CEOs and directors don’t necessarily agree on how to evaluate executive performance. Their opinion differs substantially from the public, and that can introduce risk into the equation.
In their survey of CEOs and directors of Fortune 500 companies “CEOs and Directors on Pay: 2016 Survey on CEO Compensation,” Stanford University’s Rock Center for Corporate Governance and Chicago-based executive search firm Heidrick & Struggles found that, while 76 percent of CEOs and directors believe that CEOs are paid correctly — based on the expected value of compensation awards at the time they’re granted — not so the American public, which sees CEOs as overpaid and in need of pay cuts.
The dichotomy introduces an element of risk as “public outrage over CEO pay invites legislative or regulatory intervention,” according to Nick Donatiello, lecturer in corporate governance at Stanford Graduate School of Business. Donatiello wrote in the paper, “Directors need to make the case clearly and convincingly that the pay they offer is not only tied to performance but that it is deserved based on market realities, performance, and the CEO contribution to that performance.”
CEOs, unsurprisingly, were more likely than directors, at 84 percent compared with 71 percent, to believe that CEO pay is reasonable. However, 25 percent of directors — a “sizable minority” — do not agree.
But both CEOs and directors believe that CEO pay is aligned with the company’s performance, and 77 percent believe that compensation arrangements contain the correct mix of short- and long-term incentives. While there’s not a huge difference between CEOs and directors on that, 21 percent of directors believe that compensation contracts are too focused on the short term. Only 3 percent think they’re too long-term.
Corporate leaders focus on CEOs’ contribution to outcomes and think CEOs are directly responsible for 30 percent of performance results. Interestingly, directors give more credit to CEOs than the CEOs do themselves, with the former believing the execs are responsible for 40 percent and the latter only crediting themselves with 30 percent.
But CEOs and directors disagree on performance metrics and discretionary bonuses, with directors nearly twice as likely as CEOs to cite stock price performance (total shareholder return) as the single best measure of company performance (51 percent versus 26 percent). CEOs, on the other hand, credit profitability measures — operating income and free cash flow — as the best indicators; 49 percent of CEOs versus 20 of directors do so.
And while 34 percent of directors see CEO compensation as a problem (just 12 percent of CEOs do), that doesn’t mean they want any intervention on the matter. Ninety-seven percent of both CEOs and directors agree that the government should not do anything to change CEO pay practices. The public, on the other hand, is more tolerant of having someone to step in: 49 percent favor government intervention while just 35 percent oppose it.
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