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Toward an Innovative CEO Compensation Package
By Mel Miller

Mel Miller's Mainstage Presentation at the 2016 SRI Conference

The advocacy organization, As You Sow, has documented the growth of CEO compensation, which is up an amazing 943% over the past 37 years. In 1976 the average CEO was paid 36 times as much as the average worker; by 1993, the average CEO was paid 131 times as much.

CEO compensation critics were hopeful when in 1992 the SEC began forcing companies to disclose top executive pay and benefits. The hope was that once pay was transparent, boards would be hesitant to grant executives outrageous salaries and benefits. But the new rules did not slow the growing gap between CEO pay and that of the average worker.

Transparency of compensation can lead to wage inflation as workers request increases to match their counterparts. Once CEO pay was public information comparisons were easy. No CEO felt s/he should be paid below average.

In recent surveys conducted by Stanford University, only 16% of Americans said CEOs deserve what they are paid, while 71% of directors and 84% of CEOs said they are "paid correctly."

While CEO compensation data is public, average worker pay data is difficult to obtain. Yet, as part of the Dodd-Frank reform bill the ratio of CEO pay to median worker pay will be a required disclosure starting in 2017 (unless the Trump administration and Republican Congress decide to change the rules).

Variable pay is a strong performance enhancer for individuals who perform non-creative, routine tasks. Often called piece rate, performance of routine tasks can be enhanced by paying more for greater output. Obviously, a CEO's work is not routine. CEOs need to be innovative, open to change, and able to generate solutions to complex problems. The current system is the opposite of piece rate. It is a combination of a fixed salary and a performance-based bonus.

This system evolved because of criticism from investors regarding the lack of stock ownership on the part of CEOs and top executives. The argument goes like this: If the CEO's compensation is performance linked, then the stockholders should benefit as the CEO benefits. It's now common practice for 60% to 80% of CEO pay to be tied to performance.

"I have no idea why I was offered a contract with a bonus in it," said John Cryan, CEO of Deutsche Bank, when first hired, "because I promise you I will not work any harder or any less hard in any year, in any day because someone is going to pay me more or less."

In fact, according to professors Dan Cable and Freek Vermeulen of the London Business School, variable pay for CEOs can actually be "dangerous."

Over-focusing on performance can weaken performance. Several studies have shown that when employees frame their goals around learning (i.e. developing a particular competence; acquiring a new set of skills; mastering a new situation) it improves their performance when compared with employees who frame their work around performance outcomes.

Contingent pay can result in "cooking the books." Financial engineering can generate short-term stock benefits at the expense of long-term value. Would there be fewer stock buybacks if CEO bonuses were not so commonly linked to short-term stock performance?

It's not difficult to find examples of a CEO heading a company that had a miserable performance year, where the board overrides the performance system and grants the CEO a huge bonus. The report, 100 Most Overpaid CEOs, published annually by As You Sow, offers numerous examples.

So, what might work better? In my perfect world, CEO variable performance-based compensation would be limited to 10% of total compensation. And the 10% would be limited to stock grants only. At least 90% of total CEO compensation would be a fixed salary.

I would require all stock grants to vest on a ten-year schedule and the agreements that govern the grants would include a five-year "clawback" provision. The board would be required to seek compensation reimbursement if the CEO or the company is found to be in violation of any SEC rules or even actions which hurt the reputation of the company. If the board does not take action, the stockholders at their annual meeting would be able to force the board to act by obtaining a 25% vote in favor of such action.

And in my perfect world, there would be a limit on the CEO compensation as compared to the rest of the workforce. A board of directors wanting to raise the fixed salary of the CEO would have to consider the entire workforce. But, what that limit should be is a conundrum that the disclosure of CEO pay ratio data may help to address.

First Affirmative understands that the ways we save, spend, and invest can dramatically influence both the fabric and consciousness of society. We believe that in addition to the benefits of ownership, investors bear responsibility for the impact our money has in the world. Are you making conscious decisions about the impact of your consumer purchase and investment decisions?

 NOTE: Mention of specific companies or securities should not be considered an endorsement or a recommendation to buy or sell that security. Past performance is no guarantee of future results.

Posted: February 13, 2017