Tone-Deaf Boards in Sound-Proof Rooms

As we enter into proxy season for corporations around the world, one of the key questions for boards and CEOs to answer is why executive pay seems so out of line with what inherently seems justified.

Recent headlines have brought us news that Citigroup lost an advisory "say on pay" vote, that BP executives are being accused by shareholders of having their 'snouts in the trough', and that Barclays Bank is facing a major shareholder rebellion over Bob Diamond's £18m pay package.

These are not exceptional cases from the energy or banking sectors but rather illustrative of a much broader trend: compensation packages, when exposed to the light of public scrutiny, evoke a range of negative reactions because they seem out of line with results, and pay differences and ratios are striking. So how do these packages come about? The short answer is that the responsibility lies in the boardroom, but also with CEOs themselves. In most board structures, a remunerations committee is assigned to set the level and determine the components of the pay package that senior executives receive, including base pay, bonus, stock, and privileges such as use of the company jet. Several factors are at play as the remunerations committee and the board negotiate with C-level executives.

Compensation consultants are frequently used and many make a sincere attempt to prepare a comprehensive view, taking into consideration, among others, peer groups and market pressure. What they advise may seem fair in the vacuum of the boardroom or on paper, but oftentimes it does not reflect other realities and pressures on the company from stakeholders such as investors, employees, and the community at large. Personal feelings that directors may have developed with the CEO and senior team can mean that board members feel they must offer a certain compensation to "save face." Or the directors may feel that the work the executives have done and are being asked to do in the future is onerous and must be compensated in a predetermined way — a way the board is accustomed to and feels reluctant to stray from. This can be a slippery slope, or rather a speedy escalator, as each year the desire to reward and inspire means that ever grander packages need to be put in place. It is time for a rethink about how compensation packages are composed.

A disconnect from today's reality can mean that those of us in the boardroom feel we are in a soundproof room, even though we come armed with a great deal of knowledge and information. The conversation around the table about compensation may sound reasonable in the vacuum of that room, but it is vital that directors have a finger on the pulse of the market and public perceptions and consider how pay packages will be received and how this might affect a company's reputation.

Here is one place where the CEO should be stepping in and stepping up. Of everyone in the discussion, the expectation is that CEOs have their fingers on the pulse of how the world will respond to these pay packages, and as leaders, should be willing to moderate their demands to find a package that is not just acceptable in the boardroom but also beyond it. To not do so is fairly short-sighted, and potentially damaging to the organization.

A lack of direct accountability has been prevalent until recently when board members worked in a "black box" and their decisions were beyond proper public scrutiny. Even if there was any outcry, the board, let alone individual directors, was hardly ever held accountable. Also, CEOs were not necessarily held to account for their own pay packets. This is changing. CEOs are the public face of their companies, and together with board members, they will be held accountable for their demands. Greater scrutiny and accountability mean that board directors have to demonstrate why they have taken certain decisions or voted in a certain way, and remuneration committees are being asked to justify their choices. It also means that CEOs will be asked to justify remuneration.

Calls by active investors will mean that companies will need to do a complete review of their compensation structures to ensure that pay and performance are linked and there is a "right-sizing" of pay packages across the market.

Boards and CEOs need to work together to come to grips with compensation for their senior executive teams as stakeholders have found their voices. These voices have increasing power because these conversations are not just happening behind closed doors or in specialized journals, but rather are on the front pages of newspapers around the world and across social media outlets such as Twitter. CEOs and other members of the C-suite deserve fair compensation for running companies, particularly in demanding economic times. Yet, these difficult economic times call for judicious decisions about compensation packages that are more clearly linked to performance and demonstrate that board members and the CEO are not tone-deaf in a soundproof room.