Thu, June 04, 2009
Business > Industries > US auto industry's downfall

The right way to pay the CEO of GM

2009-06-04 03:23:09 GMT2009-06-04 11:23:09 (Beijing Time)  Forbes

With the American auto industry on life support and the public enraged about executive compensation in general, there clearly needs to be a new way to pay the chief executive officer of General Motors. It should not only help taxpayers regain confidence in GM, but shareholders and the executive should benefit, too.

Historically, GM's pay practices have followed typical large corporation behavior, relying heavily on data benchmarked from a peer group of similar firms to provide marketplace norms in both levels and structure of pay. But that pay package strategy is out of touch with today's reality. The company replaced tis old CEO, Rick Wagoner, with a new one, Fritz Henderson, two months ago, but it hasn't changed the way he's paid. In the future, the compensation of the chief executive of GM should be tied to his or her performance and linked to the company's recovery, not just awarded to be competitive.

It should be put together the way private-equity-backed firms do it. That is the best model for creating a true risk-reward proposition. It is elegantly simple, featuring modest base salaries and bonuses, significant upside potential via stock options that promote shareholder value creation, little to no downside protection in the form of severance arrangements, and a required personal investment in the company.

Such a pay structure can be easily understood by investors and taxpayers, and it creates a laser-like focus on significantly increasing enterprise value and guiding the company toward becoming a stable, viable and competitive organization that repays the taxpayer. With this plan, shareholders and taxpayers win, but the CEO and executives also win, and potentially win big. If the CEO doesn't succeed, he or she gets very little, and the taxpayers' loss is minimized.

The proposed pay package is as follows:

Cash Compensation: Limit annual base salary to $500,000, and provide for no annual cash bonus. This hews to both the spirit and the letter of federal bailout legislation that limits salaries and annual bonuses at companies receiving Troubled Asset Relief Program funds.

Equity Compensation: Long-term incentives would be the biggest element in the proposed package, as they would properly reward the CEO without encouraging unnecessary risk. The long-term incentive package would be made up of three separate premium-price stock-option grants. Premium-price stock options are grants with an exercise price higher than the current market price. They're not widely used, but they create an incentive for executives to reward shareholders first, before their own equity awards become meaningful. The premium is typically 10% to 20% above the current market price.

In this crisis situation, the premium price should match a recovery of the enterprise value of General Motors ( GM - news - people ). Looking back four years, that would mean a stock price of about $30, for a market capitalization of about $18.3 billion. Currently, the market cap of General Motors is less than $1 billion. If the CEO could return the company's share price to $30, and thereby increase the market cap to prior levels, you could argue that a turnaround had occurred.

The long-term incentive should be structured into three grants of equal numbers of premium-price shares. The first tranche would get a vesting price of 40% of $30, or $12; the second tranche, a vesting price of 60% of $30, or $18; the third tranche, a vesting price of 80% of $30, or $24. This would handsomely reward the achievement of a turnaround at the cost of a modest dilution of company shares.

Severance and Change-in-Command: In this crisis situation, the CEO should be an employee-at-will. Severance pay should not be available in the case of dismissal for non-performance. It is possible that GM could be acquired by a profitable business down the road. In lieu of traditional change-in-control provisions, the CEO could receive a bonus and accelerated vesting of the stock options, but only if taxpayers were repaid their investment in the company first; if not, then the CEO should not greatly profit from the sale.

Stock Ownership: Along the lines of the private-equity-backed-firm model, the CEO should be required to own outright 2 million shares of GM stock, approximately 0.33% of the shares outstanding. With a current share price of around $1.50, that would mean a personal investment of $3 million. That is skin in the game, strong encouragement to think and act like a shareholder.

This total potential pay arrangement for a new CEO of GM greatly diminishes cash compensation, limits exposure to unnecessary risk and gives the CEO a personal stake in the company's recovery. Instead of following the kind of historical practice and conventional wisdom that produces executive pay the public thinks is out of control, this new model focuses on pay for performance. Incentives are given for restoring GM to its previous financial value--though not, of course, to its failed business model.

This kind of pay package would create a win-win-win situation--for taxpayers, for shareholders and for the executive team.

(Jack Dolmat-Connell, Forbes.com)

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