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Tie Pay to Performance -- The Innovators

Stocks in this article: BAC AIG F

In light of recent events in which the role of government and executive pay has moved to center stage, the parameters of compensation have taken on a whole new twist. But whether publicly traded, privately held, or government-supported, the basis for compensation in all companies should ultimately rest with performance.

Tying compensation to performance is the most basic form of accountability. It seems such an obvious connection, yet I can't believe how frequently I find that year after year workers who don't meet their objectives continue to get pay raises. If there are no consequences for poor performance, you can't expect improvement. What you can expect is a company full of poor performers.

Accountability at the Top

Looking specifically at executive pay, the expectation for performance should be even greater. In fact, there should be a direct link between executive compensation and the company's stock performance -- a competitive base salary with bonuses and stock options tied to company financial performance exercisable in predetermined tranches instead of at will.

An effective way to link the two is to compare the company's stock performance to the S&P 500, as well as the company's peer group over an appropriate period of time. Maintaining a balance between short-term and long-term compensation is essential in order to promote effective risk-taking. Interestingly enough, in 2001 executive pay linked to stock performance was an issue and one of the biggest concerns was with Bank of America (BAC - Get Report). Perhaps if something had been done internally then, Bank of America would not be standing at the mercy of President Obama's pay czar Kenneth Feinberg as it is today.

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