Category Archives: Compensation

Compensation, pay, and reward issues

Greed by Any Other Name

Money Bundle

There is a great article in the Wall Street Journal today [Note: I believe this link is subscription-only].

The title of the article says it all: “When $70 Million is Not Enough”. It is about how a star at Goldman Sachs, aptly named Mark McGoldrick (nicknamed “Goldfinger”), quit because he felt his $70 Million in compensation in 2006 was inadequate.

I’m quite sure that the vast majority of the world is just flabbergasted by the hubris of Mr. McGoldrick. I’m sure the indignation is quite ripe. After all, even the biggest lottery winners don’t even dream of getting this much money over their lifetime, let alone as one year’s compensation. And they marvel at the fact that the island of Saint Kitts is overwhelmed by the damage done yesterday by Hurricane Dean, estimated to be over $50 Million — an amount Mr. McGoldrick could cover and still have tens of millions to spare.

But I’m not surprised. Because I’ve seen worse.

But I’m not surprised. Because I’ve seen worse.

Yes, really, I’ve seen worse. You see, I was in charge of compensation at Microsoft at the zenith of the dot-com boom. If you want to get a brain freeze, if you want to see warped values, and if you want to see upset people, you need to see extremely competitive people discuss their compensation.

I had senior people in my office griping about net worths in the magnitude of the GDPs of small countries. They pointed to others who they deemed less worthy, and complained that just being ahead of them was not enough. No, they needed to wipe the floors with them.

I had more than one executive who was on their way out the door demand, and get, millions in compensation — for what I was not sure. They stomped and moaned and complained like children until someone, anyone, would grant them what they wanted. And then they left.

I had one case where an executive threatened to start up a business that potentially would cause one small part of the company some grief. He made numerous vague, disguised threats until he was granted $30 Million in stock options. He promptly left, and started the business anyway. And now his biggest customer is Microsoft.

So, Mr. McGoldrick is disgusting, and clearly demonstrates that all that is wrong with Wall Street today. But he’s just an amateur. If he wants to really know how it’s done, perhaps he should drop me a line.

The A-Rod’ing of Executive Pay

Bundle of Money

Today’s Wall Street Journal observes “Limits on Executive Pay: Easy to Set, Hard to Keep”. It is just one more sign that as long as executives are rewarded for the wrong things, their pay will continue to spiral out of control. It’s the “A-Rod’ing” of executive compensation.

In case you don’t know who “A-Rod” is, he is Alex Rodriguez, the highest paid player in baseball. A-Rod was the mercurial former star of the Seattle Mariners where he was the youngest player to achieve greatness. I watched him excel before his 18th birthday, with dazzling defense on the diamond, wonderful prowess at the plate, and the three C’s: charm, class, and charisma. He was, in short, a delight.

The Mariners nurtured A-Rod until he became a free agent and his agent, Scott Boros, threw chum in the water and attracted all the usual sharks to the feeding frenzy. After an exceptionally vigorous bidding battle, the Texas Rangers (of all people) outbid the big boys — notably George Steinbrenner and the New York Yankees — to land Alex with a breathtaking contract worth $25 million a year for 10 years, and a huge signing bonus. So large was the package that it remains unmatched even today, many years later.

It takes a bit more than one superstar to make a team.

I’m betting, even if you aren’t a follower of baseball, you can guess the rest of the story. As I noted in this post about teamwork, it takes a bit more than one superstar to make a team. So things just didn’t work out for A-Rod with the Rangers. It turns out that casually discarding your journeyman shortstop to bring in a single over-priced superstar wasn’t popular with the rest of the team. It didn’t help that he was paid more than 10 times any other player on the team, sucking up something like 60% of the payroll. I bet the snickers in the dugout after each strikeout still reverberate in his head.

And A-Rod wasn’t happy either. He’s a fierce competitor and losing just rubbed him raw. And it turns out playing outside in Texas in the summer is hot — who would’ve guessed that? So he begged to be traded.

NY Yankees Logo

Here too, I’m sure you can predict the rest of the story. The only team with the revenue or chutzpah to be able to pick up his contract was the New York Yankees. So A-Rod joined the Yankees, a team filled with over-priced talent. A-Rod was right at home with his fellow multi-millionaires.

