Wednesday, April 9, 2014

Conscious Compensation at Conscious Capitalism 2014

At the Conscious Capitalism 2013 conference there was little discussion about compensation.  There were a few specific examples - complete pay transparency and executive pay caps at Whole Foods Markets, for example - but no unified concept of how companies' pay practices support, or don't support, the principles of Conscious Capitalism.

Over the past year I've worked to develop and define Conscious Compensation® and have continuing discussions with clients, prospects, and our portfolio companies at Fledge LLC, the conscious company incubator, and with other Impact HUB members in Seattle about the concept.

You can read capsule descriptions of the twelve introductory principles of Conscious Compensation® at

If you're here at the Conscious Capitalism 2014 Conference this week, I hope to engage with you and talk about these ideas.  If not, contact me and tell me about how your company is exploring its compensation and benefits program design as a strategy for Conscious Capitalism.

Monday, June 17, 2013

Below the Radar - How Conscious Compensation Looks in Real Life

Fred Whittlesey
Compensation Venture Group, Inc.
Certified B Corporation

Conscious Compensation® ideas appeal to many, offend others, and are scoffed at by some. The most difficult part of the conversation is the pragmatic aspect:  Even if you agree with the principles put forth by the various organizations advocating the principles underlying Conscious Compensation®, the typical opposition is that it is idealistic and unworkable.  

In a global economy based on capitalism, and in the country known for being a primary source of that philosophy, who on earth (literally) is going to change their compensation system away from a short-term profit-based model?  More importantly, where is there any data that shows this is more than just a socialistic feel-good movement? Who cares if John Mackey or Sir Richard Branson is on a soapbox about this?

Well, here's some data.  I was made aware of this from an interesting opinion piece in the Puget Sound Business Journal (subscription required but everyone knows how to find subscription content free online).

In March 2013, Puget Sound Sage issued a report titled "Below the Radar: How Sea‑Tac Airport’s substandard working conditions hurt our region and how other major airports changed
course toward growth and prosperity."  

For those with internet-length attention spans, here's the video.  Actually, it's an 18-minute video, so it's faster to read the summary in the pdf, which points out that four west coast airports that I know so well (LAX, SFO, SJC, and OAK) have implemented changes in employee compensation and benefits practices (living wage, benefits, paid time off) in order to "reduce poverty, strengthen safety and security, improve public health and minimize the public cost of their low-wage workforces."  Missing from the list?  SEA, my home airport and home of my beloved provider of air transport, Alaska Airlines.

Yes, I know, it still sounds lefty pro-employee anti-employer.  But read on.

As a good capitalist, I know that sustainable compensation programs will be accepted by for-profit employers only if it can be shown that these practices actually increase profit. (My next blog will discuss a company that pays double the market pay rate and ends up saving 1/3 in costs.)

Maybe data like this would encourage a profit-oriented company full of profit-based executive incentives and stock-price based programs to consider some new ideas:  A UC Berkeley study assessed the results of SFO's changes and found:

  • Employee turnover reduced by 60% (lowering costs and improving airport security)
  • Decreases in grievances (45%), employee disciplinary issues (44%), and absenteeism (29%) - all of which affect profit
  • Total cost reduced by 11%
The Sage report, of course, is a call for SEA to implement similar changes.  But if we could have lower costs, better security, happier airport employees, and safer airport operations - and provide better pay and benefits to employees - then everybody wins. That's more than a triple bottom line. More like quintuple.

Even notorious low-cost Southwest Airline's CEO publicly-supported SJC's living wage ordinance writing "Southwest Airlines fully supports the objectives and purpose of the Living Wage Policy.”  

Southwest was prominently featured at the recent Conscious Capitalism conference in San Francisco.  I attended by flying AK from SEA to OAK because my airline loyalty shifted after Herb was no longer in charge at SWA, but I may have to rethink my choice of airlines in light of this new information.

That's B Corp thinking.

Monday, May 13, 2013

What's Wrong with the "S" in "TSR"

Fred Whittlesey
Compensation Venture Group, Inc.

We are caught in a zeitgeist that promotes Total Shareholder Return – the increase in a company’s stock price plus dividend payments over a defined period of time – as the most important, and perhaps only important, measure of a company’s success.  This, in turn, is applied by external observers of and advisers on assessments of executive compensation and corporate governance as the ultimate measure of a CEO’s performance. This is where the problems begin.

