Increased scrutiny of executive pay could result in smaller bonuses tied strictly to performance
Although executives can still expect some big bonuses in the future, company boards are moving towards a more conservative way of determining compensation, according to a senior executive compensation consultant at global consulting firm Watson Wyatt.
“There is probably going to be a change in the way executives are going to be paid,” said Robert Levasseur, who is based in Toronto.
“There will be more concern in terms of looking at mitigating risk… because oftentimes the employees are (in) the position where they recorded vast amounts of compensation for decisions they’ve made, not knowing if the decisions are beneficial to the organization in the long term.”
The way compensation is determined is beginning to change, in part because of the increased amount of public and media scrutiny, he said. (Pressure from shareholders is also playing a large role. For a look at what’s new with “say on pay,” see article #6842
In March, it was revealed executives from struggling financial firm AIG collected $165 million US in bonuses not long after the company received billions of dollars in bailout money from Washington.
While some executives eventually gave the money back, the incident sparked a debate about the balance between compensation payouts for retention and reasonable rewards for corporate performance.
Although hearty financial compensation is still important for retaining and attracting quality executives, “it is a market after all,” said Levasseur, and while executives are still playing the “retention card,” there are fewer opportunities for them than there were nine months ago.
The downward shift in executive compensation means the system of bonuses is doing what it is supposed to do, said Jeffrey Gandz, a professor at the University of Western Ontario’s Richard Ivey School of Business in London, Ont.
As boards observe the backlash caused by executive bonuses, they are becoming more sensitive to the overall performance of the organization when drafting compensation agreements, he said.
Use market data
When boards are determining compensation, it is important they avoid lumping all payments into the same category, said Gandz.
In order to decide what to pay a potential employee to retain her, company boards should look to market data to see what is competitive.
The next step involves deciding on the conditions they will attach to variable compensation — some for short- and long-term performance and some for financial goals.
“One of the things we are seeing is much greater care being taken to determine both the total amount and the various amounts of compensation so the system is more transparent and justifiable,” he said.
The compensation package for retiring Manulife Financial CEO Dominic D’Alessandro is an example of the importance of performance-based compensation, said Gandz.
Although Manulife reported a $1.87-billion loss in the fourth quarter of last year, D’Alessandro received $12.35 million in total compensation for 2008. He will receive $12.6 million for 2009.
“If you take a look at it from March 29, it looks like a ridiculous decision — the shares were down yet (there) was a big bonus,” said Gandz. However, D’Alessandro’s compensation was agreed upon before “the bottom fell out,” he said.
Now, the public will probably see fewer payments made because someone has done a good job and, instead, compensation will be tied to performance-based merits, said Gandz.
“There may well be bonus plans that have (provisions) in them saying ‘dependent on such-and-such,’” he said.
Retention without massive compensation
The primary way to attract and retain executives without offering large compensation packages is to provide interesting and attractive jobs, said Gandz.
While that has always been important, it is even more so now because “the externalities facing companies are not that great. There is going to be a lot more focus on the nature of work and how to improve the conditions of work for people, other than in financial terms,” he said.
“In the same token, there will be the need to be competitive,” he said. “As perverse as it may seem, there will be pay increases when people are being laid off, essentially for the need to retain talent.”
