Effective Executive Compensation: Creating a Total Rewards Strategy for Executives

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9780814410127: Effective Executive Compensation: Creating a Total Rewards Strategy for Executives

When it comes to creating an executive compensation program, it can feel like there’s little gray area between giving top performers too shiny a golden parachute, with exorbitant perks, and providing the company’s leaders with the incentive they need to continue doing their best. This book gives readers the techniques and understanding they need to design a rewards strategy that will motivate performers while benefiting the entire organization. Taking a careful look at the complicated state of executive rewards, this no-nonsense, practical guide provides readers with a complete methodology for motivating management to accomplish critical business goals. Eschewing a one-size-fits-all approach, the book uses case studies and examples to illustrate what factors should be considered—including environment, key stakeholders, people strategy, business strategy, and organizational capabilities—when designing a program that will benefit both their company and the people who fuel its success.

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From the Inside Flap:

When it comes to executive pay, it’s hard to know what to do. On the one hand, shareholders, stakeholders, government agencies, and the general public are demanding that safeguards be erected to prevent the excesses of the recent past, such as kingly pay for mediocre performance or stock options that handsomely reward short-term gain and long-term disaster. On the other hand, an across-the-board compensation program that modestly and uniformly rewards executives is a motivation killer that can quickly kill an organization’s competitiveness.

Packed with the latest research data, dozens of real-life examples, and fifty years of total in-the-field experience, Effective Executive Compensation opens your eyes to the challenges of designing a compensation package that effectively motivates executives to achieve corporate goals. There are no shortcuts and no simple answers. But if you get it right, combining short-, middle-, and long-term rewards with the right salary and clear messages regarding performance, obligations, and business imperatives, can result in enormous payoffs. A well-designed executive rewards program not only weeds out the lackluster and the greedy, it also singles out the performers who rise above generic standards to provide the focus and drive your company needs to power ahead of the competition.

Whether you’re a human resources professional, business executive, board member, or informed investor, this sharply witty and deeply insightful guide shows you how to:

· Avoid copycatting your competitors, whose executive compensation strategy may work for them, but not for you.

· State your mission, vision, and values in a way that inspires executives to meet challenges and make good decisions.

· Decode your business strategy from three essential levels—general business strategy, value chain strategy, and specific business strategy—and use the information to develop an executive rewards program that truly aligns with business goals.

· Make sure you’re looking to the future and not stuck on what worked in the past, or focused on mere incremental improvements over prior years.

· Identify your company’s “people strategy”—its operational structures, processes, and culture—and understand its impact on your compensation strategy.

· Pinpoint the exact combination of money, mix, and messages that will comprise the most effective total rewards program for your organization.

· Use the original grahall Economic Impact Analysis (gEIA) to find potential flaws in your overall compensation program design—plus many more tips and tools for designing a superior total executive rewards strategy that benefits shareholders and stakeholders alike.

Michael Dennis Graham and Tom Roth are consultants at Grahall Partners, LLC, a consulting firm that designs total reward strategies for organizations. Both have over 30 years of experience, and together have worked on over 300 reward strategies. Michael has been a consultant and or practice director for Watson Wyatt Worldwide, Towers Perrin, the Hay Group, Arthur Andersen Worldwide, Clark Consulting, and Pearl Meyer & Partners, and is the coauthor of Creating a Total Rewards Strategy. Tom Roth has worked at J.P. Morgan, McKinsey & Co., Register.com, and Pearl Meyer & Partners. Dawn Dugan is a freelance writer based in Hinesburg, Vermont.

After the Enron, Tyco, and WorldCom debacles, we all know what can happen when executives go wild. Creative accounting, inflated pay, runaway perks—and a downward spiral of the companies they run.

Make sure your executives stay on track with a carefully crafted executive compensation strategy, one that is specifically designed to promote the kind of thinking, behaviors, and results you want to see. Effective Executive Compensation supplies a complete methodology for pinpointing the most effective total rewards strategy for your specific company.

Complete with invaluable case studies, investor alerts, and the authors’ five decades of combined experience, Effective Executive Compensation brings a piercing clarity to a complex topic that defies one-size-fits-all solutions. The book shows you how the external business environment can influence compensation, and it helps you fully understand how the mission, structure, and culture of your company determines the amount, mix, and message of your package—and guarantees that you motivate executives to achieve results that benefit everyone.

