Future Students, Alumni & Visitors





Archive for the ‘CEO, Organizational Performance and Compensation’ Category

CEO Coaching: Lessons from the Trenches

Alcohol problems, drug use, sexual misconduct, financial misconduct, defensiveness, denial, berating of other senior management and directors, litigation, loss of key employees, toxicity and bulling. There is not much I have not seen when I am called in to coach the CEO. And CEO misbehavior happens in the highest level of corporate Canada. You may be surprised, but I am not.

Here are ten recent examples, disguised for confidentiality purposes: The CEO called a CFO a “moron” in front of the board and finance staff. Another CEO went silent, not talking to the Board Chair for a month. A CEO sat, arms folded, and did not say a word during an entire board meeting. A fourth CEO coaching regime occurred after a major failure, involving death and property destruction. A fifth CEO coaching was of a large manufacturing company, where the CEO’s effect on board colleagues was highly disruptive. In a seventh example, the CEO’s behavior was so disruptive that a major board rift occurred. An eighth example involved loss of key staff and an investigation into CEO conduct. A ninth example involved a CEO deliberately blocking board access to a potential successor and silencing of other senior management, from the board. A tenth example was a CEO of an iconic Canadian company shielding his compensation and expense arrangements from all directors, until I was called in by a regulator to investigate.

By the time I am called in, much of the damage has been done. But it doesn’t need to be this way.

The board’s most important job is hiring, paying and firing the CEO. Boards can get all of corporate governance wrong, but hire the right CEO, and be successful. Boards can hire the wrong CEO, and the company will fail even if the board has high governance scores.

The question that boards, prior to my coaching, often have for me is “Can the CEO change?” There are two things that are needed to change: awareness of the deficiency, and a willingness to change. I am optimistic, and usually have coaching success, but in a few instances, the CEO would not or could not change and I recommended firing the CEO.

Here are lessons for CEO coaching for any board:

The CEO’s coach is always hired by, and accountable to, the Board Chair and the Governance Committee, not the CEO.

For CEO coaching to work, the coach should understand board dynamics and report directly to the Board Chair, not the CEO. The Coach reports on coaching sessions, developmental plans, deliverables and progress, candidly and thoroughly, without the CEO present.

Prospective CEOs should be thoroughly vetted.

Normally, people’s personalities are stable, and the warning signs were visible long before the CEO was hired. A wrong CEO hire is always the board’s fault. Proper vetting now includes detailed resume checks, reference checks, professional background checks, social media and profile checks, personality testing against culture, exposure to all Directors, and multiple interviews in different settings, using external assistance. Put rigor and independence behind the CEO hire, base it on the strategic plan, and conduct an external search if only to test the market. Boards then make the mistake of not working closely with the new CEO after hire, and not onboarding them.

Collect your data and listen to employees.

CEO evaluation should always be 360 degrees, and include a board line of sight to views of direct reports in an anonymous fashion. Employee surveys should not be funneled by management, but should occur anonymously, reporting right into the boardroom. There are even software programs now that will collect employee meta-data for boards so bad news rises.

Link CEO behavior to pay incentives.

Frequently, I find the CEO has little incentive to change, as most of the pay metrics are financial and short-term in nature. In CEO coaching assignments, I normally restructure the CEO’s pay package to include non-financial metrics such as leadership, employee engagement, customer satisfaction, company culture, CEO succession planning, and/or board relations, or a combination of the above. Indeed, now, 75% of the value of a company are leading intangible measurements, such as the ones I mention, so pay metrics should reflect this. People behave the way you pay them. Boards often make the mistake of incentivizing aggressive, even unethical behavior. CEO pay should be tied explicitly, unambiguously, to ethical conduct.

Have the tough conversation with the CEO early on.

In two recent board meetings, I had to ask both CEOs to leave the room. The conversation completely changes when this happens. A board talks about CEO performance openly. When the CEO is called back into the meeting, there is a message delivered to the CEO by the Board Chair. The message is that the Board wants the CEO to succeed, and that behavioural and leadership issues need to be addressed. The CEO has to receive this message, the board needs to be aligned, and the executive session without management is the first step. Executive sessions should occur at each and every single board and committee meeting. To this day, remarkably, there are still CEOs who do not leave board meetings. The last thing a dominant or misbehaving CEO wants to do (and many CEOs are type As) is to leave the room.

Craft the CEO contract properly.