But alas, the New York crowds are brutal, and they love to chew up and spit out people who don’t live up the the hype. Even while performing well, A-Rod seems miserable. And the Yankees certainly are, having been summarily dismissed from the playoffs more times lately than suits Mr. Steinbrenner.

Translating this to the executive pay world, the same is true. Having the CEO or top executives quite publicly paid exorbitant sums makes everyone sick — from the stockholders to the employees. It just doesn’t make logical sense that anyone is worth that kind of money. And just like in the world of baseball, it makes even the mediocre players demand silly pay packages, spiraling the whole thing out of control.

Relying on superstars alone to build a winning team doesn’t work

The moral here is clear: relying on superstars alone to build a winning team doesn’t work, and rewarding people like it does just makes it worse. Everyone needs a compensation plan that doesn’t reward them for greatness, but rewards them as part of a great team. There should be little individual gain that is not backed up by outstanding teamwork.

No, I don’t think socialism (everyone gets paid the same) works. First, people are individuals, and deserve to be treated as such. Pay packages that don’t recognize this are doomed to failure.

And yes, (as I’ll note in another article) I fanatically believe that great performers aren’t just better than average, but as much as 10 times better. So there needs to be some significant commensurate compensation difference as well.

But when companies start abandoning reasonable rules like limiting executive pay to 10 (or 12 or…) times that of the average worker, things are getting out of control. You have to believe that in setting it to 19x at Whole Foods there was someone who had some kind of internal alarm go off that said “no, we can’t set it to 20, that would be laughable”. I mean after all, can you really look anyone straight in the face and say that Jim is worth 20 times what John is?

News Flash: People work for things other than money.

Companies cry “but we can’t get the talent” or “our managers are being poached by other firms”. They fail to understand the basic fundamental rule of compensation that it’s not all about the money. News Flash: People work for things other than money. Like a challenge, or respect, or a great work environment, or a great team, or … fun.

Smart companies need to realize that when the new CEO candidate demands an absurd pay package, perhaps this isn’t the right candidate. No matter what excuses about “what the market will bear” exists, maybe it’s more about what the team will bear. And perhaps the better choice is to go for the best team builder, not the best negotiator.

And today’s WSJ also has a great article with tips for boards on conquering the problem of executive pay. Not coincidentally, they bring up many of the same points.

Apple, Jobs, and Stock Options

Apple Logo
Apple Logo

There has been more than a little noise about executive compensation in general, and stock option backdating in particular. I have been quite vocal about the ridiculous level of CEO pay, it is just silly that people should be getting 9-digit pay — for anything including professional sports. I have witnessed some of the ugliest side of this, with supposedly mature executives arguing to me that, in some way in their mind, their mid-8-digit net worth was inadequate. Little in this realm shocks me any more.

So when the charismatic do-no-wrong CEO of Apple, Steve Jobs, got caught up in the whirlwind of backdated stock options, I was not really surprised. Only just a little disappointed. But in some way, it proves little more than that Steve is, in fact, a mere mortal.

Now, time for a disclaimer. I’m both a huge Apple fan and a shareholder. I’m writing this on a MacBook Pro, am very close to swapping out my Windows desktop for a new MacPro, and have at least eight iPods in the family. I love the simplicity, the way things just seem to work, and the passion for nice design. And the stock has been a winner for us as well. I am as excited as the rest of the planet about the future of the company, especially with the new iPhone in the works. So I am admittedly biased to see the Apple glass more than a little half-full.

To Apple’s credit, they admitted the issue.

Recently it was revealed that Apple issued stock option grants that don’t meet with the standards of scrutiny that should be expected. Specifically, grants were issued with dates that were the most favorable to the grantees, and this news forced the resignation from the board of the CFO at the time of the grants. To Apple’s credit, they admitted the issue, although some complain not quickly enough.

What impressed me the most is that the release disclosed quite frankly that Steve was aware of the issue. Most companies would first deny that anything like this happened, and their CEOs would almost certainly distance themselves from the fallout as quickly as possible. It is refreshing to see at least one company and the CEO admit the issue.

Steve Jobs
Steve Jobs

But to be clear, Steve is no saint in the realm of money. He is famous for his $1 a year compensation, but this belies his huge stock and option stake in Apple that has made him extremely wealthy. Combined with his Pixar (now Disney) stake, Steve is well off with an estimated $4.9b net worth, placing him at number 49 in the Forbes 400 list. In sum, he ceratinly hasn’t been short-changed with respect to compensation.

