Plum Crazy

I believe it is high time that CEO compensation be tied to more than just corporate earnings. I'll grant you that earnings are one measure of shareholder value and, on a surface level, the most important one. But in a year where layoffs are still going strong and the job market is still weak, the thought that CEO compensation may improve over 2002 leads to questions. I'd like to suggest that CEO compensation in a given year also be inversely related to the number of layoffs the company experienced that year, with one caveat - that only hold true if it was the same CEO who governed the company through boom times. We shouldn't be penalizing a new CEO for the mistakes of his/her predecessor.

The reason I make that suggestion is simple - huge layoffs in bad times implies inefficient hiring management during boom times. Many companies hire back all the people laid off during bad times once the market improves, only to have to let them all go again when there is another downturn. There are companies who avoid having to do that through more thoughtful hiring management. These companies forecast where they think the market for their product will be over a multi-year period and manage headcount on that basis.

Since most businesses have fairly definable cycles, this is not magic. About 12 to 18 months before the business forecasts a market downturn, it starts reducing headcount through attrition. Amazing. If you don't replace everyone who leaves voluntarily, when demand decreases for your product, you don't have to lay off massive amounts of employees. This benefits shareholders in multiple ways.

First, forecasting business cycles is a good thing. It allows for better planning on several fronts, all of which benefits shareholders. Shareholders ought to be encouraging this behavior.

Second, it increases earnings during the transition between the high and low points of a cycle. If headcount is reduced through attrition, expenses are lowered. In many cases, revenues are not so impacted, therefore earnings increase. Most shareholders, looking only at the fact that earnings are good, don't often stop to think that maybe earnings could have been even better. Perhaps they should.

Third, it increases earnings during the downturn. If you avoid massive layoffs through more efficient hiring management, you avoid having to pay out large amounts of severance. Once again, shareholders benefit.

None of this even considers the possibility that staffing levels during boom times are, in some cases, simply higher than they should be. In some businesses, there is a very direct relationship between product demand and need for headcount. So you expect to see huge swings in headcount tied to fluctuations in demand. This is not the case in all industries, however. Not even in those where we are very used to seeing massive layoffs during market downturns, such as on Wall Street. Although on the deal side of Wall Street, such a relationship exists, transaction volume on the market side does not necessarily change when it shifts from bull to bear. Therefore large layoffs on that side of the business during bear markets should be suspect.

I see no down side to shareholders demanding more efficient management from their CEOs. The best way to accomplish this is to tie CEO compensation to those efficient management practices. Let CEOs know that during bad times they will also be judged based on the number of layoffs that occur, and perhaps they might be incented to do a better job of managing headcount during good years.