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...conducted two decades, shows that this performance-driven approach to executive pay has played a major role in the success of the U.S. corporate model, which has generated enormous wealth for shareholders, millions of jobs, and exceptional economic growth.
Despite empirical support for the effectiveness of the pay-for-performance model, some shareholders and executive pay critics remain skeptical. They pose several arguments, but one of the most strident, popular, and seemingly persuasive is that companies still pay too much for executive "failure."
Two examples of "pay for failure" are commonly cited and used to undercut the efficacy of the model itself. The first involves the substantial severance and accelerated stock incentive value that some executives receive at termination, even when the company performed poorly. We agree that these incidents of "pay for failure" must be addressed very carefully by boards and management.
In fact, many companies are now revisiting their severance plans, spurred on in part by the new SEC disclosure rules, and changes are already occurring. For example, some companies are reducing cash severance payments and eliminating change-in-control-related excise tax gross-ups.
The second example of "pay for failure" cited by the critics focuses on large cash and stock payments made to active executives when the stock price performance is mediocre. This example, which might be called "pay for disappointment," usually unfolds in one of two scenarios. In the first, a company experiences both poor operating/financial performance and poor stock price performance. In the second, the company experiences strong operating/financial performance, but that performance has not yet generated strong stock price performance. This second scenario is the "hard spot" in setting executive pay.
Understanding the challenge
To evaluate the efficacy of the pay-for-performance model and understand the challenges that compensation committees face, we must make a clear distinction between pay...
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