Fortune: AmEx gets CEO pay right
With its new incentive plan for Ken Chenault, the card giant has created a better model for executive comp.
Through a rare alignment of the planets, the subject of CEO pay may get extremely hot in a few months. If it does, I'd advise four key groups – CEOs, board members, government officials, and presidential candidates – to study the remarkable grant of stock options that American Express's (AXP, Fortune 500) board recently gave CEO Ken Chenault. Members of all those groups have made stupid pay-related moves in the past, and here's a lesson in how to avoid doing so again: Chenault's new pay package is a model for how to smartly incentivise a CEO.
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What's key is the way the grant is structured. The first surprise is that it's an options grant at all. Options were all the rage in the '90s as the market roared, but lost favor after the bust. They've been replaced in CEOs' hearts by restricted stock, which is worth money even if the stock price goes nowhere. Since options are worth money only if the stock rises, a big grant is notable at a time when the market looks expensive by many measures and the economy is weak.
Even more striking are the extraordinarily high hurdles the board requires Chenault to clear if he's to get any of those options. To receive the full grant, he must beat several goals over the next six years, an unusually distant time horizon. AmEx's earnings per share must grow at least 15% a year on average, revenues must grow at least 10% a year, return on equity must average at least 36% per year, and total return to shareholders must beat the S&P 500 average by at least 2.5% a year. Chenault can receive a fraction of the grant for lesser performance, but below certain limits, which are still quite high, he gets nothing.
Now consider a couple of scenarios. Chenault misses all the targets but the market booms, returning 10% a year, and AmEx stock matches it. After their full term of ten years, his options would be in the money by $258 million – but he wouldn't get any of that. Why? Well, AmEx's stock presumably rode a rising tide, and his shareholders could have done just as well with an index fund while exposed to less risk. Alternatively, the market returns just 6% a year, in line with what many experts predict, but under Chenault's leadership AmEx hits all the targets and the stock returns 9% a year. Chenault collects a pretax gain of $222 million after a decade – an awful lot, but his shareholders are $35 billion richer than if they had chosen an index fund, and he's a hero.
In either scenario, compensation lines up with performance. That's a goal that CEOs and boards should aim for, and that politicians should vow not to hinder as they try to feel voters' pain this spring.
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