It's spring - time to grill your CEOs

Proxies are trickling in for the 2007 calender year and the economy is showing weakness. It is time for the "executive-compensation-is-out-of-control ritual" performed periodically by Congress, the press and assorted shareholder "representatives". Not that we should expect too much subtlety and depth of analysis from these sources but there are some learning's to be had in pointing out the real distinctions among three executive compensation stories recently prominent in the news that otherwise might be lumped together.

The WSJ and NYT have articles today on Congress's investigations into the compensation received by three executives in the banking and mortgage industries: Stanley O'Neal of Merrill Lynch, Charles Prince III of Citigroup and Angelo Mozilo of Countrywide Financial. The gist of Congress's inquiry is why they received such large compensation in 2007 in light of the terrible performance of the companies they led.

Another article in the WSJ added a twist on Mozilo's case. Apparently, two outside compensation consultants hired by Countrywide recommended lower pay packages for Mr. Mozilo. They were fired and a third consultant hired that supported what Mr. Mozil was seeking. The appearance was that the consultant was acting more as an advocate for Mr. Mozilo than an impartial advisor.

I have commented previously on the cases of Mr. O'Neil and Mr. Prince. In their case compensation packages seemed designed with asymmetric rewards between management and shareholders. That is, a heads I win, tales you lose sort of proposition in which management is improperly incented to take large risks with shareholder money. If the risks pay off, management takes home a lot of cash which is what O'Neill and Prince did for some years including deferred compensation and pension amounts in 2007. When the luck runs out and the bubble bursts as it did with mortgage-backed securities, shareholders are left with the loss and the manager, at worst loses his or her job, as these guys ultimately did. The problem is not what O'Neill and Prince received in 2007 when things went bad, but rather how richly they were compensated in the preceeding years when things were going great.

The case of Mazilo is a somewhat different cautionary tale. He may also have had a compensation package poorly designed with asymmetric rewards. The more interesting part of his story, however, is that Mazilo was one of those executives who builds their company to such an extent that they, and the Board, cannot seem to separate the CEO's personal interests from shareholder interests (to be fair, Mazilo is also a large shareholder). The compensation consultant in question fell into a similar trap of not being able to separate his role as an independent compensation consultant to the company as opposed to an advocate for Mr. Mazilo. Without excusing the consultant, I can sympathize with the difficulties of balancing conflicting agendas and demands among individuals who, in theory, all work for the same shareholder "client". Members of the compensation committee and the Board should be in front of Congress not Mazilo.

Finally, we come to the situation that Michael Corkery describes in today's WSJ of how the Boards of Toll Brothers, KBH and Washington Mutual are finding ways to grant sizable bonuses to their CEOs even as the profits and share prices of these companies are hammered by the drop in home prices and the slowing economy.

Admittedly, it does not look good when the bonus formulas for top executives are modified after the fact to ensure that annual "incentive" compensation does not drop too much which is the case with the executives cited in the WSJ article. But, let us not throw too many stones here. While CEO pay is public, anyone who is involved with setting employee compensation knows that this sort of thing happens all the time in Corporate America at non-executive levels. It is commonly called "management".

The theorists can talk about "pay-for-performance" or "pay for results" but the truth is, firms need to compensate individuals not just for what they did last year, but also for a reasonable expectation of what they will be bringing to the company in future years. If companies unthinkingly held short-term incentives to a rigid formula they may lose some of their future best performers who will get their raise or bonus from a new employer. Sounds mercenary and petty? Yes, but mercenaries and sensitive individuals can also be valuable employees.

In the real world, management (and boards) must constantly calculate at what point to stand firm on principle and when to be flexible in the long-term interests of the firm. This goes double for CEOs whose departure (or demotivation) can have the most serious consequences for an organization. I believe these are exactly the calculations made by the Boards of Toll Brothers, KB Homes and Washington Mutual made.

The magnitude and structure of executive compensation, corporate governance and consulting independence among public companies are all topics that will continue to be scrutinized by the public. The stories of greed, personal failings and corporate intrigue are just too interesting. I believe, however, our reaction to these stories too quickly jumps to "less" rather than an appreciation of the more subtle ways that we can improve the compensation practices of the organizations we advise or work for.