A New Take on Why Executive Pay Is Failing

In "Why Executive Pay is Failing" in the June 2006 issue of the Harvard Business Review, NCEO member Stephen O'Byrne of Shareholder Advisor Services and S. David Young, an accounting professor in France and Singapore, present a new take on problems with pay at the top. The ostensible goal of executive pay is to link pay to performance. In practice, however, they argue that the primary focus of compensation is "to ensure that managers are paid more or less in line with their peers." The result is that pay is decoupled from performance. Much of executive wealth is in the form of equity. Companies have tended to increase the number of equity awards when pay drops below peers and decrease the number of new grants when the existing awards are performing well. In a study of 702 public companies between 1995 and 2004, the authors found that two-fifths of the incentive pay at companies is not linked to shareholder wealth per se, but growth.

O'Byrne and Young argue that trying to maintain competitive pay levels might seem simply a response to market conditions. But, they say, the result is to overpay underperformers and underpay those performing very well. Their argument is bolstered by the fact that executive turnover has increased significantly in recent years despite the rapid increase in executive pay.