Friday, March 7, 2008

The State of Executive Compensation Reeks

Someone is trying to pull the wool over shareholders' eyes on executive pay. Wall Street firms awarded huge bonuses to CEO's while writing off billions in assets. Three of those executives, two of which are now ex-CEO's, will testify before Congress on their pay. However, the people who should be testifying are the Board Chairs. The Board of Directors approves executive compensation.

Bloomberg reported that Merrill Lynch plans on changing its "pay for performance" stock options to "retention" options. What might a simple change in semantics do to executive motivation? Studies show options cause CEO's to take riskier actions in a swing for the fences move.

The excesses of subprime lending and mortgage securitization match the aforementioned risky corporate behavior. Despite tens of billions in write offs, CEO's of Merrill Lynch and Citigroup received over $150 million in stock and options. Had they been terminated for poor performance, they would have received no incentive compensation.

Studies show extrinsic motivators have at best a temporary impact. They can improve performance in relatively simple tasks within the purview of one employee. Add any complexity to the work and extrinsic motivators distort behavior. The question is why board rooms are obsessed with rewards? The answer is most have been extrinsically motivated to provide governance. It takes quite the fish to recognize they are in water.

For a brief glimpse of our American water, consider the BBC's reporting on the hearing. "Republicans on the committee say those hearings fall outside the committee's remit which is to focus on waste and fraud." As a shareholder, I consider the state of executive compensation to be rife with waste and fraud. Recall the stock option backdating scandal that went on for 10-12 years?