One of the endearing memories of Olson family holiday lore is the time our (then) 3-year-old nephew John looked over the dinner table at a prepared feast and announced, "I want too much."
His blunt admission represented a combination of the hearty appetite of an active little boy and an affirmation that at age 3 he wanted to be shed of portion restraints imposed on him by adults. His statement generated a good laugh by the adults, but to John's chagrin, the portion restraints remained.
"I want too much" aptly described the appetite of many on Wall Street during the high-flying environment of the past decade; it resulted in, among other things, new regulations by banking regulators, legislative initiatives in the Dodd-Frank Act and general scorn by Wall Street observers.
But despite the regulations, legislation and loud condemnation, a real question facing the financial services profession and indeed all of corporate America has emerged: How much is too much? The question is complicated because the definition of compensation has changed over the years, making comparisons difficult.
For example, the highest marginal income tax rate was 91% through World War II and continuing until 1964.
During those years of literally confiscatory tax rates, it would have been lunacy for corporations to pay salaries in excess of $200,000 when the government would get all but 9% of those highest-taxed incomes. Few corporate execs in those days received even six-figure salaries; a $100,000-per-year salary was taxed at 70% on the marginal dollar.
But this doesn't mean that executives in those days were not well compensated. Corporations found many ways to provide perks that were both untaxed for the recipient and deductible for the corporation. The perks also went largely unreported in corporate financial documents, as there was no requirement to report them.
The 1980s and 1990s brought changes. The top marginal tax rates were gradually lowered, until the top marginal rate in 1990 was 28%.
Not surprisingly, taxable cash compensation at publicly traded companies soared, and so did the howls of protest when some of those wages seemed out of line with corporate performance. In 1993, that dissatisfaction resulted in legislation that denied a deduction on any compensation above $1 million unless the amount was determined "solely on account of the attainment of one or more performance goals."
How did corporate America respond to that new environment? Hello performance goals.
Performance goals work best in one of two circumstances. First, they work well when there is a tight correlation between individual initiative and a financial transaction. Thus, commission salespeople like stockbrokers and real estate agents who earn a portion on each transaction can readily justify performance goals. Their compensation arrangements go largely unchallenged as a matter of public policy because the correlation is well understood and accepted.
Even Lady Gaga's $65 million in earnings for 2009 drew less attention than her attire at a recent awards ceremony, because the link between her music sales and income is easily understood.
The second circumstance when such goals work is when compensation is aligned with corporate performance over time. The most obvious examples include instances in which founders of companies become billionaires due to the appreciation of their stock. Bill Gates and Richard Branson are rarely faulted for becoming extravagantly rich; their reward for their efforts is understood and largely accepted. Applying that concept in most managerial circumstances is more problematic.
But since the mid-1990s, when the investor community began pushing the concept of "shareholder value," investors have been willing to appropriately compensate corporate leadership that enhances shareholder value over a defined period.
So, if these two concepts are generally acknowledged and are applicable in most organizations, why is compensation management so difficult? There are several reasons.
First, tax rates have greatly influenced compensation strategies over the years and comparisons of current compensation in a 35% top rate compared to a 91% top rate are not valid unless adjusted for the tax and perk differences.
Second, the link is complicated when high-performing employees work for underperforming companies. Thus, certain traders on Wall Street who had achieved astonishingly high performance targets were widely vilified if they had the misfortune of being employed by companies receiving taxpayer bailouts.
Of course, the press attention received in the most egregious of these instances has had a chilling impact on everybody else.
So, what guidelines should compensation committees follow when making policy decisions?
First, remember that even at the highest levels, compensation has the potential to be a negative motivator. There is no better evidence of this than the whines and complaints of highly paid professional athletes. The same dissatisfaction can exist in any organization if the compensation philosophy is not well communicated and not perceived to be fair.
Second, adopt a common-sense rule that is grounded by industry norms. Even when compensation within an organization is perceived to be fair and well understood, an organization needs to compare its approach with industry norms. There are plenty of experts willing to help an organization justify ever-higher salaries, but the common-sense test should help establish parameters that keep an organization from awarding compensation at levels that are perceived as unjustified.
Third, when evaluating compensation for commission salespeople, companies need to establish caps in order to avoid circumstances in which underperforming companies have the industry's highest-paid people or when a single individual in an organization earns many times what others at a similar level earn.
Compensation committees at corporations will continue to be a focus of attention over the next few years. The above approaches are tools that can help them manage that responsibility.
