Ask Not How Much, Ask Why

Originally posted May 2013

According to a March 31, 2013 article in the New York Times by Susanne Craig: “Since the financial crisis, compensation for the directors of the nation’s biggest banks has continued to rise even as the banks themselves, facing difficult markets and regulatory pressures, are reining in bonuses and pay.”

Well, “reining in” of executive pay might be a bit of an exaggeration, but there is no question that the Chairman’s role and other board members of Wall Street firms have lucrative pay packages. And over the past several months, or even years, with a growing portion of director pay made in stock (and with share prices for these firms soaring), director pay has increased. But the bigger question is not “how much” but “how and why”.

As Michael Graham shared in his recently published book Board of Directors Governance and Rewards, “We believe that boards don’t get the respect they deserve for the success of the businesses they oversee, but neither are they held much accountable when the businesses they oversee flounder… If the business strategies work, then the CEO should get credit for execution and the Board for foresightedness (not just the credit for hiring the right guy). If business strategies fail then the CEO should carry the blame for poor choice of strategy or poor implementation and the Board for failure to appropriately examine the plans (not just the blame for overpaying the CEO).”

And speaking of how CEO pay drives behaviors, the same is true for director pay, but for directors there is a different angle. Directors (much like US congressmen) set their own pay. It is part of their responsibilities for corporate governance. Therefore board governance and board pay cannot be decoupled. Further, the most important consideration for both governance and pay is the idea of contribution: how does the board contribute to the company and how does each director contribute to the work of the board, and how  these contributions drive board pay.

There is a wide spectrum of board contribution levels from “hands off” to “hands on.” In Grahall’s ground breaking Board of Directors Research Series we found that a board’s relationship with the company can be measured and arrayed to give a quantitative understanding of its “contribution” level. Grahall identified 40 variables which are gleaned from proxies to represent the degree of contribution of each board.

With this large number of variable, there is a nearly infinite number of combinations and permutations of the influencing factors that set the threshold conditions for board governance and reward program success. Board governance and reward program design needs to be an active, dynamic, adaptive, and “situational” effort. Where there are different levels of contribution, the board reward levels should also be different.

Pay must be equal to contribution, and contribution must be aligned with governance, and governance aligned with shareholder interest. So if director pay appears high it is only “too high” if the contribution is less than the pay should demand. The reward strategy needs to be consistent with the level of contribution. High contribution should generate high compensation and vice versa.

As a general rule, boards are over extended and underpaid. As organizations have grown tenfold in the last few decades, board compensation has not kept pace except with inflation. When you add the complexity that increases exponentially with size, the typical board is understaffed, under organized, underpaid, and under siege by many of the key stakeholders. That being said boards are meeting less often than they did 50 years ago even organizational complexity have grown exponentially. So board are underpaid and possibly under involved. This might be a chicken and egg thing – as in which came first – did a relative decline in the board pay result in a decline in board involvement? Or did a decrease in board accountability result in lagging pay? Either way shareholders’ interests are under served.

So why does Jamie Dimon still want that job as Chairman? Surely not for the money, since he’s also CEO. And why might he want to leave should these positions be separated? Well with a separate Chairman, his power as CEO might be diminished. The Chairman sets the agenda for the board and controls the meetings and decides on committee assignments and more. It is a powerful position and can, appropriately, impede the demands and desires of a CEO. For mature and established businesses (not so much for start ups) separation of these key roles (and great powers) can help balance the decision making and deliver sound business outcomes.

To borrow from JFK’s great 1961 inaugural speech: Ask not what your board is being paid, ask why your board is being paid the amounts they receive.