A Pay Plan That Rewards Long Term Thinking
Your indictment of pay for performance ("The SEC's CEO pay plan: No panacea," Top of the News, July 6) suffers from a case of mistaken identity. Giving away buckets of stock options and linking bonuses to near-term accounting measures are by no means pay-for-performance packages. That managers so paid should undertake risky but detrimental ventures and cut spending to boost profits should surprise no one. That is precisely what they are being paid to do. Instead of illustrating certain inadequacies of pay for performance, these examples only testify to the abject failure of traditional compensation methods. What's needed are incentive plans that encourage managers to think and act like long-term owners. Four ways to secure such commitment include:
-- Tying bonuses to an estimate of the company's true economic profits (value added to shareholders' investment) rather than reported accounting earnings. (Among other things, this means that R&D and process improvements are capitalized, not expensed.)
-- Setting bonus targets by formula, not negotiation, to lift incentives for gamesmanship that often corrupts planning.
-- Deferring exceptional bonuses, with full payout tied to continued stellar performance, to keep managers' interests aligned with shareholders' over time.
-- Granting a significant increase in actual stock ownership but requiring managers to buy options with an exercise price that rises over time to reflect the cost of capital.
G. Bennett Stewart III
Stern Stewart & Co.