Amid the growing chorus to address income inequality, a new Securities and Exchange Commission rule is being viewed with some hope. The new rule requires public companies to list their chief executive's total pay as a ratio to their workers' median compensation. The somewhat wishful thinking goes that CEOs and their boards will be shamed to scale back excessive pay packages once these wage gaps are prominently displayed and easy to uncover.
Let's not pop the Prosecco just yet, though. Another SEC rule being debated now would effectively endorse the root cause of excessive CEO pay -- the practice of paying CEOs based on the company's stock price.
The proposed rule would require a very narrow definition of performance specifically "total shareholder return" or TSR, which is roughly equivalent to change in stock price plus dividends. If the SEC settles on TSR as the principle measure of Dodd Frank's call for "Pay for Performance"-- this limited definition of success in business will reinforce the very metric that has contributed the most to escalating pay in the executive suite.
The SEC should back away from this rule. By focusing executives on the stock price, it encourages stock manipulations like stock buybacks and the kind of "swing for the fences behavior" that makes a parody of long-term value creation -- while ignoring the principle that executives be paid for results of actions and decisions actually within their control.
And if dropping stock from the pay package is too radical for most boards, Professor Michael Dorff, author of Indispensable and Other Myths, recommends structuring bonuses so that they are smaller, attached to metrics that are easy to measure, hard to game, and within the direct control of the executive.
In his book,Fixing the Game, Roger Martin -- who helped P&G rethink their pay metrics -- reminds us that the stock market is far beyond the control of a company and thus shouldn't figure disproportionately in pay packages. The stock price -- and thus TSR -- is affected by a wide range of factors that include, according to one study in 2014 by the Investor Responsibility Research Center Institute, "fund flows, central bank policies, macroeconomics, geo-political risks and regulatory changes -- all beyond the control of executive management."
Indeed, among the many powerful critiques of executive compensation in recent decades has been the recognition that "pay for luck"-- named over a decade ago in National Bureau of Economic Research has been a disturbingly common result of attempts to tie executive pay to financial performance.
Of course, to address inequality requires action at both ends of the pay scale. There are recent encouraging examples of executives taking action; Mark Bertolini gained the attention of the press by setting a higher minimum wage at Aetna, following companies like Costco who have benefited from enlightened pay practices for decades. He, along with a growing number of other executives concerned about fairness -- but also retention and productivity -- have been improving the pay, benefits and the structure of work for their lowest paid workers. This is a good thing.
Now it's time for courageous executives to go off script and fit their own pay plans to the narrative about what the firm values and measures on its own account. With the outrage over inequity between the top and the bottom only growing, it would be nice if the SEC's pay metrics enable the best thinking from boardrooms to take root and be rewarded.