Pay-For-Performance Hinges on Causality, Time Frame

Paul Dorf, the Managing Director of New Jersey based Compensation Resources, Inc. (CRI), is a true believer in the idea that exec comp need not turn on paying top dollar but instead on reasonableness and accountability – even as research conducted by his own consulting firm can only report findings that paint a very different picture.  For example, CRI recently reported that the median bonus for executives of large publicly traded companies in 2004 was a whopping $1.4 million, up 46.4 percent from 2003.
            
“I’m the poster child for pay-for-performance,” Dorf told Executive Compensation Strategies, adding that shareholders and investors are tired of seeing their money go to executives unless justified by results.  However, he acknowledges the tension between wanting to attract and retain executive talent based on what the market says the talent is worth on the one hand and wanting to pay for action and/or results on the other.  And even if the intent is to pay for actions or results, it’s not easy to establish a causal link that is transparent and measurable.  How does one ascribe a causal relationship between anything the executive did or did not do to the company’s health and bottom line – and what is the time frame for measuring this?

Causality

           
Many companies are looking to reward executive performance based on how the company’s stock does in the market.  But this may not be related in any way to what the executive did.  In some cases, this measure of success can be influenced by accounting changes, or, unfortunately, by plain manipulation.  For example, a Harvard Law School study says that Fannie Mae rewarded senior executives with cash bonuses when earnings-per-share increased.  The study argues that this presented senior managers with an incentive to manipulate accounting in the mortgage investment portfolio.

Part of this disconnect with causality is not necessarily a lack of science but a matter of corporate culture and values.  Changing values is “like changing engines on a plane flying at 30,000 feet,” Dorf says.  Corporate culture continues to be oriented toward getting the most out of a short-term stint rather than looking at long-term tenure.  Many executive pay contracts are front loaded with cash and marked by targets deemed met ( such as guaranteed pay packages, for example).  They aren’t dependent on performance at all.

Add to this short-term, get-it-while-you-can mentality an updated equivalent of what used to be called “the old boy network.”  In many cases, executives have direct influence over their own compensation because the members of the board of directors, executive committee or compensation committees are, at least metaphorically, part of the same country club as the candidate.  This in many cases explains sweetheart deals that feature performance targets that are contractually “deemed” satisfied.  By the same token, bonuses, profit-sharing and other incentives become expected and automatic instead of being used as true rewards.

In the face of this prevailing corporate culture, Dorf unabashedly admonishes executive pay committees and boards to make sure true and verifiable causality is identified – whether short- or long-term – and that , in either case, there is a “realistic” connection between the executive and the results.

Time Frame

           
Football coach George Allen’s oft-echoed war cry for his 1971 Washington Redskins was “the future is now” – reflecting Allen’s approach to putting together a winning team by trading away future draft choices for veteran players.  Similarly, many companies today tend to view results in a short-term context but reward short-term performance as if it translates into long-term success, according to Mark Van Clieaf, managing director of MVC Associates International.  He explains that a “fundamental problem in companies today is that too many CEOs and senior executives are being held accountable solely for short-term (one- to two-year) results.  However, they are paid as if they are accountable for longer-term (two- to 10-year) strategic work and value creation.”  Van Clieaf explores this topic in greater depth in a recent article published by The Corporate Board.

And what can be reaped in the short run may not even be very pleasant, CRI’s Dorf explains.  A company’s needs in the shor-term – in general, less than three years – may differ greatly from financial targets set for the long term.  For example, capital investments may necessitate a short-term loss of revenue in the proverbial one-step-back/two-steps-forward gambit.  One possible short-term goal would be to enhance employee training, thereby necessitating an expenditure that may affect the bottom-line in the short term.  Another goal could be achieving an operational refitting that may cause disruptions now but later produces new efficiencies and enhances the quality of the company’s product or service.  A reward for an executive who can achieve such short-term goals is appropriate, Dorf suggests, particularly if it is reasonably tied in with long-term financial success.