New Executive Compensation Approach

Preet Banerjee wrote an interesting article about Sub-Prime CEO compensation. It seems that during 2007 many CEOs were richly compensated for presiding over orgies of loans that would never be paid back. Stockholders of financial companies have been very poorly served.

Now that we know that these CEOs did not deserve their 8-digit compensation during 2007, shareholders would like to get the money back. But, it is too late. Just like the lowly salesman who gets an immediate commission for selling a mortgage whose profitability won’t be known for years, CEOs get their compensation long before we can know for sure that they deserve it.

I have a fix for this problem to suggest to the board of directors of these firms: spread executive compensation out over 5 years. So, each year the CEO would be paid one-fifth of the money earned over each of the last 5 years, continuing after the CEO leaves the company. If a major CEO blunder from a given year comes to light, the compensation tap on that year could be turned off.

For most of the sub-prime CEOs, we know now that they haven’t earned their compensation for years now. They permitted their companies to make massive numbers of unreasonably risky loans. So, if this delayed compensation plan were in place, companies could save 80% of the CEO’s 2007 compensation, 60% from 2006, etc.

Of course, CEOs and other top executives wouldn’t like such a plan, but it is in the interests of shareholders. Decisions about CEO compensation are made by the company’s board of directors who are supposed to represent shareholders. Sadly, many boards just rubber-stamp whatever the CEO wants.

If these sub-prime CEOs knew that the compensation tap would have been turned off if they continued to abdicate their responsibilities, they may have acted differently. This would have slowed the rise of housing prices and softened the fall.