The person advising on the CEO contract should not be the company lawyer, nor the law firm that advises management. These people have a vested interest in not making the CEO contract hard-hitting. Firing a CEO “for cause” should be defined and broader than fraud. Just as athletes and entertainers have morals clauses in their contracts, CEOs should as well. The reputational, morale, talent and financial damage from CEO misconduct, to the company and to Directors, can be significant. Misconduct should be properly drafted to include ethical and professional conduct, with a defined process to determine whether a CEO is ever offside, with which the Board and CEO agree.

Engage in CEO succession planning and be prepared to fire the CEO.

There is a direct relationship between CEO leverage over a board and the lack of CEO succession planning by that board. CEO behaviours can get worse when the Board has no immediate or near-ready CEO successor.

In one major company, I detected defensiveness by the CEO and disrespect of certain directors. I found out that the CEO refused coaching, and that the board was four years out from an internal candidate being CEO-ready. “This is your failure as a board,” I said. The CEO is taking advantage of you because you have no options.

Conclusion

Some of the country’s best CEOs have had personal coaching, and that has contributed directly to their and the company’s success. No one is perfect, and we all benefit from one-on-one feedback, peer assessment, mentoring, and motivating coaches and trainers. Boards should see CEO coaching as a wise investment, and in the longer-term so old habits do not return.

Richard Leblanc is a governance consultant, lawyer, academic, speaker and advisor to leading boards of directors. His recent book is entitled The Handbook of Board Governance. Dr. Leblanc can be reached at rleblanc@boardexpert.com or followed on Twitter @drrleblanc.

Executive compensation is broken: Three ways to fix it

President Obama said to a reporter recently, “We have corporate governance that allows CEOs to pay themselves ungodly sums.”

Why should this be the case, and how might this problem be addressed?

Following say on pay protests in Canada at CIBC, Barrick Gold and Yamana Gold, and others at BP, HSBC and JP Morgan, the Securities and Exchange Commission (SEC) recently proposed rules linking pay to performance, six years after Congress passed the law directing them to so in the first place.

Will the new rules work? Regulators have a poor track record of getting executive pay right. Indeed, some say Congress has been the single greatest driver of increasing CEO pay.

According to a survey by Mercer, a majority of UK board members believe the executive pay model is broken. Here are three ways to fix it.

First, look at who is negotiating the pay. A CEO pay contract is negotiated between a subset of company directors – the compensation committee – and the CEO. I remember a CEO telling me once, “I will out-gun any compensation committee.” He is right. For any contract to work, there needs to be proper motivation and equality of bargaining power. Many directors on pay committees are former CEOs, have been on the board for over nine years, or tend to be men recruited on the basis of prior relationships. These types of directors are not effective in negotiating a CEO pay contract.

Directors confide to me how perks compromise them, including jobs for acquaintances, gifts, vacations, and so on. There is no free market for CEO pay if the people on the other side of the table are captured.

An effective bargaining party should be independent of management and selected directly by shareholders to represent investor interests. In other words, shareholders should be selecting the directors, not directors and certainly not management.

I advise large investors that they should press for this right to select directors. Industry Canada is considering corporate reforms, and should give shareholders the right to select and remove directors without artificial barriers. In the Canadian companies above, not a single director on the compensation committees was forced to resign, including the compensation committee chair on the Quebecor board who failed to garner majority support.

Second, CEO pay has been driven upwards by a process known as “peer benchmarking.” Invented by pay consultants, one CEO’s pay is compared to pay of other CEOs, often at larger, complex companies (“peers”). Compensation committees, who purchase this comparative data, want to pay their own CEO, not at a 50th percentile (meaning that half of CEOs are better than their CEO), but at the 75th or 90th percentile. This inflationary effect, as you can imagine, has resulted in structural increases to CEO pay. Research confirms this. The process is made worse by rivalry, because CEOs see what other CEOs are earning, and think they deserve more. This knowledge and mindset increases the leverage of the CEO during pay negotiations.

One public sector organization, about to disclose pay for its employees, whom I recently advised, is not disclosing the identity of employees and their pay, but only the position title. This pay disclosure promotes good governance and accountability, but addresses peer rivalry, privacy and safety concerns. More regulators should exercise care over the inflationary results of disclosing pay. Compensation committees should focus less on inter-company comparison, and more on the performance and value creation within their company.

This brings me to the final pay reform, which is linking pay to sustained value creation within the company over the longer term. Performance metrics are what drives management. Most performance metrics for executive pay are short-term, financial, and based on total shareholder return (TSR). Even the new SEC rules rely on TSR. Research shows, however, that much of TSR is not under the control of management, but rather reflects exogenous market forces. In other words, executives benefit from factors beyond their control, such as a bull market.

