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Title: Board Guidelines for Setting CEO Compensation
Date: 04-Aug-2009
Category: Announcements
Source/Author: Stephen B. Young, Global Executive Director, Caux Round Table
Description: Compensation programs for CEO’s should not only recognize the importance of the position but should, in addition, provide incentives for such Chief Executive Officers to carry out the full range of objectives set forth in the CRT Principles for Business. Adjusting for maximum aggregate advantage the interests, emotions, and priorities of different stakeholders – customers, employees, owners, creditors, suppliers, the environment, the community, is a challenging task. Success in achieving outcomes that enhance business value and facilitate sustainable profits deserves to be rewarded.

Introduction
 
Stephen B. Young
Stephen B. Young
The objective of the Caux Round Table Principles for Business is to provide a framework for free-market business decision-making that serves the interests of all stakeholders.
 
Collectively, the stakeholders of business constitute society. For business to invest, create new products and services, meet consumer needs, pay taxes, earn sustainable profits, provide employment results in higher standards of living and more robust social, cultural and political engagement on the part of all citizens.
 
At the fulcrum of decision-making in our large corporations is the company’s Chief Executive Officer. Hired to implement the strategic goals and objectives set by the company’s board of directors and to inspire and manage a hierarchy of subordinate company officers and employees, the CEO shoulders important responsibilities for providing vision, direction, and leading through stewardship.
 
Compensation programs for CEO’s should not only recognize the importance of the position but should, in addition, provide incentives for such Chief Executive Officers to carry out the full range of objectives set forth in the CRT Principles for Business. Adjusting for maximum aggregate advantage the interests, emotions, and priorities of different stakeholders – customers, employees, owners, creditors, suppliers, the environment, the community, is a challenging task. Success in achieving outcomes that enhance business value and facilitate sustainable profits deserves to be rewarded.
 
In the first place as recognized by Caux Round Table Principles for Business, a business must be profitable for it to meet its social obligation of wealth creation. How such profits are to be made and how the interests of relevant stakeholders are to be adjusted present many significant challenges to boards of directors and senior company managers. CEOs should be given compensation appropriate to their success in achieving these objectives.
 
Therefore finding proportionate measurements of executive success for CEOs are needed to support a just and reasonable executive compensation decisions. For a start, the CRT Principles for Business provide a framework for setting goals and objectives for company performance. Success in having the company align itself more and more with the CRT Principles, and so more and more achieve outcomes favored by those Principles, would justify more generous executive compensation
 
The Caux Round Table offers in its risk assessment instrument “Arcturus” a specific metric for measurement of a company’s alignment with the CRT Principles for Business. Incorporation of Arcturus assessments into the compensation process for CEO’s would provide a specific, objective measure of how well such senior executives have achieved corporate social responsibilities.
 
If, thank to a CEO’s efforts, a company is successful and therefore has the ability to serve society well - especially to meet the needs of its customers and employees - then that CEO should be appropriately appreciated and rewarded.
 
What, as a matter of principle, should not be reflected in amounts awarded as executive compensation is what economists refer to as a “rent premium”. Rents as a form of income flow from legal entitlements such as landlord status. They can, and most often do, reflect a fair return on the contribution of genuine economic resources (land, capital, intellectual property, etc.), but rents can also reflect non-economic returns to positional power. Seeking non-economically rational rent in return for one’s discretionary consent to activity lies at the heart of systems of crony capitalism and corrupt use of government power. CEO compensation, in particular, should reflect business results and not the CEO’s close personal relationships with board members.
 
Observations
 
Role and Function of the Chief Executive Officer
 
1)      The CEO is an employee, so CRT Principles for Business, part 3, Stakeholder Principles on Employees are applicable. While the framework of this section of the CRT Principles for Business is focused on ordinary employees rather than on senior management, nonetheless the principle remains that a CEO is hired to serve the interests of the firm and is not an owner entitled to legal rights of personal dominion over the assets of the firm.
o   Under the CRT Principles for Business, the minimum financial obligation of the firm towards those it employs is only to “Provide jobs and compensation that improve worker’s living conditions”
 
