Fair Pay, Fair Play: Aligning Executive Performance and Pay

288 Pages·2010·1.99 MB·English

by  Robin A. Ferracone

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This innovative book offers hope that orga- R intense pressure and unprecedented
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“I like the way that Ferracone tells real-world stories on executive compensation, as re- A
tion and talent development, in addition to counted by board members and executives on the front lines, and she backs up these C for accountability when determining execu-
compensation, to attract, motivate, focus, narratives with well-researched statistics. Her way of looking at performance-adjusted O FF AA II RR PP AA YY tive compensation.
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and retain exceptional executives. pay is highly innovative and offers insights that we had previously not seen.”
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—ROY J. BOSTOCK, non-executive chairman of the board, Yahoo! Inc. Fair Pay, Fair Play offers organizations,
including board members, executives,
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“This book is the best authoritative source on executive compensation today. It takes HR and compensation professionals, and
an extremely complex topic and boils it down to its simplest terms: alignment between AA investors a new way to think about execu-
pay and performance. Ferracone’s Alignment Model gives us a way to test and analyze tive compensation; suggests a model for
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alignment in our companies. In a word—it is superb! The Alignment Model is a tool that
establishing common standards of fairness
II
boards, executives, and investors alike can use. This book is required reading for every
and propriety; and shows how to develop
compensation committee member, CEO, head of HR, and institutional investor RR
a more effi cient market for executive talent.
in America.”
Fair Pay, Fair Play adheres to the overriding
—ALEXANDER L. CAPPELLO, chairman and CEO, Cappello Capital Corp.
objective: “executives should be paid on
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the basis of how well they perform for their
“Ferracone provides a set of principles combined with actual accounts of how compa- A l i g n i n g E x e c u t i v e
shareholders, relative to the external market,
nies can achieve pay-for-performance alignment on a sustainable basis. Making this AA
happen is critical to building trust and a high-performance culture.” within contemporary standards of fairness
—RICHARD FLOERSCH, chief HR offi cer, McDonald’s YY and propriety.”
P E R F O R M A N C E
ell “Ferracone does an excellent job of describing how executive performance and pay ,, In this groundbreaking work, noted execu-
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os should be aligned. She combines quantitative research with qualitative commentary tive compensation expert Robin Ferracone
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ck from those who are on the front lines in determining executive compensation. FF a n d combines her more than thirty years ex-
Ni This combination makes the book eminently readable and a very useful guide.”
y perience to provide a clear examination of
o b —ED LAWLER, author, Rewarding Excellence AA executive pay and offer guidance on how
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Ph P A Y to determine fair pay packages, suitable
“By constructing a highly fact-based and thoughtful road map, Ferracone has taken the
II actions, and appropriate designs. Fair Pay,
emotion and fear out of executive compensation decision making. Following the rec-
ROBIN A. FERRACONE is founder and Fair Play draws on a database comprised of
ommendations and analyses contained in this book will enable struggling boards and RR
executive chair of Farient Advisors LLC over 44,000 cases, broken down by com-
compensation committees to execute better, and well-performing boards to fl ourish.”
and founder and CEO of RAF Capital LLC. pany revenue, industry group, and company
—ANNE C. RUDDY, CCP, president, WorldatWork
Ferracone is a thirty-year veteran of the RR OO BB II NN AA .. performance. Using these data, Ferracone
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executive compensation consulting world provides all those charged with evaluating
and has worked at Farient Advisors, Mercer, executive pay with the ability to analytically
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SCA Consulting, and Booz Allen & Hamilton Join Us at www.josseybass.com determine an appropriate compensation
(now Booz & Company). She has been a Josseybass.com USA $34.95 BUSINESS/ AA FF EE RR RR AA CC OO NN EE package. In addition, Fair Pay, Fair Play is
senior advisor to executives and compen- Canada $41.95 MANAGEMENT fi lled with real-life stories, perspectives, and
sation committees for over thirty years and YY insights from thought leaders on executive
has served on both for-profi t and not-for- Register at www.josseybass.com/email compensation including interviews with
E x e c u t i v e C h a i r , Fa r i e n t A d v i s o r s
profi t boards. In 2003, she received the for more information on our publications, board and compensation committee mem-
WorldatWork Distinguished Service Award. authors, and to receive special offers. bers, executives, academicians, govern-
ment leaders, and shareholder activists.
(continues on back fl ap)
bbiinnddeexx..iinndddd 227788 22//2233//1100 77::3311::4499 AAMM
“I like the way that Ferracone tells real-world stories on executive
compensation, as recounted by board members and executives
on the front lines, and she backs up these narratives with well-
researched statistics. Her way of looking at performance-adjusted
pay is highly innovative and offers insights that we had previously
not seen.”
—Roy J. Bostock, non-executive chairman
of the board, Yahoo! Inc.
“This book is the best authoritative source on executive com-
pensation today. It takes an extremely complex topic and boils
it down to its simplest terms: alignment between pay and perfor-
mance. Ferracone’s Alignment Model gives us a way to test and
analyze alignment in our companies. In a word—it is superb!
The Alignment Model is a tool that boards, executives, and
investors alike can use. This book is required reading for every
compensation committee member, CEO, head of HR, and insti-
tutional investor in America.”
—Alexander L. Cappello, chairman and
CEO, Cappello Capital Corp.
“Ferracone provides a set of principles combined with actual
accounts of how companies can achieve pay-for-performance
alignment on a sustainable basis. Making this happen is critical
to building trust and a high-performance culture.”
—Richard Floersch,
chief HR offi cer, McDonald’s
“Ferracone does an excellent job of describing how executive
performance and pay should be aligned. She combines quantita-
tive research with qualitative commentary from those who are
on the front lines in determining executive compensation. This
combination makes the book eminently readable and a very use-
ful guide.”
—Ed Lawler, author,
Rewarding Excellence
ffffiirrss..iinndddd ii 22//2233//1100 77::3333::2288 AAMM
“By constructing a highly fact-based and thoughtful road map,
Ferracone has taken the emotion and fear out of executive
compensation decision making. Following the recommenda-
tions and analyses contained in this book will enable struggling
boards and compensation committees to execute better, and
well-performing boards to fl ourish.”
—Anne C. Ruddy, CCP,
president, WorldatWork
Join Us at
JJoosseybass.com
Register at www.josseybass.com/email
for more information on our publications,
authors, and to receive special offers.
ffffiirrss..iinndddd iiii 22//2233//1100 77::3333::2299 AAMM
Fair Pay,
Fair Play
Aligning Executive Performance
and Pay
Robin A. Ferracone
ffffiirrss..iinndddd iiiiii 22//2233//1100 77::3333::2299 AAMM
Copyright © 2010 by Robin A. Ferracone. All rights reserved.
Published by Jossey-Bass
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ISBN-13: 978-0-470-57105-7
Printed in the United States of America
first edition
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Contents
Preface vii
Part One: Fair Pay 1
1. Same Problems, Different Context 3
2. Shareholder Value: A Good Indicator of
Long-Term Success 23
3. The Anatomy of Performance-Adjusted
Compensation (PAC) 41
4. The Performance and Pay Alignment Zone 57
5. The Alignment Report 73
6. From Maligned to Aligned 83
7. Patterns of Misalignment 91
Part Two: Fair Play 111
8. The Root Causes of Misalignment 113
9. Aggressive Target Pay 125
10. Turbo-Charged Upside 145
11. Conventional Goal-Setting 157
12. Short-Term Gain; Long-Term Pain 187
13. Flattening the Curve 199
vv
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vi CONTENTS
14. Ad Hoc Decisions 205
15. Decision-Making Infl uences 217
16. Creating and Maintaining Alignment 231
Epilogue: Holding Companies Accountable 241
Appendix A: Analytic Methodologies 253
Appendix B: GICS Sectors 255
Appendix C: List of Interviewees 257
Notes 261
Acknowledgments 265
The Author 267
Index 269
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Preface

