A modest proposal

An issue that comes up more frequently in the Board room these days is what to do about incentive compensation for key talent.

The value of equity compensation granted in the last several years is so underwater as to be in complete darkness. Similarly, the company performance upon which cash bonuses are based is often barely approaching threshold levels for 2008. Executives are threatening that, without some sort of special retention compensation or changes to their bonus targets, they may walk. Boards are rightfully concerned.

A purist of the "that's the way the cookie crumbles" school of business will reasonably argue that there should be no change to the compensation approach just because business conditions are poor and the stock market is down. Everyone was happy with the model in 2005 and 2006 when times were good, so why shouldn't incentive compensation drop when times aren't so good?

The practical businessman of the "in the long run, we are all dead" school of business will just as reasonably argue that, like it or not, human capital is mobile and if our top executives are not paid at least equal to what they could get paid by say, walking across the street, that is what they will do.

Both arguments are persuasive. It leads me to wonder if the whole concept of "incentive" compensation and "pay for results" is flawed. We like to pretend that by loading executives up with equity and bonuses tied to company performance that their interests will be better aligned with shareholders - that they will behave as owners.

But the fact is, executives are not owners, they are employees. They are not putting up the risk capital that owners do and probably should not be rewarded in the same way. On the other hand, employees need to get paid in good times or bad.

Is it time to rethink the whole deal? Maybe the issue of changing goals in the middle of a performance year or repricing options would not be as emotional if we called compensation tied to company or stock results "profit sharing". Doesn't that term better describe what is really going on? In the long-term, companies need to grow and make money in order to pay the lucrative bonuses and stock option grants that executives expect and often deserve. So profit sharing will pay off big in good times.

If times are bad, little or no profit sharing gets paid but we would no longer say the lack of payouts is due to lack of "performance". It is merely due to lack of results recognizing that a significant portion of stock price and company results are out of the control of individuals - even CEOs.

I would not do away with incentive compensation all-together, in fact, it would still be a significant portion of an executive's pay but it would be solely tied to things the executive can really influence or control. This might include actions such as completing an acquisition, cutting expenses, grooming a successor or developing a new product.

Clearly the above suggestion goes against the tide of basing compensation on results and away from action-based incentives and profit sharing. While much of this is purely semantical - I do not expect it would change the overall magnitude of an executive's pay, I think the change in nomenclature and approach will improve performance and reduce the Board room angst when times get tough.