Most of the business model and market value of companies are composed of broader, leading indicators that are non-financial in nature. By focusing just on financial results, boards lack the ability to track leading indictors, which could be customers, reputation, employees, innovation, R & D, ethics, risk management, safety, and so on, that measure risk and broader performance. Many boards desire these metrics but they are under-developed by management, which reflects board complacency.

90% of pay is short term, which is fewer than three years. This short-term focus causes executives to swing the fences for short-term gains, taking risks, because their pay incents them to do so, rather than being aligned with the product cycle of the company, which is in the range of five to seven years.

International Monetary Fund chief, Christine Lagarde, has called for banks to change the culture of short-term risk taking. There is also director leadership responding to short-termism: The subject of the Institute of Corporate Directors conference next month is titled “Short-Termism: A Problem or Not.”

The problem is that opposing the above reforms – shareholders selecting compensation committee members; relying less on peer benchmarking; and relying more on broader long-term performance metrics – are so entrenched into the status quo and vested interests that these reforms are almost unachievable. CEO pay problems will continue. To truly solve this issue, more leadership is needed from investors and directors. Models and best practices are needed to devise roles for shareholders in selecting directors and long term pay principles. Thoughtful regulation and more industry leadership and cooperation are needed.

Richard Leblanc: Ten reasons that pay governance is broken

Executive pay is always in the news. Just last week an executive of Yahoo walked away with what was said to be a 100M parachute. I was interviewed by CBC radio on upcoming sunshine laws that are going to be enacted in Alberta. Last month, Ontario Power Generation fired three executives after an auditor general’s report on excessive compensation. The Premier of Ontario has vowed to crack down on excessive public sector executive compensation.

Do politicians have a track record of properly addressing compensation? I don’t believe so. Here are ten reasons that the governance of executive pay is broken, starting with politicians.

Politicians. Politicians have been the single greatest driver of increasing executive pay. Transparency or “sunshine” laws that politicians enact enable executives to utilize the pay of other executives to exert upwards pressure and threaten to leave, which is difficult to counteract. Transparency is good, but transparency without any guidance towards pay setting results in pay spiraling upwards. There is not a single jurisdiction that introduced pay transparency where pay has gone down. There was a time where executive pay was written within an envelope in a top desk drawer, and the focus in pay negotiations was on what the executive can do for the company, not what everyone else was earning.

Pay consultants. Pay consultants use this pay data and sell it back to the company in the form of “peer benchmarking,” which consultants have cleverly invented, which is now the predominant way to set pay. This means executive pay is driven by cherry-picked larger companies at the 75th or 90th percentile, resulting in a baked-in pay increase to the executive irrespective of performance.

Lack of professional standards. Lawyers and accountants can lose their license if they breach their fiduciary duty to their clients. They (we) have professional standards and rule-books addressing the duty of care, conflicts of interest, fee arrangements, continuing education, and just about everything you can think of to ensure the client is well served. Compensation consultants have no such obligations. Anyone can put out a shingle and call him or herself a pay consultant, and they do. You can sit on a compensation committee without any compensation expertise whatsoever. The requirement to be a director is shockingly low. In many cases, you need only to be over 18, not bankrupt and not insane. Maybe it is time to raise the bar for compensation consultants and compensation committee members. When advisors have standards, and pay-settors have expertise, they will make better decision.

Unnecessary complexity. Ask any director how much did his or her CEO “earn” last year, and see if you get a consistent answer. You likely won’t. It’s a simple question that deserves a simple answer. Pay depends on whom you ask and can’t even be defined. Is it “intended,” “realized” or “realizable”? We now have multiple “vehicles” for getting all types of pay to executives, with multiple valuations and performance periods. It becomes impossible to understand, value, and compare pay to performance. Therefore, mistakes and self-interest are possible. Pay needs to be radically simplified. Complexity deliberately frustrates and obfuscates basic analysis.

Captured pay-settors. Even if a compensation committee has formally independent directors, this does not reflect social relationships, the use of company resources by the directors, interlocks, excessive tenure, over-boardedness, reciprocity, favors, exorbitant pay to directors, vacations, gifts, donations, jobs for directors’ children, and a host of other factors that my research and work with boards uncovers. The compensation committee is then an arm of management.

Short termism. Most pay metrics are short term and financial. This means the executive is being unduly enriched and is trading on the effects of his actions that materialize years down the road, or not. Pay metrics should be matched to the actual effects of performance over time, and the value chain of the company. It is impossible to align pay to performance with only short-term financial metrics. Long term, non-financial metrics must be used, and pay-settors should have the spine and competency to insist on it. (Or regulators eventually will.)

