Ed J. Waitzer is the Jarislowsky Dimma Mooney chair and director of the Hennick Centre for Business and Law at Osgoode Hall Law School and Schulich School of Business. He is also senior partner at Stikeman Elliott LLP.
One instalment in The Globe and Mail's recent series on executive compensation focused on the pernicious effects of compensation consultants. The ability of boards to rely upon them to satisfy their statutory duties to act diligently and in the best interest of the corporation often serves to relieve directors of their sense of (and legal) responsibility and contributes to increases in compensation levels.
Having identified these and other "governance experts" as part of the "problem," it would be remiss not to also point to the critical roles that legislation and regulation have played in creating what is becoming an even broader public-policy concern.
In addition to the regulatory safe harbour that corporate law creates by allowing directors to rely on the advice of experts to avoid liability – even though the experts aren't bound by the same statutory duties as directors – there are at least three other regulatory effects at the root of current challenges with executive compensation.
The simplest was deciding to regulate the disclosure of executive compensation. It's difficult to argue against transparency. As conservative social critic Irving Kristol has argued, alienation and distrust are bound to result if the distribution of power, privilege and property "no longer seem in some profound sense expressive of the values that govern the lives of individuals." While compensation disclosure has facilitated such normative judgments, it has also led to a dramatic "ratcheting up" of compensation, as many predicted. No board likes to think that their senior management team is below average. Regulating disclosure or any other conduct also encourages a "compliance" mentality – doing things right, rather than doing the right thing. The risk is that compliance tends to undermine a sense of personal responsibility and inhibit performance.
A less obvious, but more profound problem stems from legislation passed in 1993 by the U.S. Congress that, by limiting the tax deductibility of salaries at more than $1-million (U.S.), encouraged corporations to tie executive pay to performance, a trend that migrated to Canada. This, coupled with the creativity spawned by the cottage industry of compensation "experts," turned the tide on 20 years of disappointment in the use of financial incentives to improve the work of professionals. At a time when a leading scholar described pay-for-performance as "a triumph of hope over experience," regulation elevated a failed experience into boardroom dogma.
What have we learned with the passage of another 20 years? For one, there are now plenty of recent examples that suggest that the extreme pursuit of managerial/shareholder wealth maximization often goes in hand in hand with dubious legal behaviour. It is clear that efforts to link pay to performance have often caused executives to focus on making more money and taking on more risk instead of creating long-term value. Given informational asymmetries, there are a myriad of opportunities to boost one's current income, or preclude its reduction, at the expense of the long-term interests of the corporation and its stakeholders. Of equal concern is that incentives to game short-term performance for personal reward appear to be spreading beyond the corporate realm to the compensation of senior management at our large public pension plans and other institutional investors. Worse yet, policy-makers appear to be encouraging pay for performance in schools, hospitals and other public institutions.
For those of us who have witnessed this process through several generations, it is a classic case of what the late Yogi Berra referred to as "déjà vu all over again." Regulators have encouraged outsized material rewards tied to predetermined objective, short-term, performance metrics. We have gone to great lengths to create, in T.S. Eliot's words, "a system so perfect that no one needs to be good."
But experience and behavioural science suggest the opposite approach is preferable: relatively modest pay adjusted after the fact on the basis of subjective satisfaction with performance, coupled with outsized non-material rewards, such as greater job responsibilities and recognition. These rewards, beyond a certain level of compensation, tend to drive wealth creation and, more generally, pro-social behaviour.
It may be time to consider reverting to the old-fashioned model – one less focused on the ideology of incentives and more rooted in creating sustainable value (and values).