Excerpt. Reprinted by permission. All rights reserved.:

Preface

The State of Executive Pay or Better Known as

the Don Quixote Way

You can’t escape the controversy that surrounds executive pay.

These days, it’s impossible to pick up a newspaper, fan through

a business magazine, or catch a TV news program without being

subjected to excessive hand-wringing over how much the

top executives at America’s largest corporations are being paid.

Much of what you read or see is hyperbole, exceptions to the

norm being presented as the norm, guilt by inference, and

maybe even a small amount of envy. And some of it is reality.

We say this not as mere onlookers, but as people who have

been practicing the art and science of executive compensation

for more than 50 years combined.

For most of those years, we’ve remained publicly silent on the

issue. But not any more. It’s time to break the “code of silence.”

We hope that by doing so, they won’t revoke our memberships

in the Compensation Consultants Guild, better know by the

Warren Buffet nickname of “Ratchet, Ratchet, and Bingo.”

So why the change of heart? Well, it certainly isn’t attributable

to the compensation we’ll receive for writing this book

(which could be wiped out by your average dinner and a

movie). Nor to any expectation of fame that will follow publication.

We do not expect to suddenly be invited to important

cocktail parties where our every thought, pronouncement,

and expression will be hung on by important guests. Executive

compensation consultants are usually relegated to the corner

where the proctologists are gathered.

More likely, we’re writing this book because we are fed up with

telling clients and consultants one at a time how the process

of executive compensation consulting should occur. It is far

more efficient to write a book to the profession, and to the

Boards and executives who hire those in the profession, explaining

what we believe the vast majority of the compensation

consultants have been missing the last 50 years. To the

extent that others—the general public, academics, reporters,

legislators—read this material in an effort to understand the

issue, so be it.

The Problem

So what exactly is the problem? Simply put, most of America

thinks that CEOs are overpaid. And it’s not a case of sour

grapes where the little guy who is barely scraping by is incensed

by the millions being raked in by corporate titans. One

poll in early 2006 pointed out that this belief crosses into far

more segments of the American population than you’d think.

The headline from a Bloomberg News report says it all: “Affluent

Investors Agree With Most Americans: CEOs Are Overpaid”

(1).

The story explained that in a Bloomberg/Los Angeles Times poll

taken in February and March 2006, 84 percent of respondents

that identified themselves as earning over $100,000 annually

said they believe CEOs are paid too much. This may be the one

thing that both rich and poor in American can agree on. Even

Warren Buffett, one of the richest men in America, has something

to say about the state of executive pay in his letter to

shareholders in Berkshire Hathaway Inc.’s 2005 Annual Report.

“Too often, executive compensation in the U.S. is ridiculously

out of line with performance. The upshot is that a mediocre-orworse

CEO—aided by his handpicked VP of human relations

and a consultant from the ever-accommodating firm of Ratchet,

Ratchet, and Bingo—all too often receives gobs of money from

an ill-designed compensation arrangement,” he writes.

And the shrill noise continues today—as we write this preface,

a presidential candidate is on the television making another

harsh statement about CEO greed.

The rich may get richer in America, but clearly there is a limit

to how rich the rich want the richest to become. How did we

get to this point?

The Blame Game

The problem with executive pay is multi-layered and complex,

and goes well beyond the sound bites and sensationalism

of the media picking apart proxy statements for the most

egregious examples of out-of-whack pay programs. But as

Americans, we’ve been raised on a steady diet of short news

bites that boil down even the most convoluted story into a

quick, easily digestible nugget. All the better to leave room

for the pseudo-news about Britney Spears’ latest debacle, or

stories about Dennis Kozlowski’s fantastic parties on the

shareholder dime. That is what keeps people reading and tuning

in.

So rather than view current circumstances as a set of outcomes

from a series of systematic interactions of complex forces inside

the context of a historical framework, Americans want it

simple. We want someone to be credited for the success of a

particular endeavor, or blamed for the failure.

So let’s take a look at the press coverage. When you pour

through all the reports, you find that there are at least ten

targets of blame for the shape of the U.S. executive compensation

situation: the CEOs themselves, the economy, economists,

the government and certain government agencies, the

Boards of Directors, customers, institutional investors, lawyers

(we couldn’t leave out lawyers!), human resources people, and

consultants (as consultants ourselves, we doubly couldn’t leave

out consultants!).

