The global economic crisis has aggravated existing concerns about executive compensation practices. Executive and key employee pay practices among large financial sector companies in particular have drawn public scrutiny and condemnation. Lost jobs and lost savings, as well as extensive government support for the financial sector and the automobile industry, means that executive compensation is a concern not just to shareholders, but for everyone affected by the faltering economy. The issues are now seen as so significant and systemic that our elected representatives are taking the matter out of the hands of the private sector. Congressional proposals for sweeping corporate governance and executive compensation reforms and the new Administration’s interest in tackling this subject means that there is a very real prospect for significant changes to executive compensation regulation later this year.

We do not advocate a political solution to executive compensation issues, but if a legislative response is inevitable, it is imperative that it take the right form. As we have seen in the past, a piecemeal response to an assortment of perceived, and often isolated, executive compensation abuses will create as many problems as it solves—and is unlikely to take account of the systemic issues that must be addressed. After all, the intricacies of determining the ‘‘right’’ executive compensation across the diverse range of businesses and industries comprising corporate America defy a single solution, no matter how well intended and thoughtfully crafted.

Any government regulation of executive compensation should encourage compensation practices that will contribute to the sustainable long-term value of America’s business as we emerge from this crisis, rather than simply ‘‘fixing’’ specific compensation practices which are seen as having contributed to the crisis. What is needed is a set of principles to guide the design and operation of any responsible executive compensation program. The guidelines announced by the Obama Administration recently do this, focusing in part on pay for performance and, in particular, long-term performance. However, for guidelines of this nature to have real practical application, they must provide guidance to—and reinforce accountability by—the body that makes the decisions about executive compensation—the board of directors. A measured and principled approach overseen by corporate boards is the only way to ensure that the eroding trust between companies and their shareholders is restored, based on a shared commitment to the sustainable long-term value of the enterprise. Under the Administration’s plan, responsibility for crafting this approach will fall largely to the Securities and Exchange Commission.

Fortunately, there is no need to create a new set of governing principles out of whole cloth. Legislators should look closely at the work that has already been done in this area. A useful example is the guidance developed by the Aspen Institute’s Corporate Values Strategy Group. The thinking of this group was motivated by a concern with excessive short-term pressures in the capital markets that result from intense focus on quarterly earnings and incentive structures that encourage companies and investors to pursue short-term gain with inadequate regard to long-term effects. The Aspen group recommends that companies and investors do three things to promote sustainable long-term value creation. First, define the metrics of long-term value creation. Second, focus corporate-investor communication around long-term metrics. Third, align compensation policies with those long-term metrics. While the group’s guidance describes several features of a compensation structure that supports long-term value creation, it does not purport to prescribe any particular framework.

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