Two old news items caught my eye. The first was the report from the Home Depot annual meeting contrasting investor-frien
Posted: Wed Apr 27, 2022 1:57 pm
Two old news items caught my eye. The first was the report from
the Home Depot annual meeting contrasting investor-friendlier tone
set by the company's new CEO, Frank Blake, with the previous CEO,
led by then-CEO Robert Nardelli. It's hard to tell how much of the
investor-friendlier tone was created by the fact that Blake is
earning about 70 percent less in base pay than Nardelli, totally
aside from the fact that the latter also took home a nine-figure
package in incentives. Home Depot's stock has had lackluster
performance under both CEOs. But there are those who say that
Nardelli's task of leading a transition from a highly
decentralized, founder-led organization to one more reliant on
shared services and central direction was enormous and that he was
making good progress. How much is that worth?
The second item was a report of the decision by Moody's
Investors Service to begin taking into account the spread in pay
packages between the top two executives in the organizations whose
bonds it rates. Presumably, the larger the spread, the lower the
bond rating, reflecting the higher implied risk associated with a
large spread. As Mark Watson from Moody's put it, "We are rating
the company, not the person. A bus might come by and knock the
(top) person over."
There are several assumptions implicit in these two items.
First, there are limits within which pay can elicit performance.
Above a certain amount of incentive, does pay provide an incentive
for or even influence performance? The Moody's decision might
suggest the assumption that pay reflects value to an organization,
and possibly also potential performance. In other words, one's pay
in relation to the leader reflects one's value (or even likelihood
of being promoted) if the leader were to get hit by a bus today. A
third assumption is that good leaders are very hard to find and are
worth every penny they are paid, regardless of structural
imperfections in the ways that compensation packages are negotiated
and determined.
There are a number of reasons why pay may not reflect
performance. First, many of the larger pay packages are negotiated
by those being hired from outside the organization. Most often, an
outside hire is prompted by poor performance by insiders. So in a
sense, the bargaining power of the outsider is increased,
regardless of the performance that may be delivered later. It is
one of several reasons for the careful planning of executive
succession. Further, many pay packages are determined on the basis
of what others in comparable jobs, regardless of performance, are
being paid. This creates a natural disconnect between pay and
performance. Third, current pay often reflects past performance,
not current or expected performance.
And to what extent does substantial pay for performance elicit
short-term decision making that can even exacerbate management
turnover? Does it encourage playing the "roller coaster" earnings
game, in which executives in an organization can make enormous
performance-based incentives in the odd years and none in the even
years (ironically, when the large performance-based pay is reported
to the public), thus netting a substantial performance bonus while
producing little long-term benefits for owners? Is it even fair to
ask those lower in the organization, who may be less able to afford
it, to put part of their pay package on the line?
If pay is linked to performance, should it be to past,
present, or expected performance? Or should pay be linked more
closely to past, present, or expected value to the organization? Or
are these differences academic? Do cross-company comparisons
confuse the matter even further? Just how should pay be linked to
performance? What do you think?
the Home Depot annual meeting contrasting investor-friendlier tone
set by the company's new CEO, Frank Blake, with the previous CEO,
led by then-CEO Robert Nardelli. It's hard to tell how much of the
investor-friendlier tone was created by the fact that Blake is
earning about 70 percent less in base pay than Nardelli, totally
aside from the fact that the latter also took home a nine-figure
package in incentives. Home Depot's stock has had lackluster
performance under both CEOs. But there are those who say that
Nardelli's task of leading a transition from a highly
decentralized, founder-led organization to one more reliant on
shared services and central direction was enormous and that he was
making good progress. How much is that worth?
The second item was a report of the decision by Moody's
Investors Service to begin taking into account the spread in pay
packages between the top two executives in the organizations whose
bonds it rates. Presumably, the larger the spread, the lower the
bond rating, reflecting the higher implied risk associated with a
large spread. As Mark Watson from Moody's put it, "We are rating
the company, not the person. A bus might come by and knock the
(top) person over."
There are several assumptions implicit in these two items.
First, there are limits within which pay can elicit performance.
Above a certain amount of incentive, does pay provide an incentive
for or even influence performance? The Moody's decision might
suggest the assumption that pay reflects value to an organization,
and possibly also potential performance. In other words, one's pay
in relation to the leader reflects one's value (or even likelihood
of being promoted) if the leader were to get hit by a bus today. A
third assumption is that good leaders are very hard to find and are
worth every penny they are paid, regardless of structural
imperfections in the ways that compensation packages are negotiated
and determined.
There are a number of reasons why pay may not reflect
performance. First, many of the larger pay packages are negotiated
by those being hired from outside the organization. Most often, an
outside hire is prompted by poor performance by insiders. So in a
sense, the bargaining power of the outsider is increased,
regardless of the performance that may be delivered later. It is
one of several reasons for the careful planning of executive
succession. Further, many pay packages are determined on the basis
of what others in comparable jobs, regardless of performance, are
being paid. This creates a natural disconnect between pay and
performance. Third, current pay often reflects past performance,
not current or expected performance.
And to what extent does substantial pay for performance elicit
short-term decision making that can even exacerbate management
turnover? Does it encourage playing the "roller coaster" earnings
game, in which executives in an organization can make enormous
performance-based incentives in the odd years and none in the even
years (ironically, when the large performance-based pay is reported
to the public), thus netting a substantial performance bonus while
producing little long-term benefits for owners? Is it even fair to
ask those lower in the organization, who may be less able to afford
it, to put part of their pay package on the line?
If pay is linked to performance, should it be to past,
present, or expected performance? Or should pay be linked more
closely to past, present, or expected value to the organization? Or
are these differences academic? Do cross-company comparisons
confuse the matter even further? Just how should pay be linked to
performance? What do you think?