Understanding the Link Between Pay and Performance
Despite suggestions to the contrary, executive pay structures likely did not cause the excessive risk-taking that led to the financial crisis. The assertion that pay does not support performance is little more than a media myth, according to Aubrey Bout, partner at Pay Governance, who spoke today on a panel on executive compensation and risk at the Corporate Executive Board’s 2010 Finance and Strategy Summit. Yet, there has been a surge in compensation regulation and increased proxy disclosure requirements globally and companies should move decisively and defensively on pay.
Executives should still be mindful of the potential for moral hazard in overpaying: excessive compensation correlates with excessive risk taking. CEB research suggests that executives can maximize performance by moving from away from how much companies pay their executives toward how they pay (revisit our blog post and podcast for background).
Successfully balancing risk and pay requires an inclusive approach that brings together all key stakeholders. “Almost no one in any company is an expert at both [risk and executive compensation]. You have to get people together to talk,” Bout said, noting that oftentimes they speak in “completely different languages.”
New regulatory requirements have already affected the level of risk that companies can build into pay structures. Charles Tharp, executive director at the Center on Executive Compensation, also speaking on today’s panel, clarified that what we are seeing now is “overflow” from TARP. The new SEC requirements that all companies expand risk disclosure is, “reasonably likely to have externally adverse impacts on companies as a whole,” Tharp said.
Finding an effective pay structure depends primarily on companies themselves. “Regulation in spirit is helpful, and it’s needed at times, but companies need to adopt it themselves,” Bout said.
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