Heads I win, tails you lose, or no downside for risky behaviour. Pay needs to incorporate risk-taking. We know that risk management in many companies is immature, so how can the downside of a decision possibly be incorporated into pay? If it is not, there is no or limited downside for executives to swing for the fences. Pay metrics and awards should account explicitly for risk. Most do not. This is not an insignificant point, as risk-taking compensation fueled the financial crisis. Regulators are addressing compensation and risk, but not fast enough.

Undue influence of Management. One highly paid CEO said to me once, “I will outgun any compensation committee.” If pay is truly a free market decision between owners and executives, the power, expertise and participation of shareholders must equal that of executives. Pay committees will need surgery for this to occur, starting with shareholders determining who is on their pay committee. That way, pay committees are the agents of their owners, not management.

Directors not listening to Shareholders. Directors assume that they know what shareholders want but this is folly. Surveys reveal a wide divide between shareholders and directors on executive pay. Directors need to meet directly with shareholders without executives present. Most don’t.

Lack of oversight and accountability. In the public sector in Ontario, there have been several governance scandals, including Ontario Power Generation, eHealth, Ontario Lottery and Gaming Corporation, and Ornge, that have included compensation and spending. What this reveals is defective oversight. Governance is not government. Ministers oversee 100s of agencies, boards and commissions operating in major sectors of the economy. Without independently assured oversight, and directors chosen exclusively on merit and not pre-existing relationships, often to the Minister or party in power, these scandals will continue. Premier Kathleen Wynne would be well served to address this lack of accountability and good governance. Saskatchewan has an excellent upward reporting model involving corporate secretaries and use of governance tools I helped create that apply to all crown companies.

One of my colleagues recently said to me, on the outlook of corporate governance in 2014: “Seems like a stand pat year with lots of tinkering but nothing profound happening.” With pay governance to improve, we might need some profoundness and not as much tinkering.

The new US CEO to worker pay ratio and vested interests

The US Securities and Exchange Commission announced this week that public companies will be required to disclose the ratio of the annual total compensation paid to their CEO against compensation of that of the median worker, in the form of a ratio (e.g., 200 to one). See the proposed rule, here. One consultant estimated in a guest lecture for me that ratios could be as high as 1,000 to one. (See a list of eight companies apparently with this ratio, here.)

Other compensation consultants and lawyers have commented on the new CEO to median worker pay ratio. Advisors warn about the “law of unintended consequences” in this ratio, and how societal wealth disparity should not be laid on the doorstep of companies.

Let me fault the law of unintended consequences and wealth disparity at the doorstep not of companies but of the advisors themselves.

What happens with disclosure of pay data is revenue streams for pay advisors to boards. “Peer groups” and “benchmarking” – which is how most public company CEOs are paid – are inventions of compensation consultants. So are stock options. These concepts did not exist prior to Congress mandating greater pay disclosure.

“Peer groups” is a basket of similar or larger companies compared to one company, and “benchmarking” is a decision to pay a CEO at the 50th, 75th or 90th percentile of other CEOs. It is not in any executive’s interest to be paid compared to CEOs at smaller or less complex companies, nor to be paid as a ‘below average’ CEO, even though by definition 50% of CEOs must be below average.

This one issue – benchmarking against peer groups – has been responsible for CEO pay increases more than any other. Other academics have found that using benchmarked peer data in the above fashion results in a 17% structural year-over-year increase in CEO pay, that is unrelated to the CEO’s actual performance. This structural advantage, compounded annually, has caused the wealth disparity between CEOs and the average worker.

The pay consultants may be grinning behind closed doors because the above pay ratio will provide further built-in annuities for their firms beyond peer benchmarking and say on pay. What I predict is that compensation consultants and lawyers will do the following:

(i)             Assist companies in determining and interpreting their ratio (revenue stream number one);

(ii)           Sell the data back to companies to compare and explain ratios among their peers on an industry-by-industry basis, because average worker compensation for Bank of America will be different than that of Apple, for example (revenue stream number two); and

(iii)          Sell the data to labor groups to assist them in collective bargaining (revenue stream number three).

What happens with disclosure and data sales back to the company is that people see what others are making and their competitive rivalry creates upwards pressure on all pay. The pay consultants’ business model is predicated on comparables and this exacerbates upwards pressure because data is now provided to justify approval by boards. Thus, the law of unintended consequences is perpetuated by the very people benefitting from it: executives and pay consultants.

Boards seem powerless because the entire industry is predicated on a flawed method of paying CEOs. Downward discretion is met by threats to leave, which is also a myth. Having independent compensation committee members and independent compensation consultants, which was also recently mandated, doesn’t change the way CEOs are actually paid.

Therefore, what should a compensation committee do to prepare for the onslaught of pay ratios to come? Three things.

