What's in your CEO's wallet? (Executive Series)

Complexity of top role is increasing – and so is executive compensation
|Canadian HR Reporter|Last Updated: 12/15/2014

Editor's note: Once a month, the Strategic Capability Network (SCNetwork) hosts a special seminar on a topic of interest to HR professionals and business leaders. Canadian HR Reporter covers these events for a special feature titled "Executive Series." The feature includes news coverage from one of our editors, plus commentary from SCNetwork's panel of thought leaders on strategic capability, leadership in action and organization effectiveness.

This web post contains all of these elements:

Canadian HR Reporter's news coverage
What are the skill sets? by Trish Maguire
Not $1 more, by Michael Clark
Avoiding the black hole, by Karen Gorsline


What’s in your CEO’s wallet? 
Complexity of top role is increasing – and so is executive compensation
By Liz Bernier

There’s little doubt executive compensation is climbing, and climbing fast. Top CEOs can command astronomical salaries — and once you add on their stock options, bonuses and benefits, it’s not hard to see why CEO pay often becomes the target of media scrutiny.

“In the popular press, and amongst the ‘Occupy’ movement and others, there’s a point at which CEOs are overpaid,” said Guy Beaudin, senior partner at RHR International in Toronto, at a Strategic Capability Network event in Toronto. 

But media portrayals of a handful of highly paid CEOs are far from the full picture. 

“That probably has its merits in a certain number of cases, and I think we wouldn’t disagree that income inequality in society is an important issue. But I think what we’d like to do is perhaps paint a picture of that that’s a little bit more complex, and brings some more data to bear in terms of how we think of CEOs, executives and their compensation,” he said. 

It’s true that executive compensation is on the rise, said Laura Croucher, partner at KPMG in Toronto, who also spoke at the event — the Globe and Mail reported in June that pay for top Canadian executives increased by 11 per cent in 2013, marking the fourth straight year of gains. 

“All this in spite of shareholder and investor activism,” she said. 

But the role of the CEO role has become much more complex, said Beaudin — and that has a direct impact on the supply of qualified talent.

“The role is more challenging, therefore, the number of people who can actually play that role very well is a dwindling pool.” 

High risk, high rewards
The CEO role is increasingly challenging and complex because of myriad factors, said Beaudin — technological change, globalization, regulatory changes, the diversity of the workforce and generational attitudes, to name but a few. 

In the 1950s and 60s, being a CEO was like playing a game of checkers, said Beaudin. 

“CEOs could understand most of the playing field; to win meant you had to be one or two moves ahead of your opponent.”
But today, playing the CEO role is more like a game of 3-D chess.

“There is no longer a very definitive end game. The outcome of decisions that you make may occur several years (later), sometimes after your tenure… one move can affect outcomes on a number of fronts,” he said.

There is a level of public scrutiny that hasn’t been there before, said Beaudin — even your personal life is no longer out of bounds, as it used to be.

The average tenure of a CEO has declined, said Beaudin, so often individuals aren’t in the role for long. 

“Today, the average tenure globally is 7.6 (years); in 1995, the tenure was 9.5 years. And in the past two decades, 30 per cent of the Fortune 500 CEOs have lasted fewer than three years in office.”

And the risk of failure has never been higher. 

Research indicates 40 per cent of CEOs fail in the first 18 months in office, he said. And from an HR perspective, it’s quite difficult to find people who can play the role successfully. 

“The failure tends to be attributed most often to intangibles: poor judgment, lack of execution, personality flaws. Rarely is it due to lack of experience,” said Beaudin. 

“The failure rate has gotten higher, (and) failure has generally been due to personal or interpersonal characteristics.”

All of this data is just further evidence of the complexity of the role and high risk of failure, which is why the pool of capable talent has grown much smaller. 

“Although there are some arguments at the front end in terms of ‘CEOs might be overpaid,’ we still have to consider the laws of supply and demand,” he said.

Compensation challenges
When there’s a limited supply of capable and qualified talent, the compensation package becomes critical. But there are a number of real challenges when it comes to designing a good executive compensation package, said Robert Levasseur, senior consultant and principal at McDowall Associates in Toronto, who also spoke at the event.

