So long as CEO and executive pay is based on stock compensation and market expectations for a stock's performance and not real performance, shareholders and employees will continue to lose out.

So argued Roger L. Martin, dean of the Rotman School of Management at the University of Toronto and author of Fixing the Game: What Capitalism Can Learn from the NFL.

Martin, who spent 13 years as a director of Monitor Company, a global strategy consulting firm and was recently recognized by the Harvard Business Review as one of the world's top 10 management thinkers, spoke to an exclusive ExecuNet program audience on aligning executive compensation to shareholder interests.

Martin said we now live in a business world in which stock compensation has created an incentive for senior managers and executives to manipulate expectations, cash-in after the stock has enjoyed a nice ride up, and then hedge their bets by selling stock positions when they can no longer meet escalating expectations.

"The only way to stop lower shareholder returns is to severely restrict and alter stock-based compensation," Martin told ExecuNet members. Rather than rewarding business leaders on the expectations market, he added, it would be better for companies to reward them based on the real market.

Basing executive compensation on real performance, Martin explained, would lead boards and their compensation committees to reward real gain in market share, real gain in customer loyalty and real return on net assets or equity.

If a board of directors is romantically attached to the expectations approach to executive compensation, Martin said, they should protect shareholder interests by not allowing stock grants to vest until three years after the executive leaves or retires.

Another way to align shareholder and executive interests would be to give the CEO only one stock grant when he takes over the job, versus the kind of annual grants whose strike prices can be manipulated to reward the executive in the short-term.

Joseph Daniel McCool
Joseph Daniel McCool is senior contributing editor with ExecuNet and principal of management recruiting/succession advisory firm The McCool Group. He is also the author of Deciding Who Leads: How Executive Recruiters Drive, Direct & Disrupt the Global Search for Leadership Talent, recognized widely as "one of the best business books of 2008," and its Brazilian Portuguese translation, Escolhendo Líderes, published in June 2010.

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