Executive Compensation - "Keep the Bubble in the Middle"

I once heard a speaker say, "When you go through life, walk as if you are carrying a carpenter's level -- keep the bubble in the middle." Sage advice as we are prone to flights of over-reaction in our life.

The same advice can be applied to the current sense of heightened emotion on executive pay. As a result of the recent financial crisis market constituencies are highly agitated over the perception that executive compensation seems to have ballooned in a time of economic distress. With all the over-sized pay packages and bonuses, shareholders are (rightly so) outraged by the earnings of executives as compared to their holdings.

Removing ourselves from the emotion we can begin to look more pragmatically at information. As an example, a recent academic study by Fahlenbrach & Stulz actually shows that on average the CEO's in the financial crisis did not take big gains while shareholders suffered losses. The median loss for a CEO was $5.1million. While CEO pay on the whole is up, this information helps to provide some balance to the notion that bank CEO's are "robbing the bank."

Thus as we take a deep breath, the answer to the problem does not solely lie with the government or in the hands of shareholders. Rather, both parties should recognize their uniquely defined role and work in partnership toward a result that enhances the best of parts of capitalism (freedom) while limiting its worst trait (greed). The following highlights a few recommendations to address the current challenge. Some require government action, while some just require shareholders to step up their oversight and involvement in the firms they own.

• Shareholders should expect and leverage a compensation audit practice industry that independently audits pay practices and provides ratings and insight to both shareholders and government oversight agencies.
• When a company does not hit the criteria for a bonus -- don't pay it. A review of proxy's show that boards too often fail to hold the CEO accountable to the performance objectives and pay him anyway. For example, in 2007, Fair Issac (FICO) funded the executive award pool at 48% despite the fact that "we did not achieve our financial performance targets."
• Institutional investors (especially those with public money) must demand transparency and accountability into executive compensation and ensure their vote is heard on the issue. Proxy voting units need to step up their review and accountability of their portfolio companies' compensation practices.

There is no doubt that the issues of executive compensation needs to be addressed and now is the time to do so. Let's just hope that all parties involved "keep the bubble in the middle" and develop a simple, balanced solution.