thinking that link “incentive plan effectiveness” with “shareholder returns” and “the use of compensation consultants.” (Costume idea: Picasso painting)

Here’s one thought: what if the use of compensation consultants is normally distributed across companies based on their shareholder returns? Then, on average, companies with consultants and companies without consultants should have the same return. Apparently the problem is that as soon as the consultant enters the picture, we are so brilliant in designing executive compensation programs that shareholder return should immediately improve. And if a company underperforms then they’re not entitled to professional assistance with the complex topic of executive pay. (insert scream soundtrack here) Let’s not give any consideration to past returns, industry sector, market cap, or any other relevant factors because that might ruin the predetermined conclusions that the only thing worse than executives who get paid are consultants who work for them. (Costume idea: Larry, Curly, and/or Moe)

Four days later, Financial Week published the headline “Comp consultant: CEO pay gains among Dow 30 in line with stocks’ performance.” Ah, much better. Now we know that executive pay is really OK. Except that upon further scrutiny this consultant’s analysis apparently shows that CEO pay in those 30 companies grew 15.1% annually for the past 10 years while compounded shareholder return grew by 12.1% during that time. His opinion is that CEO pay “only modestly” outpaced returns. A little arithmetic highlights the result that CEO pay went up 4x while shareholder value went up 3x during that time. That’s a “modest” difference? Those private equity fees are starting to look more reasonable. (Costume idea: Gordon Gecko)

But I really loved this compensation consultant’s point that this was an important analysis because the Dow 30 companies are “where the trends typically come from and a lot of the (other companies) follow suit.” Yeah, right. Those gigantic mature no-growth firms certainly set the pace for the several thousand entrepreneurial growth companies in America. (Costume idea: Arnold Schwarzenegger and Danny Devito as Twins)

I don’t know whether to be scared that someone like this actually gets media coverage, or to just burst out laughing. No, I’m scared that someone either really believes that or, worse, has some bizarre motive for saying it anyway. Yet some CEO somewhere will think he or she is underpaid because they don’t have a pay formula that gives them pay increases of at least 133% of the rate of total shareholder return. Ah, to work for Google with a deal like that. (Costume idea: Nerd executive in Lamborghini)

I wish that such frightful lapses in analytical ability, common sense, and objectivity were limited to the Halloween season but unfortunately we’ll likely continue to see them for months and years to come. And that gives the real experts plenty to write about and plenty to fix. And yes, I make a living doing both but still only get paid by the hour. (Costume idea: Superhero in business casual, with eyeglasses)

The other scary story this week was the “say on pay” debate but that’s too frightening to even consider discussing in the same Halloween blog. Maybe that’s a topic for All Saint’s Day, which is apparently when shareholders expect boards of directors and executives to be honored once we compensation consultants figure out how to guarantee incentive plan effectiveness and above-average shareholder returns. (Costume idea: Barney Frank)

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