What’s Wrong With Executive Compensation?

Bonus targets are fundamentally flawed. Markets are fraught with “unknown unknowns.” Boards often don’t know now what will need to happen later. And that means goals based on the past or the supposed future reward what we currently think rather than actual performance. When pay is driven by strict adherence to targets set 12 months before, CEOs look back, instead of focusing on the present and on what comes next. Compensation needs to reflect whether the CEO won all the battles but lost the war. But avoiding what might be called the “Dudley Paradox” – a CEO is paid a huge bonus for hitting targets, even as the company suffers major losses – requires boards to stop delegating the entire pay discussion to the compensation committee and waiting for the decisions to arrive, fait accompli, tied up in a bow. The full board should review the company’s operations and strategy thoroughly; only then should the compensation committee set about creating the program to act on it.

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