Greedy CEOs Are to Blame!

In some cases, it can be argued the CEOs cashing lavish paychecks

are themselves to blame for the state of executive pay.

After all, these are the guys (and yes, they’re mostly guys) who

go after the exorbitant pay days.

Greed can cause CEOs to simply not pay attention to the curious

things going on around them. We have all heard former

Enron Chairman Kenneth Lay repeatedly defend himself by

saying that he “wasn’t aware of the details” of what was happening

in his company. These executives keep their heads in

the ground, and then profit from it.

The billion dollar stock option cache is not hyperbole. William

McGuire, the CEO of UnitedHealth Group Inc., was granted

stock options that were backdated that added up to $1.6 billion

in unexercised options at the end of 2005. Yet McGuire

somehow thought it was okay to point out that this money

didn’t come out of the premiums of health care recipients. The

money came out of the pockets of shareholders instead!

Regardless of the source, he also admitted that the sum is “a

lot. You can’t get away from that” (2).

This issue of backdating options is not limited to Minnesotabased

health care CEOs. As of the end of 2007, the Securities

and Exchange Commission had opened investigations on hundreds

of companies because it looked as if they had backdated

options of their executives. CEOs are resigning over the issue,

and restatements of previous years’ financial reports are

becoming common. According to other reports based on statistical

analysis, as many as 1,200 companies may have followed

the modern version of the Aztec Two-Step, something

we like to call the Backsteppin’ Backdating Boogie!

So the media blame the CEOs and we can’t argue with that,

even though it’s easy to assume that they are, to some degree,

victims of media hype. These stories make for good copy and,

like a car accident, it’s hard for us to turn away from them.

The Economy Is to Blame!

In industries where business is booming—the way oil, housing,

and defense are right now—economic windfalls are to

blame for the largesse of the lucky executives in these fields.

These CEOs take cover behind a screen of “it’s not my fault.”

Their companies did fabulously and they profited, which is

what “pay for performance” is all about, right? Well, not

exactly.

Here’s how The New York Times business reporter Gretchen

Morgenson wrote about the issue: “Linking executive compensation

to a company’s results was supposed to align managements’

interests with those of shareholders and to bring fairness

to pay practices. But when a company does well mostly

because of a rising commodity price rather than managerial

genius, pay-for-performance becomes an unfunny joke” (3).

The same article quotes Harvard law, economics, and finance

professor Lucian Bebchuk as saying that the rising oil prices

that have fueled the executives’ windfalls “had to do with the

Iraq War and the Chinese demand, but it certainly did not

have to do with the managers’ own performance” (4). If you

are anything like us, you’ll contemplate this particular contributor

to the problem every time you empty your wallets to

fill up your SUV.

In some ways, economic windfalls in booming industries are

to blame for out-of-control pay days for executives. But there

is something fundamentally wrong with the way the rising tide

is lifting all boats, without factoring out elements of success

that have nothing to do with the way executives are performing

or the decisions they are making.

Economists Are to Blame!

Occasionally, economists will try to weigh in on the state of

executive pay. But economists are notoriously bad at crafting

the simple sound bite that Americans crave.

Until Steven Levitt, economist and coauthor of the wildly popular

book Freakonomics, takes a crack at executive pay, we’re

left with this, a passage from a Massachusetts Institute of

Technology Department of Economics working paper. The authors

call this a “simple assignment framework.” It’s the beginning

of their research on CEO pay hikes.

“There is a continuum of firms and potential managers. Firm

n P [0;N] has size S (n) and manager m P [0;N] has talent T

(m). As explained later, size can be interpreted as earnings or

market capitalization. Low n denotes a larger firm and low m

a more talented manager: S’ (n) < 0, T’ (m) < 0. In equilibrium,

a manager of talent T receives a compensation w (T).

There is a mass n of managers and firms in interval [0; n]” (5).

There’s much more to this paper, but we couldn’t find the right

characters on the keyboard to reproduce it here. Since we’re

entirely in the dark on what this means, let’s blame the economists.

Whatever they say to defend themselves won’t be understandable,

anyway.

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