Myths and realities of executive compensation board members need to know what is working--and what isn't--in executive compensation, and base their views on available facts.

• Author: Kay, Ira T.

Executive compensation is more complex, controversial and misunderstood than ever before. The media, regulators, politicians, pundits and shareholder critics have excoriated the way executives are paid in the US for more than 20 years. Criticism has reached a crescendo over the past 18 months. While the executive compensation model has some flaws, we believe that overall, the model has been extremely successful, and will in fact help the US recover from the recession and deep financial crisis that currently exists.

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However, to remain successful, it is very important for all thoughtful persons, especially the board members who have the ultimate responsibility for their companies, to separate the compensation myths from the realities. These fiduciaries need to know what is working and what is not, and to base their views on the available facts. While there may be political or sociological reasons for doing things differently, the economic and managerial reality is that many companies are extraordinarily successful overall, the existing executive pay model has contributed to that success, and no one company can fix sociological problems alone.

With that as background, here are some recent headlines criticizing executive pay:

(1). The executive pay model played a major role in the current financial crisis by motivating executives to undertake excessive risk taking, creating moral hazard.

(2). Wall St. CEOs sold their stock before the collapse, as they knew their companies were over-leveraged and filled with toxic assets.

(3). Most CEOs are overpaid and are not paid for performance.

(4). Board members in general, and compensation committee members in particular, were lax in their oversight.

(5). Many executives routinely hedge their stock, reload, backdate and reprice their stock options, and fool their boards into setting easy goals in order to "rig" the game to maximize pay for minimum performance.

All of the above are mostly mythologies and certainly exaggerations. The empirical evidence refutes all of them and demonstrates that a tiny fraction of companies, in most instances fewer than 1%, undertook any of these bad practices.

The Realities

Here are the realties, based upon our consulting experience, plus extensive academic and research by us and others:

(1). Most CEOs are paid for performance, due to their significant at-risk cash and stock incentives. Using the proper pay measure, "realizable" pay or potential earned...