The "Real" CEO Compensation Issue: Boards of Directors

As I reread my post on CEO compensation of the other day, it occurred to me that I am guilty of leaving you, the reader, hanging on an important aspect of this issue.

I attributed the mess to board members, particularly those on the compensation committees, but failed to suggest solutions for their actions. If it was not for their dereliction, on behalf of shareholders, more underperforming CEOs would be shown the exits, and shareholders would be better served. At least they would theoretically pay less for the underperformance they receive from a poorly-performing CEO.

So the question we should ask is, how do shareholders affect the recruitment, retention and behavior of board members, so that the boards behave effectively and responsibly in their oversight of the company and its CEO?

I doubt I'm going to solve this rather momentous question in one post on this blog. However, I intend to begin, as Einstein would call them, "thought experiments" on the subject. Chances are, musings about various solutions may uncover key attributes of what the solution should contain and "look like."

The overwhelmingly attractive alternative in my mind is to truly align the board members' interests with the shareholders, i.e., not stopping with doing so for the CEO, but extending this concept to his/her overseers. I would propose, and feel better about companies which, required board members to own and retain voting control of, some minimum number of shares or value of shares of the company. Today, it's a rare board member who is not already a retired CEO or a sitting senior executive or CEO of another firm. So, requiring someone to have a lot of money to be a director is really not such a major departure from current practices. About the only people it would weed out would be token appointments of unqualified, but politically acceptable directors, for public relations reasons.

This alternative makes being a board member into a rather interesting, and potentially lucrative, job. Someone could, in theory, borrow money to buy shares and run for a corporate board, intending to exercise effective oversight, in order to profit from the company's presumed increased total return.

It seems very clear to me, as I write this, that the major problem with today's corporate board structure is that it fails to require the board members to share the most important interest of the shareholders- personal financial gain or loss of a significant nature, based upon the firm's performance. In this regard, Ed Lampert's role in Sears and K Mart are a good example of expecting to make money by buying your way onto a board. In his case, he didn't stop with only "another" board seat, but became CEO.

If you think about it, the modern corporate form began in an era when most other company CEOs had contributed a significant amount to their own firm's success. Thus, filling a board with other CEOs usually meant recruiting active, successful talent on whom you could rely to know how to get superior performance from a company and its CEO.

Nowadays, though, with so much ineffectual overcompensation of underperforming CEOs, I suspect most boards are comprised of members who both have not actually demonstrated the success they are meant to foster on the board on which they serve, and who do not have a truly material interest in the success of the company in the first place. And the result is self-propagating. We see learned behavior of rewarding incompetence spread from company to company.

If a company actively publicized that its board was filled with people who met my qualifications, perhaps they would become a more attractive company to own, simply because the overseers of the CEO had the shareholders' interests as their own. And would, in time, cause better returns, which would reward shareholders appropriately.

So, at this point in my thinking, I believe that CEO compensation is simply an outgrowth of a deeper problem- incompetent, insensitive corporate boards. If board members had to own substantial amounts of a company's stock to serve, and, thus, profit, as a board member, I think the CEO compensation issue would resolve itself in short order.

My next piece on this topic will probably address how a company makes the transition from one with an ineffectual board, to the type of firm I am envisioning in this post. Perhaps a good case would be to imagine how one would transform GE from what it is now, to a truly well-run company. One which compensated its CEO appropriately for his performance, rather than rewarding him for consistent underperformance, as it now does?