By Ed McLaughlin with Wyn Lydecker

James B. Stewart recently explored the topic of annual bonuses for chief executives in his “Common Sense” column in The New York Times (“A Bonus Is Declined; A Problem Remains”, February 22, 2014). IBM’s chief executive, Virginia Rometty, and members of her “senior team” recommended to the IBM board that they “forgo their personal annual incentive payments for 2013.” She cited the company’s overall full-year results as the reason. Shortly after, Antony Jenkins, chief of Barclays turned his bonus down, too. 

Although performance bonuses make up only a small portion of a chief executive’s total compensation package, the offer to forgo an incentive payment is a fine symbolic gesture.  Stewart quoted Professor Jeffrey Sonnenfeld of Yale’s School of Management as saying, “It’s a marriage of substance and symbolism, and I find it very refreshing.” Paying bonuses to the chief executives of underperforming companies – and having them accept the bonuses – does not go down well with shareholders or the public. As Stewart pointed out, bank executives in America have been receiving large compensation increases, despite scandals. And the difference between chief executive pay and that of average employees in most companies is a hot topic in the media as the pay gap continues to widen. As Stewart wrote, “Executive compensation is going through the roof.”

As he got into his article, he raised a bigger issue: Why do chief executives have such lavish bonuses even offered to them when their companies are underperforming? The answers lie in the formulas, which use and weigh metrics like revenue growth, cash flow and operating income, but leave out stock price. IBM’s stock price has fallen over 8% percent over the past year.

Rewarding chief executives with bonuses during times of company underperformance is not the only problem. I take issue with corporate boards who lavish their chief executives with pay raises after those at the top have cut the corporate workforce. In 2013 Cisco’s chief, John Chambers, had an 80% increase in compensation just a few months after the company cut 4,000 jobs. CBS  News Money Watch ran a piece (“Mass Layoffs Plump CEO Pockets,” September 1, 2010) about a study which showed that “CEOs at 50 companies — “layoff leaders” in the study — that laid off the most employees took home an average pay of almost $12 million in 2009, 42 percent more than the average CEO pay.”

I believe that when companies are underperforming, the people at the top should be the ones who sacrifice the most. Rather than reduce the workforce, everyone in the company should take a cut in compensation.

I learned this approach from two great entrepreneurs, Bill Hewlett and David Packard. In two of the seven years when I worked at HP, I had to live with a 10% reduction in my pay. The pay cut affected everyone in the company, but it kept the workforce in place, avoiding costly outplacement and rehiring once things turned around.

When I was running my own company, USI Companies Inc., we organized compensation around profit. Senior executives and managers received bonuses based upon the profitability of their areas of responsibility.  We pushed the profit centers down to as low a level as possible. Everyone was motivated by profit.

When the economy hit a downturn and USI’s profit growth leveled off, we spent significant time thinking about whether we would cut staff or cut pay. I told our senior management team about my experience at HP and suggested we follow the same formula. We agreed that we needed to share the pain across all levels in the company and keep everyone on board. It felt it was wrong to let a portion of our employees go. We also reasoned that by preserving our staff we would be ready for recovery.

In our plan, each person making $100,000 or more would experience a 10% reduction in compensation. Every employee making under $100,000 would face a 5% reduction. We believed that the higher-paid executives could better withstand a 10% cut than the lower-paid staff.

We called a meeting and told everyone the news. It went down well, especially since the people at the top took the bigger hit. We built morale. With shared pain, everyone felt they were contributing to the general welfare of the business. When the turnaround came, compensations returned to normal and grew commensurately with profits.

Ed McLaughlin is currently co-writing the book “The Purpose Is Profit: Secrets of a Successful Entrepreneur from Startup to Exit” with Wyn Lydecker and Paul McLaughlin.


Copyright © 2014 by Ed McLaughlin   All rights reserved.