Five rules on how to pay the boss

The chief executive pay system is misguided, expensive and a recipe for decline. Corporate boards need to create plans that work in the best interests of the company, rather than bowing to pressure from compensation consultants.

by Fortune
Last Updated: 23 Jul 2013

The average pay for S&P 500 chief executives reached $8.4 million in 2005, according to the California-based compensation firm Equilar, but during that time the returns for shareholders were next to nothing.

A good place to start redressing the balance between the performance of chief executives and the spoils they receive is to cut severance pay and reduce bonuses when CEO’s don’t deliver.

Fortune proposes five commandments that should be adhered to when considering the salaries of top dogs:

1. Thou shalt pay shareholders first
Investors need a return on their capital just as lenders charge for providing debt. The chief executive is entitled to 'own' the profits he generates but only after shareholders get their share.

2. Thou shalt base bonuses on economic profit
Chief executives should get big bucks only if they generate returns that exceed the cost of capital.

3. Thou shalt not rely on restricted stock
A courageous, shareholder-friendly board resists the lemming-like shift to restricted stock grants.

4. Thou shalt favour options, cautiously
How much wealth chief executives have tied up in stock and options and how fast that wealth will increase if they boost the stock price is the most important factor in the chief executive’s success in benefiting shareholders. Fortune recommends that chief executives get equal annual grants of a fixed number of shares for up to five years.

5. Thou shalt force chief executives to hold, not sell
Boards are finally insisting on vesting periods that are longer than the standard three years in the struggle for more sensible compensation because it forces CEOs to keep a big chunk of their wealth dependent on the company’s share price.

Five Commandments for Paying the Boss,

Shawn Tully

Fortune, 10 July 2006

Reviewed by Deborah Bonello


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