On June 21, I will have the privilege of participating on a panel presentation at the NASPP Silicon Valley Chapter All-Day Conference with James Clark of Yahoo! and Madori Playford of Equinix.  Our topic is “Revisiting TSR – Solutions and Problems.” We will discuss a number of strategic and tactical issues with Total Shareholder Return as a performance measure in executive and employee compensation plans. It will be a highly technical session, as there are plenty of problems cropping up from the "solution" offered by TSR. 

In our panel discussion, for example, we will discuss that  Institutional Shareholder Services views TSR over fixed 1-year, 3-year, and 5-year periods, believing that his is how shareholders view their return on investment.  I’ll note the absurdity of this given that the average period of ownership by shareholders has shrunk from over three years to less than three months, and 70% of trading volume in US equity markets results from “high frequency trading” – firms holding shares from periods ranging from a few minutes to fractions of a second.  In these markets, CEO's and other executives have very little impact on TSR over any period of time. Stock price manipulation by traders and mutual funds is rampant. Some analysts have noted that 75% of stock price movement is driven by broad macroeconomic factors and industry-specific factors.

Moreover,  the focus on short-term results (yes, 3 to 5 years is short-term when life expectancies are 80+ years, and combined with our children’s life expectancies are probably approaching 200 years) is a recipe for disaster.  We have seen those disasters repeatedly over the past fifteen years.  But we repeat the behavior over and over.  The dot-com bust, Enron, global financial crisis, London whale, LIBOR – the latter few occurring since TSR became a prevalent measure and was supposed to "fix" this.

More important than these technical issues, however, is a point of view that has not yet been discussed in equity compensation circles, but is rapidly emerging in broader corporate governance conversations:  The need to consider all stakeholders, not just shareholders, in corporate governance and performance measurement.

So here’s what’s really wrong with the “S” in “TSR”:
  • To dispel the first argument we typically hear, the notion that Boards of Directors are legally bound to put the interests of shareholders above all others is false.  While legislation is being passed in many states to allow the formation of Social Purpose Corporations, current corporate law does not prohibit Boards from suboptimizing the interests of shareholders to balance the interests of other stakeholders.  Don’t take my word for it, read a compelling and clear legal analysis by Lynn Stout, in The Shareholder Value Myth (summary here).
  • The multi-stakeholder model, and the premise of Conscious Compensation©, highlights that maximizing the outcome for one stakeholder group – shareholders, in the case of TSR – at the expense of other stakeholder groups – debt holders, employees, customers, suppliers, the environment, and the community – is a poor way to do business and not in the interest of shareholders.  This theme permeates the concept of Conscious CapitalismResearch shows that conscious companies outperform the S&P 500 index by a factor of 10x...over a 15-year period.
  • Europe and the UK – which are far ahead of the US in progressive corporate governance practices – were early adopters of TSR as a basis for executive pay, early realizers of its flaws, and early innovators of a broader view of corporate performance.  This broader view has many labels – ESG, triple bottom line, CSR, B Corporations, Shared Value Capitalism.  The world has shifted its view of who “owns” a corporation and its outcomes, and it is not just shareholders. The US is behind on this.
  • ISS, the purveyor of TSR obsession, gives lip service in its 2013 Proxy Voting Policy about linking ESG – Environmental, Social and Governance measures – to executive compensation, stating they will “Vote CASE-BY-CASE on proposals to link, or report on linking, executive compensation to sustainability (environmental and social) criteria.”  Yet the same policy document has twelve pages of detail on how ISS intends to vote on thirty-one “social/environmental issues” including sustainability reporting, recycling, and animal testing.  Yet another example of ISS’s extreme inconsistency in its views, but perhaps a harbinger of their future view of compensation, because...
  • Gary Retelny, President of ISS, said at the ESG Risks and Financial Implications Roundtable in April 2013 "ESG issues and their financial impact on investing are very important timely topics that continue to grow in importance around the world for our clients.  They are on a par (sic) with corporate governance..."
Conscious Compensation© references the work of thought leaders including R. Edward Freeman on multi-stakeholder models of business.  It is directly tied to the framework of Conscious Capitalism. It is being introduced to our portfolio companies at Fledge, the conscious company incubator, as well as a number of clients of Compensation Venture Group with social impact missions and sustainability strategies. And it is wholly incompatible with a focus on short-term Total Shareholder Return and equally destructive measures like EPS.

Stay tuned and watch the “S” in TSR turn from "Shareholder" to "Stakeholder" and turn performance measurement in compensation upside down as Conscious Capitalism turns the business world upside down.  And don't worry, actuaries and valuation consultants - accountants will need to accrue for incentive plans that reward stakeholder value, too.