The subject of CEO and senior - level compensation is all too
often a hot- b utton issue. It meets with outrage, jealously, con-
demnation, and, occasionally, admiration. More recently, it is
meeting with government scrutiny in the aftermath of the worst
fi nancial crisis since the Great Depression. For companies in the
United States that received federal bailout money, the govern-
ment is overseeing, at the time of my writing this book, the pay
practices of these fi rms through an appointed “ pay czar. ” The
role of the pay czar is to ensure that the institutions that are
supported by taxpayer money are not unduly passing these dol-
lars along to executives through excessive pay and also to ensure
that the pay system is not causing these executives to take
undue business risks. After all, taking on risks that, in retrospect,
were not well - understood, or worse, that people were not paid to
care about, is to some extent what got us into this fi nancial mess
in the fi rst place.
But while executive pay is receiving intense scrutiny, our
fi xation on the subject is still not offering us a way to think dif-
ferently and gain new insight about it. Nor does it give us the
ability to separate truth from myth. To be sure, we ’ ve gotten a
bit smarter about how to design and govern executive pay. The
external pressures have forced some reform. But at its basic
level, we still are not only nipping around the edges of real and
lasting solutions but also still defi ning the problems.
A s I see it, executives should be paid on the basis of how
well they perform for their shareholders, relative to the external
vii
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viii PREFACE
market, within contemporary standards of fairness and propriety.
This is what I call “f air pay.” This compensation objective meets
with general agreement and seems relatively simple, at least in
concept. But when we drill down just one level, the controversy
begins. This is where we get into debates about the defi nition
of performance and pay, and what we mean by the standards of
propriety, which have their roots in both a free market economy
and societal norms. The devil is truly in the details.
S o this is why I decided to write this book. In my view,
investors; boards and their compensation committees; executives
with line, human resources, fi nancial, and legal responsibili-
ties; government offi cials; and the public in general do not need
another “ h ow- t o” book on best practices or on the technical
aspects of compensation. Rather, they need new perspectives,
not conventional wisdom; they need facts, not fi ction; and they
need to gain an understanding of the real issues, not the imag-
ined ones. They also need practical, not theoretical, ways to
analyze and solve problems. They need processes to avoid the
common pitfalls. And fi nally, they need ways to bring people
together on ideas and direction, rather than to further fraction-
alize an already divided corpus. In other words, we all need to
see some convergence on this topic.
I set out to write a book that would meet these needs.
To develop new thinking, including my own, I refl ected on the
various roles I’ v e personally played over the years as a line exec-
utive of a large - scale, publicly traded, global organization; as a
board member and compensation committee chair; as a strat-
egy and executive compensation consultant; and as an investor.
These roles have helped me to look at the issues from all vantage
points. In addition, I refl ected on the thousands of consult-
ing engagements I have conducted and the hundreds of clients
I have served.
I worked with my colleagues at Farient Advisors LLC, a pre-
mier executive compensation and performance advisory fi rm, to
analyze extensive performance and pay data over a fi fteen- y ear
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