The main problem with executive pay is not that they are compensated too highly, but that there’s not enough pain for them personally when they do a bad job. I propose that the top three executives in all public companies be required to invest 100% of their salary in their own stock each year, with a decaying lockup period before they can sell.
Why 100%? Let’s face it, if you are one of the top three executives in a pubic company, there’s no reason, financially speaking, you should need guaranteed cash compensation. Having a safety net only serves to misalign your incentives with those of your employees and your investors, most of whom are at the mercy of your decisions. If you do need a guaranteed salary to pay the bills, go get a real job! Coffee is for closers.
How long of a lockup? The point of the lockup is to discourage short-term decision making. Long-term value investors typically have a minimum 3 year horizon, and illiquid venture-backed companies typically have 3-5 year vesting schedule on contingent compensation. In the past, you could have argued for an even longer lockup period, but with the pace of innovation today, I suggest a 5 year decay with 20% of salary-purchased stock becoming unlocked after each year.
What about benefits? Any non-contingent compensation (healthcare, company car, vacation pay, etc.) should not be allowed; it just serves to undermine the goal here. Again, being a CEO of a public company is a privilege you should earn by your past performance, not a God-given right. Remember all those years before you made it to the top when you were accumulating significant personal wealth? Put some of that aside to bankroll you through your tenure as top-dog. If you are good at your job, you will be hansomely rewarded via your equity.
What about other contingent compensation? You want extra stock or stock-option grants beyond your “salary”? That’s fine as long as it’s negotiated at arms length with the board of directors, and the grants are vested over a similar 5-year period. The key is that there should be no safety nets where you get paid while the other company stakeholders suffer.
What happens year after year? Every year, you are up for a renewal or change in salary. The board makes you an offer, if you don’t like it you leave. Over the course of time, you will have stock that is being released according to the 5-year clock but on staggered schedules. If you leave, you still get your locked up stock, but there is no change in schedule for unlocking it. You have to reap what you sow, but now your long-term fate is in someone else’s hands.
What about pre-IPO companies? What about them? Private companies wouldn’t change under this proposal. But once you file for IPO, the top three execs have to agree to the new compensation rules, including the 5-year decaying lockup for all equity and options previously granted.
Why 3? Seems like a reasonable number. Most of the decision making power is conferred to the top three executives. I can see the number being tied to market cap, so that while the minimum might be 3, GE might have it’s top 10 executives paid this way.
Isn’t this plan still too soft? Personally, I think it is. One could argue that the risk-reward ratio should be turned on its head so that it’s much less risky to start a new venture* which has huge value-upside and much more risky to take the helm of a established “blue chip” ship. With this line of reasoning, simply requiring executive salary to be invested seems like too much of a freeroll to me; I’d like to see some real skin in the game and require the top execs to reach into their savings and buy lock-up stock as well. But I’m happy to try the basic plan and see how it goes.
* I’ve put my money where my mouth is on this one [REDACTED 05/08/2009: see here].