In Steve’s defense, however, is the fact that he made his money on the stock of his companies. He doesn’t hold the companies hostage for some huge pay package, he simply owns stock, makes the company and stock grow, and both he and the other shareholders benefit. In short: he earned it.

As a CEO compensation critic, this is just fine with me. As a purchaser of technical products, I love the fact that he has advanced the state of the art and am happy to let him get his just reward. And as a stockholder, I’m ecstatic. The stock is up 10-fold in the last three years. And if that works for Steve too, that’s great.

What is Obscene About Goldman’s Compensation?

Goldman Sachs Logo

There has been quite a bit of hubbub lately over the end-of-year bonuses paid by Goldman Sachs. It even provoked an op-ed piece in the venerable New York Times. Totaling some $16.5 billion, and averaging $623,000 per employee, the payouts have set off a firestorm of shock, awe, envy, and more than a few cries of “That’s obscene!” It’s really funny to see how people react when things not only work as intended, but work perhaps too well.

The more serious people question whether the pay was justified, or was prudent for the company. With the average employee getting more than $200 an hour, and some reaching into the tens of thousands an hour, it seems inevitable that there would be sour grapes but the real question should be: is it right?

In a word: yes. It’s fine, and even exemplary. I think there are three key measures by which to judge a compensation system:

  • Is it based on, and does it reinforce, the organization’s goals and objectives?
  • Is it applied according to some reasonable, and preferably transparent, methodology?
  • Is it fiscally prudent for the organization?

That’s it. Forget about providing a living wage, or some sense of social fairness, or even public perceptions of the system. If it meets these three measures, I think it is great. Let’s look at each of these measurements, and reflect on Goldman’s application of them.

Reinforcing goals and objectives

This is number one for a reason: it is by far the most important. I’ve said it here on these pages a hundred times, but the key to success in an organization is defining a clear vision followed by consistent daily application of that vision. There are many ways to apply the vision, but few are more effective than to base compensation on it. I have built compensation systems that are directly based on the company vision, and the results are astounding. [ed: more on this later]

The compensation system should reward those who exceeded those objectives so dramatically.

Does the system at Goldman Sachs meet this test? Well, from a distance it’s hard to tell. But I can say that, from what I know of the company, the goal is to make deals and trades that benefit the buyers, the sellers, and Goldman Sachs. And by all reasonable measures, they hit a home run there. Pre-tax profit (that’s net, not gross) even with these salaries included was over a half-million per head. That’s twice the Wall Street average, and 5 times what we so proudly got when I was at Microsoft.

So, even without knowledge of the specific goals and objectives that Goldman set for itself, it’s clear that from a strictly financial perspective, they scored big. And the compensation system should reward those who exceeded those objectives so dramatically.

Reasonable and transparent methodology

This is the point that catches up so many companies. Many firms have their compensation set extremely top-heavy, with those who control the purse strings, taking the most out of the purse. I like to see a compensation system that is based on some simple, clear, and preferably public, metrics. Typically it’s something like gross sales, or gross profit, or even something like regularly measured customer satisfaction. Whatever it is, it should be simple, directly correlated to things people actual have some influence over, and difficult to “game”.

Those who control the purse strings, taking the most out of the purse.

Another key component of this is that the compensation system should be very broadly based. Not just a perk for those at the top, but dipping deep down into the organization, so that all people who have a part in creating the success can share in it. When I was at Microsoft, virtually all full-time employees were eligible for stock options. That’s the kind of example I’m stressing here.

From what I can see, Goldman’s scheme meets these objectives. There are stories of most employees seeing twice to three times their peers at other firms, and this is in line with their company performance against their competition. Yes there are reports of some secretaries complaining they only got $120k when others saw millions, but that melts when you point out that’s 2x the going rate. So what this all means is that the system is implicitly broad-based and relatively effective.

Fiscally prudent

This is where Goldman has me completely won over. You see, they pay compensation in arrears. They wait until the end of the year, and then, once all the numbers are in, they divvy up the spoils. This has many great effects, a key one being that they never have to worry about paying for performance they might achieve. They know both how well the person has performed, and how much they can afford to reward them. How clean is that?