For one thing, it’s not just about offering the biggest number you can muster. 

“Whenever we open the papers and we read about executive compensation, we see these gigantic numbers. And I’d just like to remind you that they’re sort of like the elite in executive compensation. They’re like the people who get $20 million when they make a movie — there are a lot of starving actors as well. There are a lot of CEOs in this country who are never covered in the media,” he said.

It’s more important to focus on the compensation structure than to focus too much on the final number — and structuring compensation to create both short- and long-term incentives can be tricky. 

“How do you develop compensation plans that align with immediate short-term shareholder interests, as well as the long-term best interests of the enterprise?” said Levasseur. 

“It is really challenging for us to help organizations develop programs that will also incent and reward senior executives for longer-term plans.”

You also need to design incentive plans that measure the right metrics — you need them to be objective but still flexible, he said. 
Also important? Finding a way to minimize CEO compensation “hedging.” 

“What that really means is… (the CEO) designed a program where if you do well, you win and if you lose, your severance package is so high that you’ve won anyway. That is really the definition of hedging,” said Levasseur.

“I’m not suggesting that there shouldn’t be severance packages… because you’re not going to attract (talent) without them. However, you have to be careful about the elements that are included in your package.”

Internal vs. external 
Another important consideration is whether to opt for internal or external candidates, said Beaudin. Increasingly more organizations are focusing on external candidates — especially those with prior CEO experience.

“From 1970 to 2000, the (number) of companies that looked outside to replace their CEOs went from one in seven to one in four.

And then, by 2008 — so less than a decade later — 80 of the Fortune 100 companies who appointed a new CEO, 45 of those went outside to find a successor,” he said. 

“Organizations are taking much less of a risk on a first-time CEO and they increasingly turn to people who have done the job before.

“At the extreme, I think what we’ve seen also in the last decade is the retired founder CEO comes back. So that would be, to me, the ultimate expression of not wanting to take the risk on a new CEO.”

But hiring externally can inflate costs significantly more than hiring internal candidates, said Levasseur. He and a colleague looked at TSX companies’ data from 2012 and 2013, and compared the 12 new CEOs hired in that time period.  

“We found out that external hires were six per cent more expensive than the predecessor CEOs… and the internal promotions were 12 per cent less expensive than the former CEOs,” he said. “In this particular sample, the median (cost) was $8 million if you came from the outside, and a little over $4 million if you came from the inside.” 

Hiring external candidates usually involves heavy negotiations and lawyers, which can drive up the compensation, said Levasseur.

“Any way you look at it… it is an expensive process. Which probably begs the question: Why are we not developing more CEOs internally?”

Organizations should strongly consider succession planning and building up the internal leadership pipeline, said Levasseur. 

But, at the same time, it’s important to find a candidate who is up to the growing challenge, said Beaudin. Adaptive ability is a defining characteristic for the success of today’s CEOs, he said.

“Intuitively, you might think, ‘That makes sense.’ But if you think about the people in your department, how many people actually are able to demonstrate that kind of flexibility, both interpersonally and intellectually?”

What are the skill sets?
By Trish Maguire

It’s interesting that in listening to a panel consisting of two expert consultants and one expert HR leader on “what’s equitable in executive pay,” no one ventured to validate what the indispensable skill sets are for an effective, “best fit” CEO in a global marketplace that warrants a shift in equitable executive pay. And nobody identified definitive performance measurement criteria for the CEO role. 

“Equitable” typically means fair, reasonable and even proper, unbiased and impartial. So not only am I curious about how “pay for performance” is actually determined for the CEO role, but also, how would the same process measure up to the pay for performance strategy many organizations use for employees’ pay? 

In simple terms, a CEO’s job is to drive an organization’s profits and growth. But might you also subscribe to the notion that today’s CEO needs to focus on how an organization’s current business models need to change in order to be better equipped for unexpected future trend? 

Yet, despite a brief comment on the North American practice of scrutinizing quarter-to-quarter results, there was no actual discussion on the dichotomy between delivering today’s performance for short-term profit versus building an organization’s capacity to deliver tomorrow’s profits and organizational growth. 