2)      As an employee acting under principles of agency law, the CEO must meet duties of loyalty and due care in the execution of his or her corporate office.
o   Under the duty of loyalty, the CEO must have sufficient personal character to place service over self.
o   Under the duty of due care, the CEO is expected to lead the corporation in the achievement of its goals and objectives.
o   Under the CRT Principles for Business, the goals and objectives of the firm extend beyond short term profit or stock price. The full range of stakeholder constituencies must be managed with a view towards enhancing the residual value of the firm. Thus, the work of a CEO may be as important when market conditions are adverse as it is when the business environment is conducive to income gains and a rising stock price.
o   The principal test of a firm’s success is its prospects for long term profitability as reflected in its fundamental market valuation.
o   Comprehensive metrics to measure firm achievements are required.
o   A significant proportion of a CEO’s remuneration should be directly tied to the level of achievement. Simply basing remuneration outcomes on comparative salaries earned by CEOs in other firms is not relevant to the issue of how well a CEO is doing with respect to meeting the firm’s salient goals and objectives.    Failure to perform should not be rewarded.
 
 
 
3)      The CEO leads a management team and inspires productivity throughout the organization, and so must demonstrate skills in governance.
o   Vis-à-vis the board of directors
o   As a leader implementing the core values of the corporation
o   As a manager getting the most from his or her direct reports and throughout the organization
o   360 evaluations are relevant metrics for this aspect of CEO performance.
 
Principles To Guide Board Compensation Committees
 
Board context is legal and fiduciary duties to shareholders to insure enterprise success
 
1)      Board must articulate in writing a clear philosophy regarding the ends and objectives of compensation as part of a values framework for the company.
2)      There must be a governance process to keep compensation decisions within the company’s values framework.
3)      Compensation decisions must be transparent, with no manipulation of data or hidden terms and conditions
a.       comp committee report to full board
b.      decision made by independent directors
c.       no captive compensation consultant
d.      stock options count when granted, not when exercised
4)      The Board must insure alignment of compensation decisions to company goals and objectives. Compensation is only an incentive to encourage its agents to accomplish company goals. Company goals take precedence over individual wants and desires.
a.       Performance measures for:
                                                              i.      growth
                                                            ii.      dividends
                                                          iii.      stability
                                                          iv.      excellence in minding the store
                                                            v.      turn around situation
                                                          vi.      corporate citizenship
5)      Setting of executive compensation is not a robotic exercise in regimentation or fealty.
6)      Use of comparables should look to median compensation levels, not to the highest levels; comparables should also reflect not only which companies have prospered, but also which ones have seen failures or reversals
7)      Special situation arises when hiring a CEO from outside the company.
a.       Beware “super star signing bonus” fever
b.      Avoid too lenient exit terms such as grossing up a severance payment to pay for income taxes
c.       Remember there are many more fish in the sea
 
Goals and Objectives:
 
1)      Set proper time horizons for executive accomplishment: short term/mid term/ long term
2)      Tilt compensation for level of responsibility:
a.       High level – 40% fixed salary/60% future appreciation or 30% fixed salary/35% bonus/35% future appreciation
b.      Middle managers: 75% fixed salary/25% bonus or future appreciation
c.       Low levels: 95% fixed salary/5% bonus or future appreciation
3)      Performance measures
a.       financial measures
b.      corporate citizenship/CSR measures
c.       consider company stock price against benchmarks from peer companies, industry or other relevant comparables, not just increase in market price; look at trends in stock prices, not isolated one-time prices
d.      consider if company is operating in a down market or an upmarket
4)      Perks
a.       In principle, perks and special benefits outside a salary must have a business purpose. Entertainment allowances, personal driver, financial planning services, club memberships, use of company planes and vehicles, expense accounts, all need to serve company goals and objectives and be very clearly business related.
b.      Payment of taxes for a CEO is improper.
c.       Use of automatic stock trading plans to sell company stock based on inside information constitutes a company sanctioned manipulative device linked to terms and conditions of executive compensation.
d.      Retirement plans that provide more than a reasonable multiple of fixed salary deserve careful consideration.
 
Reporting and Communications
 
1)      provide reasons for compensation decisions
2)      provide analysis of company goals, objectives, risk factors and accomplishments
 


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