When we think of governance invariably our mind goes to the negative – stopping, preventing, punishing etc. Rarely do we stop to think of the need for positives such as rewarding good behavior when governing.
It is for this reason that I believe that governance and leadership compensation are inextricably linked. Rewarding good leadership behavior is critical to meeting the primary objective of good governance – creating shareholder value.
However, when does this reward get to be a liability for governance? When it is disproportionate.
How do we know when we have stepped into disproportionate territory? As justice Stewart once commented on the definition of obscenity: “I know it when I see it,” disproportionate is often at display to an impartial person. If the CEO makes 364 times the average worker, I consider it disproportionate. If the CEO gets a bonus while the company’s stock is going down, I consider it disproportionate.
Quite often the board – especially the compensation committee – are happy to give their friend and benefactor the CEO an open check book. Shareholders take notice of this. Employees take notice of this. The immediate direct reports of the CEO take notice of this.