Five commandments for paying the boss

Back in 2006 before the world of finance fell apart, FORTUNE's Shawn Tully wrote an article (here) in which he laid out 5 rules that boards and shareowners should follow when crafting executive compensation.  If only someone listened.  We would not have as many examples of CEO and top executive pay coming so unglued from economic performance.

Of course, there are many exceptions like Harsco (HSC), Herman Miller (MLHR) and Briggs & Stratton (BGG), but they are few and far between.  Tully writes:

Misguided pay is expensive; worse, it is a recipe for decline, because it rewards self- defeating behavior, such as inflating earnings per share to wow Wall Street.

It is up to corporate boards to stand up to the bullying of the compensation consultants and to design plans that work for the best interests of the company. One place to start is to limit severance pay and eliminate bonuses when executives don't perform.

"You don't get paid for failure if things don't work out in a leveraged buyout," notes a prominent hedge fund manager. "Why should you in a public company?" And if performance is not sustained, CEOs should pay back the big bonus.

Such clawback mechanisms make it less likely that CEOs will "pump and dump" - that is, buy earnings through bad management (e.g., cutting R&D), then sell when the stock price begins to drop a few months later.

CEOs that pump and dump?  CEOs that leverage their companies to the hilt? Earning hundreds of million dollars before you get fired and the new guys get hauled in front of Congress while you figure out how to hide your dough off-shore somewhere?

Maybe some of that behavior could have been avoided if boards would follow these five FORTUNE commandments:

I. Thou shalt pay shareholders first.

 

II. Thou shalt base bonuses on economic profit.

 

III. Thou shalt not rely on restricted stock.

 

IV. Thou shalt favor options, cautiously.

 

V. Thou shalt force CEOs to hold, not sell.

 

I'll have something to say about each of these in later posts.  Value-Aligned companies already explicitly follow these rules - that's only 10% or so of the Russell 3000.  Pity the fools that hold forever the rest.

 

BERK

Comments

[Scott]

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[esther tolan]

Now if we could get all CEO's to follow those rules.
Then we have to have congress have the same health care and pension system the rest of us have to follow, take the pork out of the bills they pass, tell the public the truth, not give into special interest and run on what they will do and not bad mouth their openent but point out real difference this would be a better country. Do you still beleive in the tooth fairy?