What investors want executive pay to do.

• Author: Davis, Michael L.
• Position: Chairman's Agenda: Balancing Shareholder Interests

What Investors Want Executive Pay To Do

Institutional investors are a new and important force in executive compensation. Traditionally, executive compensation had been within the exclusive purview of senior management and the board - the board being the only official "voice" of the shareholder. That, however, is no longer true.

Institutions recently have begun to speak out on executive pay, particularly on matters relating to golden parachutes (the most notable instance being Transamerica). Other initiatives are being taken as well. Furthermore, it is unreasonable to assume that institutions will stop here. Sooner or later they will speak out on the rest of the executive pay package.

What will they say? What are their issues? Although the answers are anyone's guess, our bet is that they will deliver four important messages on what executive pay plans should do: * Link with shareholder interests. * Be competitively and financially justified. * Vary payouts with performance. * Emphasize the executive as owner.

Link With Shareholder Interests

Individual equities are included in a diversified portfolio for a variety of reasons. A company's equity may be attractive because the company is driven by a sound, value-creating strategy. It may be a stronger performer relative to other choices in the industry. It may be a consistently good performer. It may provide more than a reasonable return given the level of risk.

Whatever the reason, it is important that the executive compensation program be driven by these same factors. Otherwise, management will be working toward one end while the shareholder will be working toward, or expecting, another.

Institutions and other shareholders will benefit when this linkage exists. The exhibit on page 42 illustrates how various investor objectives might be translated into executive pay design principles.

Be Competitively and Financially

Justified

Compensation for top officers of a publicly held company is disclosed in the company's proxy. For this and other reasons, boards seek periodic competitive analyses of the company's executive pay program to ensure that payouts are within competitive norms or policy guidelines.

Much less effort is expended to assess the financial appropriateness of these programs. This leads to situations in which a competitive analysis tells you one thing while a financial analysis tells you another. For example, many companies set annual bonus plan thresholds (the point at which the...