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Staying Competitive with Executive Compensation

Richard E. Caruso, Founder and Chairman, Integra LifeSciences Corporation

Executive compensation comes in many forms, including cash, equity, job satisfaction, health benefits, individual identification, and a personal opportunity for growth and experience. However, in our society, when it comes to compensation, the issue most focused upon by the press and the public seems to be the amount of cash and the value of equity given to top executives, especially in those cases that appear outrageous and improper.

What the public sometimes overlooks is that competition for the best executives is severe, and companies within the United States are competing on a worldwide stage for the best talent. As a result, when the contract between an executive and the organization is negotiated, the most sought-after executives hold considerable power and are able to negotiate handsome rewards for themselves even when the companies do not do well financially or when executives are terminated for poor performance.

Three Ways to View Executive Compensation

From a company's perspective, there is certainly more than one way to look at executive compensation.

  • Some view it as simply an expense of operating an enterprise. The reality is an entrepreneur or board of directors that adopts this stance may be viewing executive recruitment in a short-sighted fashion. Growing, successful businesses do not just run themselves. Top executives have influence on the direction an organization takes and the success it experiences as a result. The two go hand in hand.
  • Some consider it as an investment in a human resource asset, similar to the organization's investments in other assets. Much like buying a new piece of equipment, some entrepreneurs or boards view hiring top executives similar to purchasing any other expensive asset. This too can be a mistake because it underestimates the value an executive's influence brings to the organization.
  • The most successful companies view it as a partnership: the company makes an investment in the executive and the executive makes an investment in the company. A good executive joins a company knowing that she has some potentially significant ability to influence both its success and her personal return as a result. She will do much more than just manage an organization; she will be innovative in the development and growth of that company.

Challenges in Creating and Measuring Value

Assume a top executive takes a job in a public company, and in so doing makes an investment in that company and has the important responsibility for creating value for the organization.

While this is the goal, there are challenges with regard to measuring impact on value creation. Sometimes value can be created for an organization regardless of the actions of the top executive. For example, increases in the price of oil and the growth an organization experiences as a result might have little to do with the part the executive plays and more to do with external circumstances.

On the other hand, assume an effective chief executive is leading a company in a declining industry, such as the automobile industry. A great executive may save that company and do a better job than the executive in the oil industry. But how is compensation determined for that terrific executive when stock prices don't increase? These challenges remain difficult to address.

The Trend to Go Private

Because public companies report compensation and results, these details are easily accessible and, therefore, easily criticized. Because of this, as well as Sarbanes-Oxley legislation, many public companies are choosing to go private. There is a great deal of equity being raised in private companies, which can be much more creative in the ways they compensate executives.

Publicly held organizations that take this route often restructure, enhance the value of the company, and then take it public again. Executives who own a large piece of the equity when this happens can avoid criticism when companies go public because the executives are already shareholders.

This causes concern for many public companies that stay public and find it increasingly difficult to attract the best creative and effective leaders. If companies lose the ability to compete for the best talent, they won't be able to enhance their value as well as they would have otherwise. As a result, they are more vulnerable to decline and subject to purchase by private equity groups.

Staying Competitive

For many years, the United States was the center of most innovative economic activity. Now other places around the world, including China, India, Russia, and even Africa, understand the advantage the U.S. had was its entrepreneurial spirit, and they are now developing that for themselves. This is not necessarily a bad thing. Competition can be very good for a company with the proper leadership. But without it, a company will surely fall behind.

The trick for U.S. companies, no matter what their size, is to compete worldwide with the idea that was originally ours-entrepreneurship. They need to find and competitively compensate the best leaders out there, using compensation that aligns an executive's interests with the interests of stockholders. If public companies in the United States lose the best leaders to private American companies as well as companies in other countries, this negatively impacts the U.S.'s ability to attract investment.

But just as important, a company must recruit that executive who feels passionate about the company. Health benefits, job security, and the ability to excel and grow in what they are doing are all critical parts in recruiting and keeping the best leaders. A company that is innovative and entrepreneurial can create the environment and the desire to ensure top executives know that they are a part of making something, not just running it.

© 2007 Ewing Marion Kauffman Foundation. All rights reserved.

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