Money Matters: Executive Compensation — How much is too much?

Executive compensation has become a hot topic for consumers and employees as we all grapple with the ways the recession has affected our wallets and our companies. There has been a public outcry in reaction to executives receiving high dollars as their companies are doing so poorly, and CFOs of all industries are trying to anticipate how the backlash of current legislation battles surrounding the TARP program will affect their non-related industries. As Jeffrey Burchill, senior vice president and CFO of FM Global, puts it in the June 2009 issue of CFO Magazine, “The sad thing about AIG and the TARP regulations on executive pay is that successful, careful companies will be painted with the same broad brush.” 

While Vail Resorts CEO Rob Katz has publicly announced that he has cut his pay to zero dollars for 2009, retail compensation in the sporting goods sector increased 12 percent from 2007 to 2008, so it seems that a discussion concerning executive compensation in sports-related industries is warranted.

Whether legislation-controlling executive pay levels passes or not, and assuming you are in compliance with the laws and making professional cash-management decisions, the real question to be asked here is, how much pay is too much? Is it a matter of ethics or compliance that should dictate how much someone can or should make?

While some may be laughing at the issue knowing you are taking home a relatively miniscule amount of executive pay as you struggle to make ends meet, this is a question that deserves serious discussion. Whether or not you own a company facing these executive compensation questions, you are likely dealing with them in some fashion. My experience consulting with companies in and out of the outdoor industry both pre- and post-bankruptcy provides a viewpoint from which to offer the following caveats to public and private companies of all sizes:

Could you scale down if you had to? People need to play, and I’m the last person who would ever fault a love for recess. However, I’ve observed that high compensation encourages lifestyles and households that cannot always be scaled back very easily. If your company’s market share is suddenly whacked 30 percent by macroeconomic factors, then your salary could easily become the biggest overhead burden on the books, thus a glaring reason the company cannot be profitable. You may be willing to cut your salary back in relation to the company’s lower performance, but can you and how quickly? Your personality may not have changed from the previous year, but if you’re in a situation where you are letting people go and your high salary remains unchanged, it can damage your relationship with your bank, employees and stockholders. You could become the “bad guy” all of a sudden. You might analyze how much of a sales decline your company could experience and still afford your salary, as is. If the answer is “not much,” consider how flexible your lifestyle is to scaling back so that you can take a salary that doesn’t overburden your company.

Give credence to employee morale. It can be a bit much for owners who have poured blood and sweat into building their businesses for years to swallow the fact that they should care what an hourly employee thinks about the owner’s vacation time or new car. However, I’ve observed many times in organizations that it takes only one disgruntled employee to begin a gangrenous spread of negativity. That type of disruption is not just an interpersonal problem; it’s a business problem. Verde Consulting offers advice on managing internal communications during a recession in Kristin Carpenter-Ogden’s Power Players’ Lounge article, “Open Internal Stakeholder Communications are Essential,” in the June 26 issue of SNEWS®.

Who cares? — Your customers and biz partners might. Under the shadows of prolific bankruptcies this year and tight credit markets, all sides of the sports-related industry distribution channel will likely increase due diligence on a company’s financial health when it comes to large orders, and I’ve already seen that happening. In addition, consumers and business partners might begin to connect the dots between executive compensation and the bottom line and weigh that information into its purchasing decisions. Consumers barely have to research when newspapers like the Boulder Camera are publishing articles, such as this one on June 22, 2009: “Boulder-area CEOs’ Compensation In-depth.”

Pre- and post-bankruptcy considerations. With 20/20 hindsight, the time to scrutinize finance decisions in anticipation of a bankruptcy proceeding would be four years prior to it. Four years is the “lookback” period the debtor has to testify to regarding certain financial transactions. The three big areas of claims, according to bankruptcy attorney Eric Johnson, of the international law firm of Holme, Roberts and Owen, are: breach of fiduciary duty, preferences and fraudulent transfers. A salary that is excessive or not approved properly in a Chapter 11 (reorganization) could be viewed as a breach of duty toward the creditors on grounds of waste or self-dealing. If there is an increase in compensation while the debtor is spiraling down and might be insolvent, that marginal increase could be challenged as a fraudulent transfer. Problem is, there are no firm and fast rules regarding what is excessive, and many companies do not identify their moment of insolvency, which can be long before a potential bankruptcy. In a bankruptcy proceeding, excessive executive compensation is up to interpretation, but could be challenged by representatives for the creditors, a bankruptcy trustee, stockholders, and possibly others. In Eric Johnson’s opinion, “One of the best things that a debtor’s management can do to engender creditors’ trust is to ‘take one for the team’ and share their pain by significantly reducing compensation during a period of financial distress.”

Handle executive compensation contracts professionally. In my experience in the outdoor industry, and as a CFO in a salesforce-driven company, if you have taken the time to truly incentivize your key employees with a compensation and bonus structure, then they will take the time to care very deeply about the nuances. It’s generally much less expensive to have a contract professionally prepared than it is to fight a claim. Sales commission structures in the consumer goods industries might have you obligated to pay commissions, even when the company may be losing money. My favorite compensation structures reduce the likelihood of this happening, but most plans I’ve seen don’t mitigate this risk very well. Large bonuses and commission payments are more subject to scrutiny in a company that is on a downward trend. However, the scrutiny may not be anticipated at the time you’re making the payments. I recommend even smaller companies having the contract approved by your company’s CPA and attorney.

The issue of how much executive compensation is appropriate is not an easy one. There are many options for structuring executive compensation packages. If attracting top brass is your goal, you need to be competitive enough to do so. Justifying salaries by using market comparisons can certainly be a guideline. On the other hand, taking a salary that is “below market” to force profitability doesn’t necessarily make your company profitable from an investor or acquirer valuation perspective. When dealing in these grey areas that may prioritize preserving reputation over whether or not the amount of compensation is technically lawful, I believe informed common sense should always weigh heavily into final decisions.

Kira Riedel, whose sporty passions find outlet on the rock, snow and ice of Colorado, is bringing over 15 years of venture capital, investment banking and CFO experience to sports-related companies on a fee for service basis, through her boutique practice, CFO Services www.cfoservicesnow.com. CFO Services provides corporate finance and private equity services supporting business planning, buy/sell/merge representation, recapitalizations, pitchbooks, fundraising, systems consulting, staff training, turnaround services, insolvency issues, and other specialty accounting and finance projects.