So What Do We Do About Overpaid, Underperforming, Unethical Executives?

[Note: this is a series of three articles on ethical pay in organizations right up to the CEO level, first published on HR.com.I believe CEOs shouldbe paid a lot for several reasons - the job is tough and often short-lived due to very difficult challenges and impatient Boards of Directors - and because people in organizations need a highly paid position they can aspire to in order to help motivate them to strive to move up. However when CEOs are given guaranteed astronomical compensation arrangements or ones that pay out regardless of performance, there's something very wrong for everyone. CEOs are the first to say pay should be given for performance. Fairness demands it. And lack of fairness in pay is one of the most "dismal," destructive practices imaginable - so why should CEOs, Board Chairs or anyone else be exempt?]

My previous article pointing out the significant role HR plays in establishing and maintaining solid ethics in organizations [Is HR living up to its role in promoting corporate ethics?] triggered a flurry of comments, uniformly in agreement. Clearly these are sore points for all of us.Essentially that piece noted that enforcing sensible principles sensibly, from small issues up through larger ones, and involving senior managers in the decisions when major issues arise, sets a tone that makes it harder for anyone, even the CEO, to misbehave. Amen, readers said. But they had other questions about where HR has been on related issues.

Along with the positive comments came a lot of puzzlement about how we have gotten ourselves into the present predicament. Faith in corporations and executives seems to have hit an all time low. Suddenly the enormous pay packages that have been evident for some years now are seen to be a symbol for greed, fallibility, bad intentions and misdeeds. Writers wondered how and why this has grown up and what, if anything, could be done about it… assuming Boards of Directors or shareholders may decide they want to do anything at all. Those are two pretty big questions about which I have definite opinions.

How this has grown is, like most other things, little by little, but with increasing momentum. Ironically, the very push to make CEO salaries public, which was designed to create openness with checks and balances where shareholders could see how their money is spent, has instead created unfortunate benchmarks and dilemmas for Boards. Whenever a CEO must be replaced, every Board worth its salt must try to get “the best” available. No one wants to go recruiting for second best or third best. Well, of course, to attract what everyone currently believes to be the best all too often means pulling a CEO or high ranking executive from another company, likely in the same or similar industry. No one scans the bread lines for “the best.”

Look at is from the recruit’s point of view for a moment. If you’re doing well where you are (ie: you actually are good), your bonus is shaping up to be good and you’re well positioned to survive another couple of years at your current high compensation package, which, let’s say, you legitimately earned. Now New Company wants to hire you away. You’re naturally going to ask for at least what you’re getting plus a significant premium for the risk of leaving a solid spot and taking on an unknown, failing operation in a company you’re less familiar with and therefore less likely to survive. The stage is set for New Company’s Board, in all sincerity, to pay you much more than either you or their old CEO was earning. With CEO’s being booted on average every three years or less, it doesn’t take long for compensation packages to go through the roof. Companies sometimes replace several in succession. Who can blame Boards for using stock options, which, until you look closely, appeared to be “cheap” ways of putting together big packages. We’ve all learned some very expensive hindsight lessons.

Before public disclosure, the pay package of most CEO’s was a mystery. Now every one in every public company is known. It becomes easy for recruits to say, well for all the risk you expect you should pay me more than the average for the size of company. This also accelerated the growth of packages and every Board bought in because they were desperate to have “the best.”

Now, one could ask why there aren’t perfectly good candidates internally in companies, willing to step up for the very good basic pay increases any promotion brings, without ending up with stratospheric compensation. Simple: as one CEO here and there is recruited from outside at enormous wages, they are under the gun to do more spectacular things, and especially do them sooner, than any promoted executive with a slower learning curve could be expected to achieve. The increasing pace and intensity of competition is cited by Board after Board for having to recruit someone who is already a seasoned CEO. In short, panic! And doesn’t nearly every outside recruit soon fire most of the old team and replace them with outsiders he or she knows, but who now have longer learning curves than the former incumbents. And these good people are more likely to say yes to the new CEO’s possibly misfitting programs.

Solutions? Let’s give priority to succession planning and executive leadership development internally so there will be a bench of great candidates if and when the CEO stumbles. If we groom enough, even if some are stolen away for bigger packages, there will be plenty left who would be happy to get a promotion with a reasonable pay increase. This takes time, but that’s what having a good strategy is all about. It isn’t new, but it’s so fundamental, we have to stop ignoring it.

Next time: How highly paid CEO’s come to believe they’re not paid enough and how the “cult of leadership magic” accelerates things in the wrong directions.