Saturday, April 13, 2013

Whatever Happened to the CEO Pay Ratio?
Fred Whittlesey
Compensation Venture Group

I just returned from the Conscious Capitalism 2013 Conference. There was scant discussion of compensation other than occasional references to the CEO pay ratio. Then I spent a few hours catching up on email and links to the endless stream of online commentary on compensation and there it was. The CEO Pay Ratio.

It’s amusing to me that almost 3 years after the passage of Dodd-Frank Act which requires the disclosure of the CEO Pay Ratio – the ratio of a company’s CEO pay to the median pay of that company’s employees - some commentators (I resisted the temptation to link) are just now writing about all of the complex technical implementation difficulties with the CEO Pay Ratio disclosure requirement. I addressed that in a WorldatWork Journal article in July 2010 and there’s been ample coverage since. It’s a tired issue, covered extensively and now repetitively.

The definitional and implementation complexities are indeed overwhelming and over-debated, no doubt the reason for the SEC’s continued avoidance of the issue. (The SEC seems to have decided in response that the best way to avoid missing deadlines, which they have repeatedly done with respect to Dodd-Frank requirements, is to stop setting deadlines, which they have done. As many of us know, a project without a deadline is a project that may never be completed.)

But while the SEC has not acted, it has not stopped their discussing it. In February of this year, SEC Commissioner Aguilar in a speech touched on this issue, identifying it as a risk management and disclosure issue: 

“...risks relating to compensation go beyond the immediate incentives of a particular compensation plan or policy. The relative pay of different classes of employees, such as the ratio between CEO compensation and median pay, can also create risks to an enterprise, including the risk of employee, customer, and shareholder discontent.”

But the populist anti-pay movement is extending beyond the C-suite. On April 1, 2013 (why does any organization issue any significant information on that day?) the IRS issued proposed regulations for Section 162(m)(6). Section 162(m) is the “million dollar cap” (cap that is not-a-cap) on CEO pay. Subsection 6 now imposes a new “cap” of $500,000 on ALL employees of certain health insurance providers. It’s an extremely complex rule but an extremely simple concept – legislators and regulators worldwide are looking for opportunities to impose constraints on highly-paid people. So far, we have on the list CEOs, bankers, and healthcare insurance employees. More to come, to be sure.

In the US, we’re focused on Dodd-Frank and the SEC, but the movement is global. In Switzerland, citizens voted for additional limits on executive pay, beyond the recent approval of strict say-on-pay rules. As Broc Romanek noted, in his blog, “The Young Socialists, the youth wing of the left-leaning Social Democratic Party of Switzerland, have collected more than 100,000 signatures--the threshold needed to call a vote--in support of a referendum to limit executive salaries to 12 times those of a company's lowest-paid employee. The campaign, dubbed the 1:12 Initiative for Fair Pay, is named for the organizers' belief that no one in a company should earn more in one month than the lowest-paid employee makes in a year. “

In the meantime, those in the US more concerned with the concept than the regulatory details have forged ahead, much as other organizations and companies have done with the Pay for Performance requirement which the SEC has similarly failed to determine. For example:

· Whole Foods Markets states in their 2013 proxy discusses their salary cap by saying “we have placed a cap on executive and other leadership members’ salaries and equity grants…in an attempt to balance our competing objectives of fairness to all stakeholders.” They publish a table showing that the cap is a multiple of 19 times the average annual wage since 2008.

· DuPont in their 2013 proxy discloses the concept of a “pay equity multiple” comparing CEO pay that of other executives which is roughly 3x.

Interestingly, there are several large companies that in the past disclosed positions described as “internal pay equity” which no longer do so. It is a difficult concept to manage.

Outside the US, a longer-term example of the concept exists in Mondragon Corporation in Spain which determines pay ratios between executives and other workers that range from 3x to 9x, averaging 5x. Mondragon has been in business for over 55 years, and has more than 80,000 employees working for more than 250 companies.

Paraphrasing Arlo Guthrie in Alice’s Restaurant, if one person does it they’ll think he’s really sick; if two people do it in harmony, they’ll think they’re (censored) and they won’t take them; if three people do it they may think it’s an organization; and if fifty people a day do it, they may think it’s a movement. The CEO Pay Ratio is a movement, and one to watch. With or without the SEC.

The problem with most of these ratios, though, is that they only capture base salary or granted pay; the real story is in realized pay. Next week I will be quoted in another article in the Boston Globe citing CVG’s research that a CEO was granted approximately $5 million in pay in 2012, but actually realized over $16 million that year. The big story is that he has accumulated an estimated future $83 million over his tenure at this company including 3 different pension plans, a deferred compensation plan, and the outstanding equity awards still unvested or unexercised.

