Would JC Penney’s directors have made such a bad choice of CEO if their pay depended on it?

April 9, 2013
April 9, 2013

Activist investor fund Jana Partners lost its fight to put directors on the board of Canadian fertilizer company Agrium. But Jana’s proposal for compensating its nominees based on Agrium’s stock performance is not going away.

Opponents of such compensation say it doesn’t fit with a director’s oversight duty. Most directors earn a straightforward cash payment. But tying a board member’s pay to a company’s performance is an interesting idea to make directors more accountable, especially since such oversight over directors is lax.

Another activist investor, Elliott Management, has suggested a similar compensation structure tied to performance for its director nominees for energy company Hess. Fellow activist Relational Investors is supporting Elliott and also favors that pay structure, which is similar to how some CEOs are paid.

Obviously, there are also a lot of pitfalls to that idea. The New York Times’s Deal Professor had a good look at the pluses and minuses. A director could make decisions that aren’t necessarily in the long-term interest of the company in exchange for a short-term jump in the stock. That could mean taking more risks that end up hurting the company in the long run. And the system would obviously work better if directors across the board had a similar pay structure, instead of just the ones nominated by activist investors.

But it’s clear something needs to be done to make directors more accountable. Corporations are rife with boards that are derelict in their duty, but still get paid hundreds of thousands of dollars a year. Directors at Chesapeake Energy dragged their feet before former CEO Aubrey McClendon finally resigned. The board’s audit committee chairman also had to resign. McClendon was accused of using his stakes in Chesapeake wells to secure private loans. A shareholder revolt ensued, but the board members, many of whom are close to McClendon, still cleared him of wrongdoing.

Maybe compensation tied to stock performance would have made JC Penney’s directors think twice before making their ill-advised CEO pick. Bringing back former CEO Mike Ullman, who previously struggled to make JC Penney more relevant among shoppers, caused the stock to drop by about 12% today. Ullman was brought in to replace Ron Johnson, who was recruited from Apple to revamp the ailing retailer. But Johnson’s elimination of JC Penney’s popular discounts caused sales to tank.

If shareholders wanted to kick out JC Penney’s directors, they would have to launch an expensive proxy fight that only the big investors can afford. And because of complacency by many retail investors, it’s hard to garner enough votes to oust directors. Even former Hewlett-Packard board chairman Ray Lane, who is blamed for many of HP’s recent fiascos, squeaked by in a vote to reelect him. He stepped down last week.

Maybe performance-based pay isn’t the magic solution. But at the very least, it should start a debate on holding directors more accountable.

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