Overpaid CEO’s and What Can Be Done About It (Part 2)
Previous articles triggered interest in how CEO’s come to be “overpaid” and what could be done about escalating senior executive pay packages.After noting the significant role HR plays in leading solid, consistent, bottom to top ethical standards in organizations, I pointed out that many Boards and CEO candidates have legitimate reasons for high pay packages – to compensate for real risks an outsider takes to come in and try to fix a challenged operation. They also know exactly how much less risky competitors are paying, so they know what to ask for.

It should go without saying, though perhaps not these days, that Boards and CEO’s are almost all highly ethical people simply trying to do the right things – get the best people in place. In theory everyone agrees that better internal succession planning would help. Yet problems still occur. The tendency for salaries to get out of control is one part of a larger issue that argues for a much greater focus on this key solution than ever before.

How Bad Can it Get?
Paying a new, outside CEO a high starting package may be warranted for the risk initially, but several other factors create the bigger problems that we see. I mentioned lack of good internal successors and succession development, a problem HR can try to head off. This is worsened by the fact that a new CEO from outside often fires old team members and brings in players he or she believes to be reliable (or occasionally just cronies, which is worse). Once again this is often for the best reasons – new blood, energy and ideas. But knowledge of the particular industry may be lost, newcomers’ salaries are undoubtedly higher and the ripple effect in replacements below that level and on morale in the organization can be substantial. Not only is HR’s carefully marshaled successor bench strength eroded, but the new hires frequently fall outside the ranges of reasonable compensation plans.

This sets the stage for further trouble. The new, expensive team needs a year or so to get a new strategic vision together and roll it out and then a year to see if it works and tinker. Haven’t we all seen a bit too much of this? If big shareholders, like pension funds, are pushing to see rapid results, the chances of another major leadership shakeup are pretty high (exactly why the new CEO demanded a high starting rate). More old 2nd tier executives are fired and more new expensive ones recruited – after all, we aren’t blaming the new CEO… yet.

The higher salaries of the new team around the CEO start to make his or her package look “low” and highly publicized CEO pay rates at other companies, showing up in annual proxy circulars, start to be even higher. It’s a steadily escalating target. In one recent year at big Canadian Companies, average CEO base pay went from $600,000 to $900,000 – a 50% increase driven mainly by a few high profile benchmarks across North America and an increasing sense of risk in the economy. With fewer internal critics due to the unsettled new team being in no position to make realistic comments, CEO’s can become out of touch with reality, making it easier for purely personal concerns and “benchmarking” against the most outrageous, but highly publicized competitor salaries to take over their thinking.

The few good, or lucky, CEO’s in any industry have lots of alternatives if not outright offers from other companies. Boards rightly want to hold on to the person they’ve just hired (as long as they still have faith in the person) and so they cave in to not so subtle demands not only for parity, but in fact to be the very best paid, and since Boards are touting that they still have the “best” person, why not?

So, It’s a Downhill Spiral, What Will Help?
I’ve purposely painted a worst case scenario to drive home the point that it’s a downhill spiral that well-meaning Boards hiring outsider CEO’s almost inevitably will fall into. Any reader can probably add a dozen more reasons why it’s tough to get off this slippery slope once the company is on it. The key is to understand how bad it can get in order to motivate the hard work needed to avoid these problems.

Are there solutions? One critical element is that Boards need to be not only up to date on, but actively involved with, the best successors that exist in-house. HR can help ensure this only if a good relationship exists with the CEO and Board, one that includes a focus on succession planning. Some CEO’s are understandably reluctant to tout great potential replacements. But that’s just what needs to happen.

Both the CEO and HR executive have a role showing off successors in the best light as well as ensuring that they are getting the kind of development support that will make them viable candidates as soon as possible. That way, the Board can be involved, can latch on to, support and promote the idea that developing successors is a priority. They can meet and help develop effective successors so they know who is coming along when vital decisions need to be made.

If and when the Board promotes an internal candidate, the salary is more likely to be realistic as befits a newly promoted executive. Moreover, the Board can continue its role in aiding the growth and development of someone they understand to be on a learning curve rather than treating the new CEO like a savior from afar. Promoting this approach is a challenge for HR executives, who often haven’t been asked or encouraged to take a lead role with their Board. It’s a skill worth learning though, and corporate survival may depend on it.

With today’s pace of change, there is no such thing as ‘too soon’ to get people ready. Only with a bench of internal candidates is the spiral of excesses more likely to be staved off. Then, even if an outsider is chosen, a Board’s awareness of good internal executives slows down the rest of the downward spiral of senior team replacements with the inevitable unrealistic salaries to the greatest extent possible. There are other less obvious benefits of this approach as well, which will be the subject of further articles.