Some would say that pay levels like this are not “fair”. I always tell clients (and the media) that I never use the “F word” when discussing compensation because I don’t know what “fair” is.

What I do know is that if suppliers are being pressured to lower prices, customers are paying higher prices, employees’ pay is stagnant relative to inflation, employee ownership plans have been axed because of institutional shareholders’ and proxy advisers’ arbitrary policies, and the impact on society and community is of concern in a company that provides tens of millions of dollars of compensation to a CEO running an auto-pilot business…in a capitalistic free-market society the collective stakeholder groups - suppliers, customers, employees, the community - will change things.

That society can wait for a misguided Congress to legislate irrational laws that securities regulators balk to implement, or the society can wait for its youth to trigger still more legislation. Or that society can awaken to some conscious, rational approaches to paying executives, board members, and employees that rebalance the current stakeholder hierarchy where shareholders rule at the expense of all other stakeholders. We have collectively allowed the latter to occur and now have the opportunity for the former.

Conscious Compensation ® raises these questions and proposes solutions to supportConscious Capitalism © and the progress of global society. The CEO Pay Ratio dialogue is the door to making progress on this. Don’t be fooled by the consultants, like me, who in the course of our professional roles debate the mechanics of such a concept. Just like granted pay, realized pay and accumulated pay, the regulated Pay Ratio requirement may make be complicated and make no sense, but the concept is not an Arlo Guthrie organization, it is an Arlo Guthrie movement. 

Tuesday, January 15, 2013

Time Warp: Old Solutions for Old Problems

Fred Whittlesey
Compensation Venture Group, Inc.
Conscious Compensation®

With the new year upon us and "proxy season" on its way, we can expect to hear some familiar refrains about executive pay. Maybe something like this:

"...corporate profits rose 108 percent, and CEO pay rose 481 percent, but the average worker's pay rose just 28 percent (during the 8-year period), barely more than inflation..."

"...pushing the average large company CEO pay to 419 times more than the average manufacturing worker..."

" is inappropriate to compensate senior executives for improvement in company performance that are attributable to factors beyond their control."

Are these quotes imagined media coverage from Spring 2013?  Or a rehash of 2012 media coverage of executive pay?   Nope.

These are from an article on Social Funds - "the largest personal finance site devoted to socially responsible investing" - dated March 14, 2000. I was interviewed for that article and quoted several times.  Yes, I was promoting Conscious Compensation® ideas long before any of us had heard of Conscious Capitalism and were still under the rubric of "social responsibility."

In the article I extol the virtues of indexed stock options as a solution to the perceived, and in some cases actual, excessive pay delivered from ordinary stock options (see my Effective Equity blog for more technical treatments of topics like this).  It was a good solution then, as it would be now, except...

"...current accounting rules in the U.S., which are continuing to diverge from economic reality, reinforce the aversion to their use" said Whittlesey.

The accounting rules in place for equity-based compensation in 2000 discouraged the use of indexed stock options.  Subsequent changes in accounting rules in 2005 continue to provide such discouragement (FAS123R, now ASC Topic 718).  Changes to the tax rules (Section 409A) put another nail in the coffin of indexed stock options.

A key theme in my work in Conscious Compensation® is the continuing tyranny of the accounting and tax community - legislators, regulators, and practitioners - forcing companies to adopt compensation practices that optimize reported (accounting) and actual (taxation) financial outcomes and drive pay design in the opposite direction of conscious values and principles.

Fiscal years, tax years, quarterly earnings results, profit-based annual incentive programs, imaginary noncash expenses that bear no relationship to compensation actually paid - all of these concepts must be revisited by a company devoted to the idea of Conscious Capitalism and supporting that strategy through providing Conscious Compensation® to all employees, including executives.

As this old article shows, it's not a new problem and it doesn't require new solutions but does require a very different perspective regarding which stakeholders matter.  Not just shareholders, stakeholders - including all employees, including executives.  Those accounting and tax professionals are stakeholders, too.  We call them "suppliers" and every conscious company needs "collaborative, innovative suppliers." Even their compensation consultants.

Tuesday, December 4, 2012

Auto Parts

As a compensation consultant, I work with three auto parts manufacturing companies.

