Pay for Value: Cutting the Gordian Knot of Executive Compensation

Abstract

Executive compensation has moved through different phases over the last 70 years. From a base salary with a modest bonus added on, compensation skyrocketed after the mid-1980s with the practice of large stock options grants Changes in the nature of ownership and governance of publicly listed corporations coincided with this revolution in compensation.For a period of time, the compensation of Canadian CEOs was but a fraction of their American counterparts. However, the pay of chief executive officers at large Canadian corporations has increased substantially over the years 1998 to 2010, achieving virtual parity with American CEOs by the end of that period.At the same time, the compensation of CEOs moved up and away from that of the other senior executives at the same company. As well, the relationship of Canadian CEOs’ compensation to the average salary of Canadian private-sector employees jumped from 60 times in 1998 to some 150 times in 2010.The reasons for this much increased compensation are multiple and complex and the various interested parties have very different perspectives on the phenomenon. This policy paper describes how investors, board members, corporate executives and society at large have come to view the issue of setting a fair and appropriate compensation for company executives.As recommended and urged by investors, some governance specialists and government agencies, a large portion of these pay packages is deemed to be “at risk”, meaning that their actual pay is subject to stock price variations and some financial measures of performance. Some (mild) form of claw-back in case of reversal of performance is now built into many compensation programs.The form of executive compensation has become largely standardized and its level is established on the basis of selected “comparable” companies, deemed to act as a basis to appreciate the market value of a corporation’s executives.This paper is critical of most of these bits of conventional wisdom and makes some specific recommendations for the setting of executive compensation.