The New Return on Investment of Executive Pay

Fred WhittleseyPay and Performance: The Compensation Blog0 Comments

In May 2006, I presented at WorldatWork’s Annual Conference a session titled “The Real Meaning of Return Of Investment…for HR Professionals.” It was a financially-oriented look at how HR folks need to present their ideas – in dollars, just like the other areas of the business organization. I was thrilled to learn that it was named “Best of Conference” (though the dog show “best of breed” comes to mind) based on attendance and attendee evaluations and I have been invited to present it again, as a webcast, on 01 November. I was particularly pleased that such a highly technical and complex topic was so well-received by an audience not known for its financial savvy (sorry HR people, but I’ve been teaching the WorldatWork Accounting and Finance certification course for the last 10 years and there just are not many in our field with that particular competency). One of my professional colleagues said he had never seen so much information presented in such a short period of time (75 minutes).Since receiving the invitation to present this webcast I’ve been pondering how it needs to be changed and updated because my presentation slides are never done, only submitted and immediately agonized over. I also was wondering, now that I had become my own hard-act-to-follow, what I might propose for next year’s Conference.

This week I participated in a two-day webcast on the new SEC rules for compensation disclosure (I know, you think I just had an attention deficit moment, but hang in there, I’m going somewhere with this). Somewhere during John Olson’s keynote address on day two I had one of those professional epiphanies, the “aha!” experience.

The costs of designing and administering executive compensation plans, particularly equity-based executive plans, is significant. Moreso for global plans. As accounting and tax rules have both constrained and enabled the features of these plans, the design and administration costs have increased. The new SEC disclosure rules add more cost, due to both the processes required and the documentation and reporting of those processes and decisions.

So, (in Seattle we love to start our sentences with “so” and I don’t know why) it became clear to me that we, as a profession and as a group of professions (accounting, tax, HR, law, plan administration) have never, ever attempted to calculate the total cost of the intricate equity-based compensation programs we collectively design, and relate that cost to the compensation delivered through those plans.

Well, I just lost some friends there and made some new enemies. As either Benjamin Franklin or Thomas Jones may have said, friends may come and go but enemies accumulate. Interestingly, there has never been a time when executive compensation – as a topic, a concept, a practice – has had so many enemies. The new disclosure rules will provide more fodder for shareholders, pay critics, and the media to take potshots at executive pay practices and, more critically, the members of the Boards of Directors approving those practices. And by extension, their advisors. There will be knee-jerk reactions, poor decisions, and then revisiting of those decisions a year later. That creates more design work, and more professional fees and internal costs, and may reduce return of investment.

Here’s an idea: we measure the return of investment of executive pay. Is that possible? Has it been done? Well, the ROI models I developed for last year’s WorldatWork Conference – and which I’ve been using for over 20 years after learning the concepts from my mentor Eric Flamholtz, the father of Human Resource Accounting – can be applied to this problem. There is a New ROI of Executive Pay and I hope to be presenting those ideas at the 2007 WorldatWork Conference. In the past few days I have constructed an interesting model that Boards of Directors will want to use to grapple with the uncharted territory we all are facing. It’s new, it’s financial, and it’s going to raise a lot of tough questions.

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