MVC Associates International
Sept 25, 2003
The Honorable William H. Donaldson
Re: Corporate Governance - Fixing CEO Selection and CEO Compensation in America
Dear Chairman Donaldson,
I am writing you as a follow up to our formal comment filed with the SEC Sept. 4, 2003, regarding proposed amendments to NYSE rules for listed companies. In this comment we noted concerns about proposed rules as they impact Boards of Directors in effectively carrying out their governance duties related to CEO compensation and CEO Selection / Succession Planning. ( this filing is on our website in the research and publications section )
The most important recommendation we made, based on our research and expertise i addressed a significant gap in the NYSE listing rules related to the board's role and required process to carry out its duties related to CEO Compensation and CEO Selection. These are processes and standards that are required to restore investor confidence in corporate America, including the capital markets.
Far too many boards and advisors in executive compensation and executive search lack a clear and legally defensible framework for defining CEO work and accountability, performance metrics and the comparison of CEO roles, skills and compensation. As outlined in our Sept. 4 document, without a rigorous executive job analysis Boards have no legally defensible basis from which to assess candidates when making CEO hiring decisions, or when comparing CEO roles for making executive compensation decisions.
This is nowhere more evident than in Mr. McCall's Sept. 9 response to you about CEO compensation at the NYSE. On Page 8 of his response he details the accomplishments of the NYSE over 2000 and 2001, as a basis for linking these to their Longer Term Incentive Plan and executive compensation payout. Yet the majority of the accomplishments listed were operational and productivity improvements over 1 to 2 years.
If the top three levels of the organization have the same 1-2 year metrics and the same short-term time horizon for planning and decision making, then what is the real value-add of the CEO that is different from his or her direct reports or direct reports once-removed? Compensation Policy disclosures that focus on year over year operational efficiency metrics ( VP / Director level work accountability) as the basis for executive compensation, call into question whether the CEO is being held accountable for the right work and or/ being overpaid for the work he/she is doing.
In the case of the NYSE we would have to ask the same question about their top 3 levels of the enterprise.
As we mentioned in our Sept 4. comment, the Level of Complexity of the CEO role at Johnson and Johnson versus at El Lilly, is exponentially more complex, as it is at Procter and Gamble versus Kimberly Clark. Yet Eli Lilly and Kimberly Clark have chosen these peer group companies and CEO roles to benchmark against that are far more complex than their own CEO roles. J&J and P&G due to the higher complexity of their CEO roles should have a CEO compensation band exponentially higher than Eli Lilly and Kimberly Clark. ii However, faulty benchmarking is contributing to excessive executive compensation for the less complex CEO roles. This example represents much of current practice. This problem is further exemplified in comparing the CEO role of the NYSE to the CEO roles at JP Morgan Chase or Merrill Lynch. Not all CEO roles are at the same level of work complexity (not-for-profit or other), and thus many of the comparisons are not defensible.
Research and field implementation has shown that the size of the business, budget and number of employees does not determine the level of complexity of CEO / General Management work. The fact that the largest public pension fund in America is developing a model for evaluating CEO Pay for Performance effectiveness based on similar inappropriate benchmarking, just further highlights the problem in understanding levels of executive work and appropriate compensation across corporate America.
So what is the standard we need to improve CEO selection and CEO compensation practices?
Boards must analyze the CEO role and answer the following questions to determine the true level of accountability, work complexity and value-add of the position. Only then can effective and defensible CEO selection and pay decisions be made by Boards of Directors.
1) What is the level of innovation which the CEO role will be held accountable for;
a) Process innovation and productivity improvement
b) New Product / New Service innovation
c) New Business Model innovation
d) Global Industry structure innovation
2) How far into the future must this CEO role think and plan for;
a) 1 to 2 years
b) 2 to 5 years
c) 5 to 10 years
d) 10 to 20 + years
3) What customers / stakeholders does the CEO need to spend time with most to add value;
a) Today's current customers related to today's products / services
b) New and current customers for New Products & Services
c) All key Stakeholders that impact the external environment on a country level in which the business operates and could impact creating a new business model
d) All key Societies that impact the external environment globally in which the enterprise operates and could impact transforming global industry structure.
A CEO title can apply to any of the 4 levels of work complexity we have identified (a-d) above.
However, answers to the above and similar questions define the true level of work complexity which a CEO role could be held accountable for by the Board.
Too many CEOs today are held accountable for the wrong level of work (more operational in nature), are measured against the wrong metrics, and are overpaid for the work they are doing, using the above as a basis for analysis. With 55 % of the S&P 500 only measuring and disclosing CEO performance and compensation metrics for one year, it calls into question what is the value-add of many CEO roles for which compensation seems excessive.
We would hope that in creating a new model for corporate governance for America, the Board of the NYSE would:
1) Give serious consideration to incorporating many of the recommendations outlined in our Sept. 4 comment about required NYSE listing mandate rules for the compensation and human resource committee;
2) Undertake a rigorous executive job analysis for the go forward CEO role of the NYSE, based on its charter and strategy, by defining:
a) which level of CEO work will the role be held accountable for, as outlined above
b) what will be the key accountabilities and decision authorities of the CEO role and how will these be different from direct report positions
c) what will be the key metrics used to evaluate success of the CEO role, over what time horizon, and how are these different than direct report positions
d) Based on the strategy for NYSE, Level of Work of the CEO role, outline what key activity areas does the board expect the CEO to spend his/her time ( 20 % buckets )
e) Only after the above has been defined and agreed to, the board will then define the most critical skills and experience for the new CEO of the NYSE;
3) Share the final draft position guide / skills profile for the CEO role resulting from the above executive job analysis with key stakeholders for comment, prior to starting any search for CEO candidates. You can't assess executive talent if you have not effectively defined the role.
I appreciate the opportunity to share with you our recommendations on improving CEO selection and CEO compensation practices as part of restoring investor confidence, and would be pleased to provide further input.
Hon. Paul Atkins, Commissioner, SEC