With all of the recent news and discussions about CEO pay, the question is in the air: What to do about the egregious abuses of executive compensation? This is the wrong question. As is the case with most issues of human affairs, the essential solutions lie not in "what" answers but in "who."
Let me explain. In a five-year study of what it takes to turn good companies into great ones conducted at my management research laboratory, we'd speculated that executive compensation would play a key role in corporate transformation. Surely, we thought, with the huge pay packages and widespread use of stock options that have become commonplace, buttressed by the conventional wisdom that executive pay should be closely tied to share price as an incentive for managers to perform, there must be a link.
After all, why would boards of directors pay out tens or hundreds of millions of dollars of incentive pay if it doesn't translate into improved corporate performance?
We were dead wrong in our speculations. After 112 separate analyses looking for a strong link between executive compensation and corporate results, we found no pattern whatsoever. How does executive compensation drive the transformation of good firms into great companiesones that create exceptional shareholder value?
Our conclusion: It doesn't. We learned in our research that making a company great has very little to do with how you compensate executives and everything to do with which executives you have to compensate in the first place. If you have the right people, they will do everything in their power to make the company great, no matter how difficult the decisions and largely independent of their stock-option packages.
Consider, for instance, the late George Cain, the chief executive who turned Abbott Laboratories from a mediocre family business into a health-care powerhouse that eventually generated cumulative returns to investors 4.5 times better than the general market, handily outperforming industry superstars Merck and Pfizer.
Cain's first priority as CEO was to destroy the nepotism that had infected the company's ranks. He set forth a simple mantra: If you do not have what it takes to potentially be the best in the industry in your span of responsibility, then you will not hold that seat on this busregardless of your family connections. He rebuilt the entire management team, putting the best people he could find on the bus, and he rebuilt the board of directors with independent thinkers more interested in building a great company than perpetuating a family ATM dividend dispenser.
Now you might be thinking that Cain came into his role as a highly paid, outside change agent motivated by stock options to shake the place up. But you would be wrong. In fact, he was an 18-year insider and a family memberthe son of a previous Abbott CEO.
Cain was a man driven from within by a creative needalmost a neurosisto make the company the best it could possibly be even if that meant incurring the ire of brothers, sisters, aunts, uncles and cousins. He did this not because of what he would "get" for it but simply because it could be done. As one of his colleagues summed up, "George could not stand the company he had inherited. He could not tolerate the way it was being run. He was a very strong person, and he was going to change it!"
The best executives are like Cain: people revolted by the idea of leaving unrealized potential on the table; people driven to create excellence for its own sake; people never satisfied because there is always a higher standard to work toward. If you have the right type of leader, incentive compensation is no more likely to affect whether she will do everything in her power to make the company great than stock options would have changed the dedication Beethoven brought to composing his Ninth Symphony.
Would Lou Gerstner have tried half as hard to rebuild IBM to greatness had he been able to walk away with $50 million rather than $127 million? Would David Glass have led Wal-Mart to, say, only $100 billion rather than $192 billion in the post-Sam era had his pay grown at only half the rate? Would George Cain, Darwin Smith, David Maxwell and all the other good-to-great CEOs we studied have made twice the quality of decisions and brought double the intensity to the job had their compensation potential been doubled?
No, no, no and no! Any CEO whose dedication to building a great company goes up and down depending on the amount and structure of his or her incentive compensation is simply the wrong person for the job.
This is not to say that we should entirely ignore the compensation question. Certainly, many corporate boards have failed in their responsibility to shareholders by granting compensation packages that have huge upside and little downside for even the most mediocre leaders. For the sake of basic fairness, not to mention self-interest as corporations face increasing social outrage that can easily lead to government-imposed constraints, boards must change their compensation practices.
Still, the most important decision a board makes is not how it pays, but whom it pays. If boards of directors would stop lurching after the high-profile, "it's all about me and what I get" style of leader and turn instead to the disciplined, workmanlike leaders who produce true greatness over time, we would see better companies. While we cannot expect the trend in executive compensation to reverse itself any time soon, perhaps we can expect boards to pay that compensation to the types of leaders who actually come closer to earning it, rather than to those who feel entitled simply because they carry the lofty title of CEO.
Jim Collins is the author of Good to Great: Why Some Companies Make the Leap ... And Others Don't. He operates a management research laboratory in Boulder, Colo.