20 is the magic number

With all the talk lately about the exorbitant salaries of CEOs, there was a good news story that hit the airwaves last week. CEO of Japan Air Lines, Haruka Nishimatsu was reported to receive $90,000 annual salary. Yes, that's right, not $9 million, not even $900,000, but $90,000. And there are no bonuses or share options attached. In fact Nishimatsu gets paid less than his pilots – and JAL is one of the worlds top 10 airlines.

What's more, he doesn't receive any executive perks. In fact, he lines up in the staff canteen with his fellow workers for lunch each day and even catches a bus to work.

JAL was going through some very tough times in 2007 when Nishimatsu was appointed CEO. Jobs were cut. People were asked to take early retirement. As he commented "The employees who took early retirement are the same age as me. I thought I should share the pain with them. So I changed my salary." Now that's really "walking the talk".

By comparison, CEOs of large U.S. corporations averaged $10.8 million in total compensation in 2006, more than 364 times the pay of the average U.S. worker, according to the latest survey by United for a Fair Economy.

In 2007, the CEO of a Standard & Poor's 500 company received, on average, $14.2 million in total compensation, according to The Corporate Library, a corporate governance research firm. The median compensation package received was $8.8 million.

For specifics, take Richard Fuld of failed bank Lehman Brothers, who made $37 million in 2007. And Lloyd Blankfein of Goldman Sachs, who got $70 million in 2007.

So what is the appropriate rate of pay for a CEO?

There's been a lot of discussion by governments around the world about taking measures to limit the pay to CEOs and senior executives. This is seen as one measure that might mitigate another financial crisis meltdown in the future. Nothing concrete has happened yet.

No one seems to have come up with the magic formula.

At the heart of the problem, is the (incorrect) management philosophy that you must "pay people to perform". I've written previously about the dangers of this maxim when taken to its extremes. It can even be fatal, as I explained here.

As managers, we know that what gets rewarded gets done. So, when CEOs get rewarded with exorbitant salaries, it's only natural they will focus almost exclusively on short term, bottom line results.

Is there an answer?

It's been reported that Peter Drucker, the doyen of management philosophy and practice, once suggested to his students that "CEO salaries should be a maximum of 20 times the salary of the lowest paid worker".

How would this work in practice?

Any good pay scheme should have four components:

1. Base salary. Needs to be in line with industry standards, appropriate to the role and to be seen as "fair and equitable" both within and external to the organisation.

This should be the major component of the package. For CEOs, it would be limited to 20 times the rate of the lowest paid worker within the organisation.

2. Share of company profits. Needs to be calculated on net profit prior to distribution to shareholders.

This should be the second highest component of the salary package for CEOs and senior executives. Once again, it would be limited to 20 times the share of profit received by the lowest paid worker (Yes, that's right, everyone should share in the profits). Profit share would be approved by shareholders through their reps, the Board.

3. Team performance rewards. Based on a pre-determined set of criteria and relative to the top team's performance.

This should be the third ranked level of salary package component. Limited to 20 times the bonus reward for the lowest paid organisational team performance. Up to a maximum of 20% of average individual profit share (as in point 2).

4. Individual performance reward. Based on the achievement of pre-set goals.

This should be the least component of salary package. Limited to 20% of base salary.

What gets rewarded, gets done. This approach to remuneration, rewards; teamwork, a sense of community, a drive for performance, and above all a sense of "we are in this together" – all stakeholders working for the betterment (and rewards) of the organisation.

Peter Drucker was right. The magic number is 20!