The “fixed-value” bonanza

Posted by Marc Hodak on May 10, 2010 under Executive compensation, Reporting on pay | Be the First to Comment

The press reports on the soaring value of executive equity.  The lead:

America’s top CEOs are set for a once-in-a-lifetime pay bonanza.  Most of them got their annual stock compensation early last year when the stock market was at a 12-year low. And companies doled out more stock and options than usual because grants from the previous year had fallen so much in value that many people thought they’d never be worth anything.

“The dirty secret of 2009 is that CEOs were sitting on more wealth by the end of the year than they had accumulated in a long time,” says David Wise, who advises boards on executive compensation for the Hay Group, a management consulting firm.

The first paragraph is a backhanded explanation of the “fixed-value” philosophy of equity grants so popular among public companies.  The theory is that equity grants should make up a constant value of compensation over time.  So, when share values drop from one year to the next, one should give more shares or options to the executive to remain “competitive.”  Likewise, when share prices increase, we should lower the number of equity grants to keep the total value of the grants in check.  Of course, this philosophy rewards management with more shares/option when the stock drops, and penalizes them when the stock price rises.

The really dirty secret, from the perspective of me and my colleagues, is that this fixed-value philosophy is favored by all the major compensation consulting firms, including, ahem, Hay Group.  And their client boards say, “OK” because they don’t want to stick out on any compensation policy, however perverse its effect.

And then when we have a huge rebound, the AP writes a story about the windfall that CEOs are getting, and boards have to defend this windfall, and the major comp consulting firms we compete with shrug and say “hey, who could have predicted this?”

One can’t blame the reporters this time for making CEO pay look bad, only for not being able to identify the underlying causes.  They didn’t call me because none of my clients are part of this story.