In addition, they have the benefit of drawing the bonuses not from pending revenue, but from cash on hand. And they’ve had the better part of a year to invest that money wisely, before they have to pay it out. I think every small firm that has had to scrape to make bonus payments would do well to consider a scheme like this.

I think Goldman has it just about right.

So, in summary, I think Goldman has it just about right. They pay people from their profits, they do it in a manner that rewards for definitive past performance, and in line with their corporate objectives. The fact that the company was enormously profitable isn’t something people should resent. Envy, maybe. Emulate, probably.

Gambling on Compensation

Want to make the minimum wage yet still gross almost $100,000 a year? Be a dealer in casino in Las Vegas. Want to make a little more than half that amount? Be their supervisor.

Wynn Las Vegas Resort
Wynn Las Vegas Resort

That’s right, even though the minimum wage in Nevada is just $6.15 an hour, because of tips many dealers make nearly six figures. Their supervisors, the pit bosses, however are salaried and make around $60,000 a year, with no tip sharing. This inequity makes it hard to convince talented people to leave the table and become a supervisor, with all the challenges that position entails.

Recently, Steve Wynn decided to make a change at his Las Vegas Resort. Experiencing trouble getting supervisors for his 580 dealers, he added he pit bosses to the tip pool. This earned him the ire of the dealers, who worried about dilution of the tips and the honesty of the tip counting process which they had long controlled. It was bad enough that, years ago, the tip process had been formalized so that it was taxable income. But it came to a head when a generous winner spread out almost $500,000 in tips in a single flurry. Adding the bosses to the pool diluted the shares by more than 10% and created quite a fuss.

Never make your compensation system dependent on variables that you do not control

This experience points out one of my most important rules: never make your compensation system dependent on variables that you do not control. I have learned this one the hard way, and spent one of the most challenging years of my career trying to fix just such a system.

Microsoft was one of the first tech companies to spread stock options well down into the organization, essentially to all employees. This had the wonderful effect of letting a very broad range of people share in the ride when the stock was on its incessant rise to the stratosphere, and minted numerous millionaires. The excitement at the company in the late 1990s was palpable. There is little doubt that the company benefited by paying low base wages and letting this “free” compensation provide the rest.

But of course, there were downsides. The signs were there, even when the stock was on the rise. People paid constant attention to the stock price. There were people spending their evenings writing desktop stock tickers, and mounting led stock tickers in the hallways. And the pressure to constantly split the stock (which seemed to spur further rises) was enormous. It was all people talked about for weeks at a time approaching a split.

And obviously, the ride was destined to end. The company simply couldn’t double in market capitalization every few months without eventually being the equivalent of the GNP of an entire continent. It just had to stop. Steve Ballmer (Microsoft’s CEO) was well aware of this, and that when it did stop, it was going to be ugly. Without a constantly rising stock price, the entire compensation scheme would collapse.

Our compensation plan was at the mercy of NASDAQ

As VP of HR for the company, I used to say that our compensation plan was at the mercy of NASDAQ. I spent the entire last year of my tenure at Microsoft reconstructing the compensation plan for all 35,000 employees to be less dependent on stock options. And my successors (there have been three) have spent their tenures furthering the effort. Given the exodus of key people over the last several years, their job is not complete.

Back to Las Vegas, you can see that having the casino workers’ pay being largely based on tips is dangerous. Not only do you run into the inequity issues, but the compensation plan is in control of others whose motives may not match those of the organization. Yes, people tip when they are happy customers, but they also only tip when they win (which doesn’t help the organization), or when they are drunk, or simply when they feel like it. And if their economic prospects go down, so do their tips. Is this variability good for the employees?

Wynn swung the pendulum in the wrong direction

Clearly, Mr. Wynn swung the pendulum in the wrong direction. Rather than adding the bosses to the tip plan, he should have crafted a compensation plan for the bosses that derived less from the tips, but on broader organizational objectives. Some ideas may be to base it on measured customer satisfaction, personal job performance, or even profitability at some level. Most likely a simple combination of a few measures would be effective. It’s hard to say without direct input into the process. Perhaps Mr. Wynn is reading and would like me to look into it…

In any case, this is yet another example of why compensation plans must be thought through carefully. As I have said repeatedly, you get what you deserve. If you measure and reward some narrow behaviors, you will get people who respond, and even overreact, to those rewards. Be careful what you wish for, you will undoubtedly get it.