Monday, October 15, 2007

Executive Pay: Complex or Complicated? (Redux)

Fred Whittlesey

Principal Consultant, Compensation Venture Group, Inc.

This entry updates a previous blog item from June 2006

I was once in a Board of Directors meeting in which one director said the compensation plan I proposed was complicated and his fellow director corrected him saying that it was not complicated, just complex. Merriam-Webster helps us with this distinction:

Main Entry: com·plex
Function: adjective
COMPLEX suggests the unavoidable result of a necessary combining and does not imply a fault or failure

Main Entry: com·pli·cat·ed
Function: adjective
1 : consisting of parts intricately combined
2 : difficult to analyze, understand, or explain
Executive pay is complex, indeed the “unavoidable result of a necessary combining.” A leading life sciences company recently disclosed an intricate performance-based stock award program for executives. The award is divided up into three tranches, in each of which the pay amount is determined by a matrix of two performance measures relative to a peer group. Complex, but fairly easy to understand. I have to include some of the disclosure here for you to fully appreciate it:

Executive pay, to many, is complicated and difficult to understand. Base salary, annual incentive, stock options, RSUs, performance plans, multi-year cash bonuses, annual incentive awards paid out in restricted stock, deferred compensation programs, and more. Add to that some intricate time-based vesting schedules, performance acceleration, and performance vesting.

The trend in performance plans among small and mid-sized companies is further evidence that pay will continue to get more complex. As it does, sometimes it will be clearly disclosed as required by the SEC’s new disclosure rules. Sometimes it will be so complex, or so poorly explained, that it will seem very complicated. As I've said before, I believe compensation professionals have a responsibility to design plans that are appropriate for the business situation, no matter how complex that may be, and ensure it is properly communicated as to not appear complicated. Journalists have what is perhaps an even greater responsibility to take the time to understand these complex plans, no matter how complicated, and report them accurately to ensure the public does not misunderstand them and arrive at false conclusions about executive pay.

Stay tuned for the details of recent research we’ve done on these complexities. Just the data on vesting schedules is overwhelming, and then we’ll next discuss performance acceleration and performance vesting. By then, no doubt, there will be a new category of complexity that we’ll need to define and address.

Next blog: How things got so complicated

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