How to better achieve CEO investor alignment: stock ownership guidelines miss the boat. More important are rigorous equity retention requirements.

• Author: Larre, Eric
• Position: EXECUTIVE COMPENSATION

ASINVESTORS and proxy advisory firms increasingly focus on stock performance in examining CEO compensation practices, many U.S. companies have responded by adopting one or more of the following compensation policies:

--Requiring executives to own company stock;

--Tying a majority of the pay opportunity to stock price performance;

--Mandating mid- to long-term retention of a portion of company shares received as compensation.

At the same time, however, companies' public disclosures reveal a lack of clarity with regard to how and why companies use stock--and, more specifically, stock price performance--in structuring their executive compensation programs. These disclosures frequently blur the lines between various objectives. Do companies seek to treat CEOs like investors, link CEO pay to investor returns, or both? Or is stock ownership a tool to mitigate short-term risk and/or promote retention (when coupled with vesting restrictions)?

Compensation committees should take a fresh look at their objectives in crafting stock ownership, retention and pay policies/programs to ensure that they're aligned with appropriate risk management concerns. While aligning the financial interests of CEOs with those of investors is certainly appropriate, an approach that substantially affects both an executive's balance sheet (through ownership and retention mandates) and his/her pay risk and earning opportunity (via stock options and/or relative TSR plans) is likely to have a negative influence on desired and reasonable risk-taking behaviors.

For many companies, an appropriate objective of executive pay philosophies may be to promote sustained and meaningful investment in company shares by top executives. Given this objective, an approach that combines compensation for performance against internal financial metrics with rigorous equity retention requirements would be effective from a compensation governance perspective. Such an approach links executive wealth creation opportunity to the sustainability of business decisions and also aligns executive and investor long-term financial interests.

Ill-suited mechanism

Executive stock ownership policies are now in use by more than 85% of U.S. public companies. However, most stock ownership guidelines are ill-suited to achieving effective alignment of executive and investor long-term financial interests for a number of reasons, including how they are quantified, how their value is measured and when their value is...