A Mandate For Executive Pay-For-Performance

The AIG bonus hoopla was a real eye opener for all of us. I was surprised to learn that some industries have been far more aggressive than others at tying executive pay to company performance. And the public outcry over AIG's retention bonuses tells the laggards it's high time they got on board.

What got me thinking about this was a comment on my original post by reader johubbs:

Although Microsoft, Apple, and Google may have similarly valued caps, they are hardly "comparable" [to AIG]. These firms are in entirely different industries. Financial firms routinely pay their employees low salaries and make up the difference with bonuses. IT firms traditionally rewarded performance with stock options. "Retention bonuses" for those who caused the crises compared with "pay for performance" would be a worthwhile discussion.

As an example, let's take a look at executive compensation at Cisco and GE. Both companies have the same market cap. I looked at the latest proxy statement for each company and aggregated compensation for the top six named officers.

At Cisco, 10% ($3.4M) of total comp was base salary, 26% ($8.9M) incentive bonus, 12% ($4.1M) stock awards, and 52% ($17.5M) option awards. There was materially zero pension or deferred compensation.

At GE, 17% ($10.6M) of total comp was base salary, 28% ($17.7M) incentive bonus, 41% ($26.0M) stock awards, and 14% ($8.6M) option awards. GE had an additional $20.2 million in pension and deferred compensation earnings that I did not include in the percentages.

Note that only option awards are worthless if the share price declines from the award date. That's not the case with stock awards. Also note that, in 2008, Cisco's revenue increased 13% and earnings grew 10%, while GE's profits declined 22% (to a multiyear low) on 6% higher revenue, both year-on-year.

My conclusions from the data:

1. Cisco ties compensation far more aggressively to company performance, since option awards was 52% of comp versus 14% at GE.
2. Monetary compensation - salary and incentive bonus actually paid out during the year - was 36% of total comp for Cisco (in a good year), versus 45% for GE (in a bad year).
3. GE places much higher value on executive retention; longevity has a big impact on pension and deferred benefits - a significant motivator to stick around.

Bottom line: the tech industry has been innovative in tying executive compensation directly to company performance. In my opinion, other industries place too high a value on retention, which essentially gives executives a safety net, even when they screw up.

Sometimes I think public sentiment is overblown. This time, I think the public outcry over AIG's retention bonuses is dead-on. It's long past time for corporate officers and directors to take notice.

[Many thanks to reader johubbs]