Joan Treistman

New Approach Links Exec Compensation to Corporate Debt

July 8, 2010

FROM RETAILWIRE:
Risks taken by leaders to build up corporate equity (along with their compensation packages) has been tied to the financial industry's house of cards that came crashing down in 2008. The time may have come, according to a Knowledge@Wharton (K@W) article, to reconsider adjusting those packages. Is it time for a lower percentage of executive compensation to be tied to share prices?      [more...]

Tying compensation to equity had its merits when the risk to the executive is comparable to the corporation's risk. However, that is not typically how it is put together or analyzed. The fundamental thinking as I have understood it is: If the company does well, you'll do well. However, that's not exactly the case. There is usually a base salary that could be sufficient for many to live on (and then some), while the equity package is icing on the cake. So if the company's performance is not the goal; greed is the goal. Consequently executives begin to focus on profitability, not long term growth for the corporation. Immediate profitability can influence stock prices. Long-term corporate growth doesn't do a thing for the executive's compensation.

Further, linking compensation to equity suggests that there is an understanding of what makes stocks worth more. Time and again we learn that stock prices are not controllable. Prices may be predictable within the context of other stocks. Take a look at the past week's performance of the US stock market as an example. There are many outside forces that influence stock prices. Typically, corporate executives are not asked about Elliot waves and how they predict their company's performance.

The authors of the article are definitely correct. I just think there are additional factors they might have considered to bolster their argument.