There is a lot of talk lately about CEO pay, how much they get and how we have elevated them to superstars.  As I posted on my blog, I was recently listening to a speaker on this topic and realized that of course we have a problem with CEO pay, we as a society have set it up to be that way.  And we did it for all the right reasons, or so we thought.

Here is the problem.  By assuming that CEO pay will incentivize appropriate behavior, we are in fact putting the CEO’s focus on his pay.  And once we have done that and say we expect you to maximize your pay then that is what they will do.  And often to disastrous results.

You see the problem is that we assume by aligning the CEO pay with that of shareholders we will get behaviors that maximize shareholder return because the CEO will be maximizing their return in terms of their pay.

The first problem is the underlying assumption about thinking that the way to get the behavior we want is through pay design.  What this has the potential of doing is drive the CEOs attention to his pay.

What’s wrong with this you ask?  Well what is wrong with it is the same thing we see when all an organization does is focus on profit.  We forget that profit is the result of fine tuning the organization to perform at its fullest potential.   It is the metric not the outcome.  When all we care about is the metric then it is often easier to adjust the gauge that is producing the reading than to work on the system that is producing the result.

How does this show up?  Well one easy example is off-balance sheet transactions.  We can adjust the reading of profit without changing anything in the underlying performance of the system.  And we all know what that has led us into over the last 10 years.

Well I would argue that driving the CEO to focus on pay as the indicator of success will produce similar self-interested pay maximizing behaviors that we have seen lead to the crisis we are experiencing.

What we want is to ensure the CEO is actually behaving in accordance with the long term value of the organization.  By understanding that it is A Living Organization™ and the CEO is the custodial of its spirit, will go further to ensuring proper decisions and choices than trying to design a pay package that will “predict” or “force” the right behaviors.

In my next blog I will address some of the other mistaken assumptions in designing Executive Compensation.