The delicate balancing act of executive compensation

Executive Compensation

It’s one of the most important duties tasked to the members of a supervisory board: finding the right executive board members to lead a company, and finding the right incentives to get them on board.

Financial incentives are obviously a major factor, but supervisory board members walk a slippery slope when it comes to coming up with a figure: Offer too little, and the best candidates walk away. Offer too much, and there’s that headline-grabbing phrase looming in the distance: “excessive executive compensation.”

Worth every penny?

We all know the stories of executives pocketing millions despite poor performance or even scandals at a company.

The figures thrown around when it comes to executive compensation have a tendency to make our eyes water. I’m reminded of Martin Sorrell, CEO of WPP, who last year claimed he was “worth every penny” of his 70-million-pound compensation package when he took the helm of the company. My eyebrow wasn’t the only one to be raised at that statement.

But, as Sorrell pointed out, he’d been with the company for 31 years and had been instrumental to its growth. In other words: he was the right person for the job, and getting the right person has its price. It falls to supervisory board members to know what this price is.

A moving target

Unfortunately, determining the right incentives for a C-level exec is far from an exact science. As the complexities of a company rise, the pool of qualified candidates who can competently handle the job shrinks. Like football superstars, the best in the business are in high demand and fetch the best prices.

To help with this process, here is some food for thought for supervisory board members when it’s time to talk brass tacks on an executive compensation package.

–         It’s glaringly obvious, but it bears repeating in this context: shareholders are looking for good value. Feeling good about ROI also extends to the performance of executive board members: a compensation package can look like a great investment if an executive is doing a good job; the same package can look absurd if an executive is making bad decisions.

–         Related to that is the fact that good performance should be rewarded, and poor performance should have consequences. Keep the win-win principle in mind: if the shareholders win, the board member should win, too. The same principle applies if shareholders incur losses; executives should take a hit in that case, too.

–         A win can be a difficult thing to define, however, which means incentive-based compensation needs to be tied to appropriate assessment benchmarks. These should be limited to free cash flow, residual gains, and the share price (or changes in share price).

–         Incentives tied to residual gains and share price can be used quite effectively in tandem to arrive at a mutually-beneficial compensation package. Using both can lower the risk premium and shift focus to long-term performance when the assessment benchmarks are spread over a several-year period.

–         As a final point, a more harmonious relationship between shareholders and the board can be achieved if their fates are intertwined. Stock incentives, as an example, should come with minimum holding periods, which sends a signal that board members have skin in the game along with shareholders and are invested in the long-term success of the company.

Every situation is unique when it comes to creating an attractive compensation package for executives that also weighs the long-term interest of shareholders. These guiding principles were created by a VARD expert study group consisting of supervisory board members in Germany and are meant to drive discussion on the subject.

There are no right answers to the question of ‘what constitutes excessive executive compensation.’ That’s why supervisory board members need to engage in discussion with each other to establish the limits and norms of this sliding scale. As an international corporate governance advisor, I am looking forward to continuing the conversation online or in person at the 11th GermanBoardConference on June 30 in Dusseldorf.

If you have any questions or would like to receive further information on this topic, please do not hesitate to contact me.

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