First, don’t let the ratio, the CEO, or the workers drive pay in either direction. Focus on governance and the actual performance within the company, not beyond it. An anomalous ratio could indicate CEO entrenchment or lack of succession, or worker retention, morale, or productivity issues.

Second, resist being overwhelmed by pay data and complexity. You are elected by shareholders to exercise your business judgment and discretion. I have interviewed numerous compensation committee members who are overwhelmed and intimidated by the glossy reports, the expertise of advisors, and the sheer complexity of how pay has morphed. Have a sense of self and the heft and confidence – and competence – to simplify, understand, and push back when you need to. You are driving the bus. Be fearless and do the right thing, as one director recently said.

Third, appreciate the vested interests of pay advisors. You are not obligated to have them. If you ask a barber if you need a haircut, you know what the answer will be. Consultants, when or if needed, work for you, the compensation committee, or at least should do so. Be very willing to oversee metrics and data that are customized to suit your organization and no one else’s.

Reforms to director compensation need to occur: Richard Leblanc

Activist investors in both Canada and the US recently proposed – for Hess Corporation and Agrium Inc. – that the independent director nominees they nominated to serve on both Hess’s and Agrium’s boards should be paid incentive pay directly by the activist investor that is tied to share price appreciation.

The rationale for this incentive pay – which has been termed “golden leashes” – was to incent new directors to the board to maximize share price.

There were several arguments against this proposal (see here and here for example), but the proposal itself raises a disconnect between how current independent directors on boards are paid and incented to perform, or not.

Most independent directors on public company boards are compensated in a blend of cash and company shares. The equity component is typically restricted or deferred until the director retires from the board, thus postponing taxes and enabling the director to amass a portion of equity in the company to align his or her interests with shareholders (it is believed). The equity can be a predetermined number of restricted shares, or a set monetary amount in the form of share “units.”

The problem with paying independent directors this way is that there is little incentive for personal performance or company performance. Directors get paid the cash and equity regardless. There is little if any downside, especially when directors can ride a stock market or Fed driven increase in overall share prices.

Not surprisingly, the activists noted this lack of incentive pay.

It is hardly surprising that boards do not focus on value creation, strategic planning, or maximizing company performance, survey after survey, as much as they do on compliance. Their compensation structure does not incent them to.

Compensation incentives drive behavior, both for management and for directors.

Here is what is needed to align director pay with shareholder interests:

  1. Directors should be required to issue cheques from their personal savings accounts to purchase shares in the company. Bill Ackman of Pershing Square stated that if Canadian Pacific directors were required to cut cheques for $100,000 each, the CEO would have been fired prior to Pershing Square being involved. Mr. Ackman is right. “Skin in the game” for a director does not mean shares are given to a director in lieu of service. The motivational factor to be attuned to shareholders is greater if directors are actual investors in the company. In private equity companies, non-management directors are encouraged to “buy into” the company and invest on the same terms as other investors.
  2. For Directors’ equity to vest (the portion they did not purchase), hurdles would need to be achieved that reflect personal performance and long-term value creation of the company. Assuming you have the right directors, this sets up a situation in which Directors are forced to engage in value creation and be rewarded for doing so, similar to private equity directors. The hurdle rate provides the incentive. The vesting hurdle should be based on the underlying performance of the company, commensurate with its risk and product cycle, possibly peer based, and not simply on riding a bull market.
  3. The long-term performance metrics for value creation should also apply to senior management, and the board should lead by example. The vast majority of performance incentives are short-term, financial and quantitative. We know that the majority of company value however is now based on intangibles. Long-term leading indicators such as innovation, reputation, talent, resilience and sustainability are being completely overlooked in compensation design. You get what you pay for.

Management has proposed “passive” pay for directors and short-term pay for themselves. Boards have acquiesced.

Where the activists went wrong, above, is in proposing short-term incentives tied to stock price that applied to a sub-set of directors. However their point is excellent in that independent director compensation is flawed. The correct approach is long-term value creation and incentives that apply to all directors, and to managers, and to shareholders.

Only when this shareholder-director-manager alignment occurs will the compensation issue be solved. It makes little sense to award executives on a biased short-term basis when the effects of their actions can last for years, or to award directors on the basis of time – or, as one of my students put it, “showing up.”

Compensation consultants are using the same short-term metrics as before the financial crisis. They need to be directed by their client boards to do otherwise.

The need to establish long-term value-creation metrics, in the words of one American director, “is one of the greatest challenges in establishing long-term incentive compensation plans.”

Join me in my next blog where I will address reforms to executive compensation.



text cloud