The financial meltdown that began in 2008 caused a lot of finger-pointing: who was to blame and why? Although the list of potential culprits is long and varied — from bank deregulation, to the increased use of credit default swaps and other hyper-complex financing structures, to a “play today, pay tomorrow” mentality that allowed average Americans to rack up staggering amounts of debt. But, according to many observers, corporate Compensation Committees were also partly to blame because they were authorizing huge compensation packages, laden with equity, that literally encouraged and rewarded their executives for taking excessive risk.
After the collapse and impending recession, people began asking — is it really necessary to offer CEOs and other executives such lavish compensation packages?
Not surprisingly, corporations and their Compensation Committees defended their executive compensation decisions by arguing generous pay packages were necessary to keep talented executives from jumping ship. This assumption — that executives were mobile and their skills transferable — drove the Compensation Committees to benchmark what other similar companies were paying their executives. By assembling this so-called peer group benchmark, the Compensation Committees could ensure that they were paying their executives generously enough to keep them from leaving to join a competitor-peer.
But a new study discussed in today’s New York Times debunks this fundamental assumption about executive mobility. According to researchers at the Weinberg Center for C0rporate Governance at the University of Delaware, CEOs cannot readily transfer their skills from one company to another. Very few departing CEOs actually land new CEO jobs at other companies. Given this finding, the study’s authors concluded that the first step to changing excessive executive pay is to eliminate the heavy reliance by Compensation Committees on peer-group benchmarking. With benchmarking gone, a “shareholder conscious” Compensation Committees should instead set executive compensation by developing “internally consistent standards of pay” based on (1) the nature of the company, (2) its particular competitive environment, and (3) its internal dynamics.
The New York Times article that discusses this new executive compensation study can be found here.