Opening keynote: rethinking Pay for performance: what have we learned about pay for performance in the current financial crisis that can help us do a better job in the future?

• Author: Perry, Debra

Our approach to executive compensation needs significant overhaul. At a time when several major financial institutions and industrial companies are on life support, shareholders have every right to question pay practices that have delivered outsized financial rewards to executives despite poor or unsustainable company performance. As the federal government has stepped in to backstop banks, auto manufacturers and our largest insurer, public outrage about executive pay has intensified.

The public acrimony over the AIG retention bonuses marks a new and alarming peak in anti-business sentiment that risks compromising the success of the measures being taken to repair the damage to our financial markets. It may also complicate our efforts to repair the economy. Private sector reliance on taxpayer-funded bailouts has also invited retaliatory legislative action on pay levels and pay policies. However, one-size-fits-all compensation rules crafted on Capital Hill are not likely to provide the right incentives to recruit and retain the skilled managers that we need to fix our companies and our economy. The recent executive compensation rules outlined in the stimulus package will further de-link pay from performance and over time, prompt an exodus of talented professionals from the very institutions in greatest need of managerial talent. This is not a good outcome for public companies' stakeholders--not the taxpayers who are now sizeable creditors and not the shareholders either.

This disconnect between pay and performance has occurred despite the hard work of many board compensation committees and outside consultants. Both have worked to more effectively align management rewards with shareholder value. But high levels of dissatisfaction with their work in the current environment demands some careful analysis.

What have we learned about pay for performance in the current financial crisis that can help us do a better job in the future? I believe that there are several takeaways for boards and for compensation committees.

Performance goals that govern pay should be set within acceptable risk parameters

I believe that the compensation excesses of failed financial institutions are first and foremost a failure of risk oversight. Setting financial or operating performance objectives in the absence of clear and thoughtful risk parameters may be an invitation to bet the ranch. Companies make money by taking risk; the objective is not to eliminate risk but to...