By Andrew W. Bischel
It's tough being a director these days. Some criticism heaped on directors is deserved. Shareholders were defrauded at some companies. Even at others where there was no fraud, compensation reached egregious levels; pay at the senior ranks often seemed disconnected from performance.
How should board's reward management in ways that promote the building of shareholder wealth? No matter what one believes about someone's altruistic motives, managers tend to do what they are financially motivated to do. Incentives need to be structured to align motivations with shareholders. So it is in shareholders' interest for the board of directors to get it right. Here are a few suggestions for boards:
c Require each member of the senior management team to own stock, at least five times his or her annual base compensation, not connected to any options program. There's nothing like having skin in the game to align the interest of management with shareholders. Non-qualified options certainly motivate management to get the stock price up for a sufficiently long period to enable them to cash in these options and earn a bonus of their own timing, but it doesn't turn management into shareholders in a way that motivates them to build sustainable wealth in the company.
c View the auditor as a friendly adversary. The review and advice from auditors is critical to helping the board meet its fiduciary duty. For this reason, a board should also decline to engage in contracts with the management consulting side of the auditor's firm.
c Never base cash or restricted stock bonuses for top management on one-year earnings per share. Management has great discretion to defer an expense or accelerate a revenue recognition to meet a threshold for bonuses. Incentive plans need to be set up on the basis of at least rolling three-year results, just long enough so no one is motivated to goose the results of one year at the expense of the next. Also, all non-extraordinary income and expenses should be included in these measures. Management must be held accountable for business growth decisions that turn sour.
c Pay dividends. Though some companies have growth opportunities that exceed their cash flow generation and make payment of a dividend inappropriate, these days the ability to pay and sustain dividends cuts through the questions about the quality of earnings. There is no greater statement that the board and senior management are managing the business at least reasonably well than to pay or raise the dividend as the company's earning power increases, and maintain it during business downturns.
Andrew W. Bischel is president and chief investment officer of SKBA Capital Management LLC, San Francisco.
