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Fixing executive pay
Business Strategy Review, 2003, Volume 14 Issue 2, pp 69-71
Fixing executive pay
Orit Gadiesh, Marcia Blenko and Robin Buchanan
That is certainly the view of institutional investors.
Setting executive pay should reflect
The critical question they are asking about executive
sustained and superior performance. For
compensation is not “how much are we paying?” but
institutional investors the issue should not
be how much executives are paid but what
Interviews we conducted with more than 40
they are paid for.
institutional investors in the UK and US underscorethis point: more than 90 per cent oppose option re-
Sidney Taurel, Eli Lilly’s chief executive officer,
pricing; 82 per cent say they want to discontinue rich
addressed the pharmaceutical company’s 41,000
severance packages; and 70 per cent are against
employees via videoconference in October 2001 to
awarding bonuses tied to acquisitions. Yet 63 per cent
outline far-reaching cost reductions. Standing in the
say they are willing to approve compensation plans
cafeteria of Lilly’s Indianapolis headquarters, Taurel
that give senior managers a larger share of the value
added up the financial impact of losing patent
they create for shareholders – as long as senior
protection for Prozac, the blockbuster antidepressant
managers also share in the downside.
that accounted for more than a third of Lilly’s $2.8bnprofit in 2000.
Indeed, when pay is the measure, most executives stilldon’t feel the same pain as their shareholders. In 2001,
No one would receive pay increases in 2002, Taurel
when stock prices of the S&P 500 fell 13 per cent and
said, and managers would give up bonuses and
corporate profits were down 35 per cent, median total
stock grants. Then Taurel delivered a blockbuster
compensation for CEOs rose in nearly all industries,
message of his own: he had asked directors to slash
ranging from an increase of 31.6 per cent in
his 2002 salary to $1. Employees got to their feet
construction to 0.3 per cent in financial services,
according to the most current data on executivecompensation compiled by The Conference Board. The
In an era of ambiguous compensation plans for top
exceptions were retail and telecommunications, where
managers, Taurel’s request to cut his own pay sends a
CEO compensation was unchanged by Conference
clear signal of accountability. But compensation plans
Board calculations (which involve taking into account
should not rely on individual acts of responsibility,
annual salary and bonus, plus the value of long-term
however admirable. Instead, such plans should
grants and payments, including stock options and
explicitly and systematically link executive pay and
restricted stock grants, and long-term performance
70 Orit Gadiesh, Marcia Blenko and Robin Buchanan
They are clear about what drives value in theirbusinesses; they communicate it widely – internallyand externally - and they measure what matters
They tie compensation to the real value created –reflecting the performance of both share price andthe underlying business over time
They recognise that the frontline drives the bottomline and cascade appropriate measures andincentives to key employees
They build trust with compensation systems thatare simple and transparent to employees as wellas investors
Be clear on measures that matterDell Computer has built a pay system that hits manyof these marks. Dell’s strategy of cost and customerleadership has not wavered in a decade. Costleadership, for example, hinges upon the company’sability to manage inventory levels, working capital,return on invested capital, and service support costs.
With a clear picture of what drives value, Dell’s paysystem starts with executives’ base salaries, which areaverage among high-tech companies. A biggerpotential slice of the pay package comes from long-term, equity-based compensation that helps motivatemanagers to increase shareholder value.
The reward for successful strategy execution is builtinto Dell’s annual bonus, which uses value driverssuch as operating profit margin and customersatisfaction metrics to set ambitious targets for
executives. In 2001, for example, CEO Michael Dell
received only 25 per cent of his possible bonus,
Tying executive compensation to sustained value
although the company performed well relative to
creation won’t happen simply by linking compensation
peers. The reason? The business fell short of hitting
to stock price. Management could be focused on the
wrong priorities but benefit from a rising market. Orit could be doing exactly the right things but still be
penalised as a result of forces outside its control.
Consider also Reckitt Benckiser, the UK-based makerof household cleaning products. Senior managers’ base
The best compensation systems pay out for successful
salaries are well below competitors and long-term
strategy execution while including an equity
incentives do not pay out unless the company achieves
component to align management and shareholders.
growth rates that are double the industry average. The
Executives are pushed to outperform both ambitious
system’s multi-year aspect focuses management on
internal targets and their peers in the stock market.
sustainable, not short-term, growth.
The companies that appear to get real benefit
To earn their bonuses, Reckitt Benckiser executives
from linking pay and performance apply four
must show measured progress towards the company’s
strategic targets. Net revenue growth that exceeds the
industry average is one such target; executives achieveit by investing in high-growth categories where thecompany has strong, market-leading positions.
The plan also ensures management feels the pain ifshareholders are suffering. Besides using stock-basedincentives, Reckitt Benckiser mandates minimumholdings of 200,000 shares for each senior executiveand 400,000 shares for the CEO. The plan prohibitsre-pricing options and requires that bonuses bewithheld when targets are not reached. “I want tomake people sweat,” says CEO Bart Becht.
Cascade incentivesSome companies do link executive compensation toboth shareholder value and strategic targets but failto focus the rest of the organisation on the same goals.
Online trading company eBay, for example, recognisesthat customer service employees on the frontlines arevital to profitability; they help build a loyal customerbase and encourage existing customers to explore newcategories. These key employees are paid based ondirect customer feedback and can access reports ontheir performance at any time.
In a similar fashion, Nucor, the US steel maker, haspushed production incentives out to its mill workers,
who are key to determining productivity. The
Dell: only 25 per cent of his bonus
company pays hourly workers about half as much asthe competition, then adds weekly cash bonuses
support once the performance requirements for the
that can double or triple the hourly wage depending
on the amount of quality steel handled by a workteam on its shifts. When the weekly bonuses are
The debate on executive compensation is set to
included, Nucor’s hourly workers, all non-union, are
continue, particularly with company performance
the highest-paid in the industry but the company is
lagging and the stock markets feeling their way
one of the most efficient in terms of labour costs per
through uncertain economic times. But this debate will
be more productive if companies and shareholdersfocus on the right question – not whether executive
teams are overpaid but how compensation can be
Once companies have linked compensation to what
linked more effectively to sustained and superior
drives value, they can explain compensation packages
performance. Eli Lilly’s Taurel is an inspiration but it
to employees and investors with credibility.
should not take an individual act of responsibility by
Compensation has greater impact when everybody
the CEO to align pay and performance.
knows what he is paid for. Indeed, shareholders whounderstand compensation packages are more likely to
Orit Gadiesh is chairman of Bain & Company.
accept them – 73 per cent of institutional investors are
Marcia Blenko is a Bain vice-president in
looking for more transparency, according to our survey.
London and Robin Buchanan is the seniorpartner in London. A version of this article
When Reckitt Benckiser laid out its executive
appeared in the World Economic Forum’s
compensation plan for 2000, the media’s initial
Global Agenda magazine in January 2003.
reaction was hostile. But scepticism turned into broad
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