The first, Company A, is a traditional company and has been in business for many years.  They market to all of the auto manufacturers, plus aftermarket suppliers.  Being a disciplined business, they seek the lowest prices for raw materials, labor, and capital that allows them to make parts within their defined range of quality and price point. They obey the law in their conduct of business.  They have published a Code of Conduct and Statement of Corporate Ethics on their website. The company has never had a major corporate scandal, major lawsuit, or any criminal investigation.  They're a good company. Their executives are good guys (yes, they are all guys).  They sell parts to the big three - GM, Ford, Chrysler - and have some business with smaller companies including some of the "green" firms like Tesla.  Like any company, their shareholders expect management and the Board of Directors to make decisions that maximize profit and shareholder value.  Their executive compensation plans reflect those priorities, with their long-term incentives comprised of stock options and performance-based equity based on TSR (total shareholder return).  Very mainstream design.

Company A knows that they also have to do some "politically correct" stuff to keep down the noise level with investors, customers and the community.  They in fact are quite generous in their financial donations to various charities and community organizations.  They are a sponsor of the annual community 10-K run which is a fundraiser for breast cancer research.  The CEO of the company even wore a pink ribbon on his  blazer this year at the event. The cost of these expenditures are classified as "marketing" expenses in their budget because it is good advertising to be associated with these causes.

Company B is much more progressive than Company A.  Company B is fully committed to the concept of sustainability and has built the concept into business operations.  They have realized that the reduce/reuse/recycle methods actually do improve short-term profitability.  They have suggested to suppliers and customers that this is an effective approach, but haven't put themselves out there, stood on the soapbox, preached the ethic.  They just make more money by their reduce/reuse/recycle theme, employees like it, and they promote it on their website. They consider these factors in many of their business decisions.

Company B created the position of Director of Sustainability who is responsible for ensuring that the company is continually exploring ways to reduce/reuse/recycle and use environmentally-friendly products.  The company has considered escalating this role to a Chief Sustainability Officer and has discussed the concept of a "triple bottom line."  This company also encourages employees to donate time to community efforts and provides five hours per year of paid community service time for each employee.

Company C is a conscious company.  They believe that optimizing for all stakeholders is more than being "politically correct" or "sustainable" but a value-maximizing business strategy.  They commit a percentage of their revenue to charitable giving, of course.  Reduce/reuse/recycle is embedded in their daily life at the company and no one ever mentions it unless you're a new employee and don't understand the difference between the recycling bin and the compost bin.

But Company C does business differently.  They select suppliers based on the conscious value system.  They will turn down customer relationships.  They will hire and not hire employees based on the value system.

It goes further.  They believe in employee ownership but don't grant stock options like many start-ups because they aren't seeking short-sighted venture capital funding and don't believe in an "exit" strategy.  They don't want sales reps selling to customers that do not have consistent value systems, even if the sales rep, and the company, could make a lot of money from that customer.  They passed on a low-cost supplier because they believe they'll make more money on the back end with the higher-cost supplier and that supplier's ways of doing business.  They pay employees to stay home when they're ill because they know that ill employees in the workplace spread illness to other employees, customers, and suppliers - reducing value for the entire value chain, and affecting the quality of home life as the kids catch the bug.  Contrary to the "paid time off" trend, they provide "sick days" and "vacation days" because the Company believes both are important.

This is difficult.  The lowest-cost supplier that has the ideal mix of product but does not meet their profile, so they pay more for materials from another supplier.  Their sales reps are not allowed to approach certain companies and those companies they are denied would in fact produce the highest sales commissions.  They often turn down candidates in the hiring process when those candidates are the absolute best in skills, experience, and fit with the position, which is difficult for hiring managers and peer employees. Some employees abuse the sick pay system, with more"sick" absences on Fridays and Mondays, and a rush of "sickness" during December, just before those sick days expire.

Why do they engage in these business practices?  Because it produces the best long-term outcomes (and even short-term outcomes in many cases) for all stakeholders - shareholders, suppliers, customers, employees, the community, charities.  Company C has learned that they can actually make more money by having a longer-term view with all stakeholders in mind.

Sounds touchy-feeley?  Sounds politically correct?  Sounds left-wing?  Not at all.  It's hardcore capitalism, with sensibility.  And it's huge.  Stay tuned to this blog for more detail on what this is, what it means, and how to do it when it comes down to the most difficult business issue of all:
Employee Compensation.

(By the way, I don't really work with three auto parts manufacturing companies, but you knew that because I'm a West Coast guy and we don't have much of that here.  I actually don't even know any auto parts manufacturing companies.  I do know where one auto parts store is nearby, which is what caused me to think of this as a parable for Conscious Compensation,  as I stood in the aisle looking for a tail light bulb and discovered that there are ordinary bulbs, and "green" bulbs (not green-colored bulbs).  Aha, the light bulb came on.)