All three panellists agreed on how complex the CEO role is and the need to be a transformational leader. What exactly does that mean, though? Emerging technologies alone require a CEO to understand how to harness and leverage social media channels and increase speed-to-market innovations. 

Yes, today’s CEOs face continuous uncertainty and are expected to resolve the most challenging issues while at the same time being inspirational leaders. Surprisingly though, nobody actually defined what the behavioural traits or cognitive criteria are for such a mission. Bearing in mind that the CEO role is unique, I did not hear any description as to what a CEO should be doing and how different the role is from any other executive team member. 

So is it accepted that for a CEO, equitable pay is based on driving the successful transformation of an organization by being personally involved and showing up as the role model for the requisite behaviours, belief systems and mindset changes? Does it require a CEO to communicate the importance of the desired transformation clearly, consistently and in a way where employees understand where their role fits and how important their contribution is in making it happen?

 Does it require that the CEO builds a strong and effective top team of leaders who are willingly open to promoting innovation and prompting employees to take risks? 
The reality is the CEO owns the top position in any hierarchy, no matter how flat the organization. Everybody looks to the CEO first for clarity around vision, strategy, direction and “proper” behaviour. The CEO is the ultimate boss with the absolute authority to ensure the right people are in the right jobs with the best possible skills. 

He has to make tough decisions about who has the ability and motivation to drive essential changes efficiently and successfully. He has to set an example of excellence others emulate. All things considered, the CEO needs to have a track record that proves he knows how to increase profits, talent, trust and commitment in an uncertain growth environment.

Perhaps both HR and the board could find inspiration from Leroy Eime: “A leader is one who sees more than others see, who sees farther than others see and who sees before others see.” I wonder how different the final choice could be if in selecting a “best fit” CEO, both parties used this quote to create two powerful behavioural questions: How might this increase your employees’ innovation, commitment and trust? How different might your organization’s future profits and growth be?

Trish Maguire is a commentator for SCNetwork on leadership in action and founding principal of Synergyx Solutions in Nobleton, Ont., focused on high-potential leadership development coaching. She has held senior leadership roles in HR and OD in education, manufacturing and entrepreneurial firms. She can be reached at synergyx@sympatico.ca.

Not $1 more
By Michael Clark

The panel at the recent Strategic Capability Network event on equitable executive pay dodged the big question within the question: “Equitable to whom?”

While the panel was true to the fine print of the session description, ultimately, the audience did not get a satisfactory answer to any question.

From an organizational effectiveness perspective, the equitability of executive compensation is made manifest by CEO effectiveness: “Does the candidate have what it takes to develop and execute strategy?” Within that context, and from the perspective of shareholders, the answer to equitability in executive pay is easy: Equitable is what it costs to hire someone sufficiently effective — and not one dollar more.

But many feel compensation levels are not fair and shareholders are paying a lot more than one dollar more. Why do we feel this way? Research into human behaviour has shown that “felt fair pay” directly corresponds to levels of work and the associated time span at each level. In a properly stratified organization, the CEO of a medium-sized firm is expected to be planning out five to 10 years.

If we compare that to the time span of, say, a director (one to two years) two levels below the CEO, then the CEO’s compensation “feels” fair if it is four to eight times the compensation of the director (one year x two x two, or two years x two x two). Based on the rising disparity between increasing CEO pay and the flat-lined pay for the middle ranks and below, it’s no wonder things don’t feel right .

And yet, at least one panellist cited “supply and demand” — some combination of scarcity and desperation has driven compensation into the stratosphere, and that’s just the way it is. How do we square that with the fact that 40 per cent of CEOs fail in the first 18 months? 

What is so concerning is why neither of the two compensation experts on the panel dug into that. Robert Levasseur of McDowell Associates at least alluded to equity — and performance-based compensation — but would not drive to a discernible point. And while he clearly knows CEO packages tend toward “hedging” — where the candidate succeeds whether or not the shareholder succeeds — he prescribed no solution.

