Squishing a Balloon—Executive Compensation Changes

Squishing a Balloon—Executive Compensation Changes

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We are all aware of the many changes in executive compensation that have occurred over the past few years–changes in the proxy disclosure rules, as well as changing shareholder attitudes about what best practices are for executive compensation. As a result, companies have been changing and refining their executive compensation programs. Based on the latest proposed rules from the SEC regarding the Dodd-Frank Act requirements, I believe companies will continue to make changes to their compensation programs.

Shareholder and proxy advisor pressure has had an impact on executive compensation as well.  Just look at the decline in excise tax gross-up provisions for executives at FORTUNE 100 companies over the past two years and you can see something is afoot.

Yes, the only constant in life is change. But, sometimes, change for its own sake should be avoided.  Folks urging changes to executive compensation should stop and consider the implications (read that as “unintended consequences”) of the changes being proposed to see if those are things they truly would want to have happen.

Case in point? Perquisites.  I understand how aggravating and annoying these can appear to shareholders (hey, I’m a shareholder too!). I also understand that there have been some excesses and that the 2006 proxy disclosure rule changes basically would have caused some companies embarrassment if they had to disclose all of their perks. As a result the then emerging best practice of limiting executive perquisites began to gain a greater following and many boards and management teams did away with many of their executive perks. A turn of events that every shareholder should have applauded, right? Yes, until you consider that often times the elimination of the perquisites was coupled with an increase in base salary or bonus opportunity as a way of “making up” for the perks that were cut.

Some shareholders have continued to push against executive perks.  Their latest target? Executive relocation benefits. There was even a recent (10/25/2010; click HERE (subscription required)) Wall Street Journal article on this very topic, which looked at what some companies had done and the way some companies are changing their relocation benefits (Click HERE to read Microsoft Corporation’s recent blog explaining why and how its executive relocation policy is changing).

On the surface, that all appears well and good.  However, I am concerned about what this might do to the ability of companies that make these changes to recruit the best executive management talent to help execute on their strategic goals and objectives. Say an executive is highly sought after by several suitor companies.  One happens to have reached an understanding with shareholders that it will tie relocation benefits to a pay-back obligation while the others have not. The suitor company with that obligation is therefore at a disadvantage viz-a-viz the other suitors on this point.

Now, you could rightfully say that the company might still be attractive for other reasons, which seems reasonable. But suppose the executive ends up seriously considering the offer of two suitor companies one with the pay-back obligation on the relocation benefits and one without. Further, let’s assume that the executive was hard hit by the recent real estate melt down, but is good at negotiating (we did say he was a sought after talent). So the executive tells the suitor company with the pay-back obligation on the relocation benefits that while he’s interested in the position, the offer is worth less because of the pay-back obligation.  Don’t you think that the suitor company would then look for ways to “sweeten” its offer? Perhaps it would offer a cash signing bonus, an additional equity grant or something else that has value. Let’s suppose that the executive accepts that sweetened offer. Now, when it comes time for proxy disclosure, the shareholders see that the company followed its relocation policy and gave the new executive relocation benefits that have a repayment obligation.  The shareholders also notice that the executive gets something as a signing bonus and some equity awarded for joining.  However, nothing is ever said that the amount of the signing bonus or equity grant is slightly higher as a result. So much for transparency for executive compensation!

So, everyone is happy, right?  You’d think so.  Unfortunately, that happiness could be short-lived (depending on your point of view). Why? “Unintended consequences.”  The shareholders of the company that hired the executive never learned that the company had to pay the executive more because of the repayment obligation on the relocation benefits. Furthermore, the sign-on bonus or equity grant would get picked up when other companies look to fill similar positions. They likely won’t know that anything “extra” had been included in the signing bonus or equity award or why those amounts might be larger than they otherwise would have been. And so, hire-on compensation overall increases as the hire-on of this one executive gets factored in when other executives get hired later. So pay will float up, transparency of pay to shareholders has gone down. And everyone should be happy? Maybe I’m nuts but I see this as ultimately against both shareholders’ and companies’ interests in the long run.

The thing I try to keep in mind when thinking about making changes to executive compensation is that it is like when you squish a balloon.  If you squeeze it in one area, it is likely to bulge up in another.  Now, you might say that compensation would just “pop” if you stick a pin in it.  That’s true, but what would happen to a company that had its compensation “popped?” Would it still be able to recruit the talent it wants or would it have to “settle” for those executive that are now willing to work for the level of pay it now offers? Does that limit the future upside of the company or its ability to execute on its strategic goals and objectives, which in turn could lead to lower returns for shareholders? I don’t have all the answers to these questions, but these are at least some of the questions everyone who advocates change to executive compensation should consider.

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