Fixing the Myth of the Miracle CEO That Underlies High Salaries and Ethics
Earlier articles looked at what pulls CEO’s and Boards of Directors toward trouble over high salaries. The same pressures can result in dubiously optimistic financial reports and ethical disasters like Enron. The search for the mythical lone savior ranks high on the list of causes, but it’s a stubborn one to change.

HR plays a key role in many basic ethical safe-guards such as building cultures where ethics form part of everyday thinking at all levels, doing solid research for realistic compensation plans and developing solid plans and relationships with the Board of Directors needed to develop more effective (and affordable) internal successors. A single rogue CEO can do a lot of damage, but Boards and CEO’s rarely set out purposely to do wrong. Unfortunately the myth of hiring that single superstar, fix-it executive is hard to shake and leads some CEO’s to imagine they are above the law or above good behavior of any sort.

The tendency of Boards to try to rush better results for shareholders by hiring sensationally highly paid CEO’s is actually a human reaction any of us could fall into… really. Human beings work at the top of corporations and they make human mistakes. After a while high pay seems natural, when you see so many highly paid executives popping up everywhere. We can complain, but these things won’t go away through wishing. We need to start facing what it will take to reduce our human tendencies to give in to these pressures and the mind-set that leads to the problems.

There may be more than these three potential solutions that I see – 1. building cultures in which people feel able to point out major errors and survive, 2. educating leaders (including Boards and existing CEO’s) to see that the concept of one individual as savior, having all the power, is always dangerous, and 3. promoting the idea that every good strategy should be based on building solidly and steadily over time, so that we all get away from thinking about quick fixes. None of these is an over-night solution, but that’s exactly the point.

There never is one. Working on all three ideas would be great. The three are linked, but I’ll save the first one for another article since it deserves attention on its own.

Quite a few of us should be ready by now to believe that quick fix strategies and single saviors are bankrupt strategies. If quick fixes were possible, someone inside a company would likely have found them by the time the rest see problems developing. Either that or we have to believe not only that a savior can come in and see them, but that all the executives in a given company are downright stupid to begin with. Actually that’s exactly what we’re saying when we hire a miracle-worker. We need to look at why we think the people who run our institutions and companies are collectively so dumb. Either way, if this is true, what are the odds that a single individual can remedy all that foolishness?

Why do we invest in such doomed enterprises. Hiring ‘a savior’ ought to be a strong message to potential shareholders that further disasters are on the way. Boards should actually be trying to hide the fact that salvation is what they’re hoping for. Yet time and again we see history repeated when a miracle-CEO announcement is used to trigger a buying frenzy… and it works.

When Boards hire gunslingers and let them replace entire teams, they gamble just as some investors do that they’ll look like heroes when short term hype pops up the share price. We can call it greed on everyone’s part, but the pressure they’re under for quick fixes makes it inevitable that some Boards will be drawn into such gambles despite the fact that they fail more often than they win.

Gambling instinct is the single most powerful motivational force after pure will to survive. It takes common sense to counterbalance this pull of the lone-leader myth when it’s sometimes backed by instant market results. Or it takes fear – that the investment you’re about to make is like betting on a lottery.

Yes, better management makes a great difference. But it isn’t instantaneous anywhere but in the market. Some gamblers will always jump in, legitimately expecting that the same action by many individuals will lead to a short term price rise. I don’t follow market news enough to bet I’m in first, so I don’t play this game. You also have to get out right afterward, too, or the short term rise will dissipate… and today that happens with lightning speed. I won’t play Russian roulette either.

Of course the market won’t change, but we can hope that recent events have convinced more people that this is how it works. Educating the public, investors, pension fund participants and others that this is so will occur inevitably over time. Anything we can do to speed it along would be wise. In HR we can provide retirement planning advice – and that’s being done now for employees as young as 30 (never too soon). That way anyone investing will value stable, steady companies over turnarounds unless they understand fully that they’re gambling with a few dollars they are likely to lose – not something you’d likely choose to do with your own pension money. If big and small investors start behaving more logically, Boards of Directors will be encouraged to do the right thing, too, and analysts will start pointing out the truly valuable companies and warning against flashes in the pan. Such results can have a cumulative impact reasonably soon.

Would better retirement planning support really fix the problems? Think of how many individual people employers can reach if we act in tandem… much of the population. As noted, it isn’t instantaneous, but then what would be? Slow and steady is the best solution with all solid plans, but this appears to many people to be just too slow to be worthwhile mentioning. I’m often asked, what can we do… about unrealistic salaries, about questionable ethics, for instance… and this sort of answer draws somewhat blank looks. A national campaign of realism in investment behavior isn’t out of the question, is it? Certainly HR managers are in a good spot to spearhead such a move.

First published on HR.com

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So What Do We Do About Overpaid, Underperforming, Unethical Executives?

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