There may be very good reasons not to attach performance to compensation or to tolerate hedging in negotiations, but the panel did not provide any cogent argument for or against. Ultimately, what we learned is not what is equitable in executive pay but executive pay just is what it is.

Michael Clark is director of sales and marketing at Forrest & Company in Toronto. Forrest is an organizational transformation firm, with more than 25 years’ experience in developing the organizational and leadership capacity in organizations. 

Avoiding the black hole
By Karen Gorsline

Can organizations develop capabilities to keep them from spiralling into a “hot CEO market” black hole?  Three assumptions about CEO compensation seem to be driving organizations, rather than organizations driving their own futures. 

Assumption 1: The world is now so complex that fewer people can successfully function as a CEO, causing the market price for these individuals to skyrocket. CEO compensation has moved from 20 times that of the average worker to 200 times since the mid-60s. Given the shift to knowledge work and the typical worker having a higher skill set, even in manufacturing environments, how can this ratio be justified? And, even if it can, is it a sustainable approach?  

Possible responses: 
Aggressively look at what is needed to sustain the organization and plan for success in the future. This requires a disciplined approach that does not rely on opinion but on facts and documented research.

Look at leadership as a team effort. Can other members of the executive team cover what is needed? What leadership capabilities are needed to create comprehensive team capabilities and how should gaps be filled?

Isolating the CEO and putting all the weight on his shoulders will not work. The world is too complex for that. The board needs to view the leadership team as one accountable entity with the CEO as team leader. 

While being sensitive to the market, adhere to a compensation structure that makes sense internally. Money isn’t the only reward sought by senior leaders.

Assumption 2:  Organizations more frequently go outside for a CEO rather than promoting internally. This is often rationalized by a need for new thinking or skills. 

Possible responses:
Take a team-based approach to allow for a much broader set of skills to be leveraged.

Use business scanning and strategy to develop skills not present within internal talent.

Develop out-of-the-box methods to give internal talent opportunities to broaden capabilities important to the future of the business, to draw out latent abilities and gain practical experience. For example: secondments to not-for-profits; use of a coach or mentor from a different business to develop a needed capability; and participation in internal and external business environmental scans.

Use scenario planning to shake up perspectives of the future, comfort with the status quo and to foster flexible thinking.

Identify talent in terms of real capabilities and business needs. Focus on strategic needs, not tactical quick fixes that may not contribute to the longer term.

Assumption 3: The risk inherent in the job is so great that executives who demand extensive “golden parachutes” must be accommodated. When so much effort has gone into selecting the right CEO, why set a high reward for failure? With CEO tenure decreasing, shouldn’t the emphasis be on incenting success?
 
Possible responses:
Just because there are business challenges, organizations are not precluded from selecting a CEO with a stewardship mentality. Sustainability and growth with a stewardship focus set the board and organization up for success in both the short- and long-term, striking a balance with what shareholders value today and future success.

CEOs often fail due to personal attitudes rather than technical or business skills. They need to look at the organization today, value its strengths and provide a path for all in the organization to grow toward what is needed in the future. This comes from having a leader perspective and knowing she can’t do it on her own. This requires the CEO to seek advice, information and other views.

New CEOs need to be set up for success. This requires clear identification of support structures for transition, clear and realistic criteria for success in the short term, and participation in developing success criteria for the longer term based on stewardship. 

Organizations need to demonstrate investment in CEO success and in their own compensation structures. Regardless of how good a candidate seems, there are other fish in the sea. The preferable situation is a candidate who feels fully supported and who is more invested in providing stewardship and success than being rewarded for failure.

Organizations and boards that don’t develop strategic capabilities to manage and mitigate the current trends toward hiring a gunslinger with the built-in blackmail of a large golden parachute have already failed to think and act strategically. That does not bode well for their future.

Karen Gorsline is SCNetwork’s lead commentator on strategic capability and leads HR Initiatives, a consulting practice focused on facilitation and tailored HR initiatives. Toronto-based, she has taught HR planning, held senior roles in strategy and policy, managed a large decentralized HR function and directed a small business. She can be reached at gorslin@pathcom.com.

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