Pay CEOs a lot if they produce better performance than their comparison group. But if they don't, their compensation should reflect that

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By Fred Lazar

I have long taught my students that corporate governance worldwide is a joke. There are no term limits for directors. Their selection reinforces an old boys’ club. CEOs shouldn’t sit on boards (they’re just hired hands). Directors are free to serve on far too many boards for anyone’s good. And of course there are the excesses of executive compensation.

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In their fiduciary duty to shareholders, directors’ main responsibilities are: risk management, selecting the CEO, getting CEO incentives right and monitoring CEO performance, including implementation of the company’s strategy.

To provide guidance on a new CEO’s contract, boards typically retain a compensation consulting firm. It prepares a comparison group of “peer” firms, usually competitors and other firms similar in size, geographic scope and so on. The consultants then recommend offering a new CEO a package — annual base salary, annual bonus scheme and long-term compensation — typical of the top 25 per cent of the peer group, on the grounds that the market for senior talent is very competitive.

One problem with this approach is that a new CEO who proves to be a super-star (though very few do)........

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