Lots of talk this week on executive compensation, with fascinating trajectories for American culture, business, society and public policy. I followed the debate so you don’t have to.

As you might expect, much of the conventional wisdom has focused on a potential Wall Street brain drain should comp restrictions be put into place (examples here, here and here).

The week’s best commentaries came from The Economist and compensation expert Frank Glassner.

First, The Economist points to big investment bank bonuses and introduces the concept of “employee capture:”

Such rewards, in the face of public protest, feed the impression that banks are victims of what some call “employee capture”. The top ten investment banks at the start of 2008 made an average return on equity of just 8% between 1999 and 2008. Four made cumulative losses. Staff got four times as much as shareholders did in profits. In 2008 Merrill Lynch paid cash to staff equivalent to over 100% of the capital left by the year-end.

Normally, this would be just a problem for shareholders. But because the public had to get involved, it’s now everyone’s problem. Next, the newspaper debunks the banks’ revisionist protests that, because they’ve repaid public subsidies, their bonuses should revert back to those of 2007. Fact is, they continue to operate on public support:

It is not just that they were saved from destruction. They got public capital (much of it now repaid), short-selling bans on their shares and rescues of counterparties, such as American International Group, which the public otherwise had no interest in saving. Today they enjoy laxer accounting, loose collateral rules at central banks, explicit debt guarantees and asset-purchasing schemes. And, critically, they can borrow cheaply because they are deemed too big to fail. All of them-from comparatively healthy Goldman to the nationalised weaklings-are being subsidised by the rest of us. As a way to keep cash flowing to the wider economy and help banks rebuild their capital, this subsidy made sense; nobody intended it to go to employees.

The heads-I-win-tails-you-lose aspect of all this has got America steamed. But The Economist argues that the answer is not simply to tax the banks’ highest earners:

In the longer term the bonus mess underlines the importance of getting the state out of finance: setting a time limit for the explicit guarantees and finding ways to lessen the implicit promise of support through living wills and the like…. Retrospective taxes are usually bad news. They distort incentives, and scare investors in other industries who fear they may be next. A wholesale cap on pay would lead regulators further into the swamp of micromanagement. And symbolic caps on a few top executives, as the White House is threatening, are too feeble a response.

The resident expert on pay on CNN, Bloomberg, and elsewhere is Frank Glassner, who’s been omnipresent this week on TV, newspapers and across the blogosphere. Frank is CEO of Veritas, the top pay consulting firm to Fortune 1000 companies. Because our firms share clients in common, I’m on his private email list. Frank this week sent his clients a manifesto advising that when it comes to pay, it shouldn’t be a matter of “how much,” but “how.” I sought his permission and bring that note to you here. An excerpt:

[G]overnment regulation will probably have unintended consequences, without curbing excessive pay. For example, if the maximum ratio of CEO pay to worker pay were mandated, companies would likely respond by outsourcing the work of the lowest paid workers, rather than curbing CEO pay.

For the rest of us who are not recipients of public largesse, the lesson we can take away is the delicacy with which we should approach compensation, and how it needs to be situated within a broader human capital strategy. Company directors will be under greater scrutiny than ever. Says Frank:

[C]ompanies should design compensation packages to attract the right people for implementing the company’s strategy. For instance, below market salaries coupled with aggressive incentive pay linked to individual performance is likely to attract self-motivated entrepreneurial individuals, however, that very type of pay strategy may create increased risk taking as well, and would need to be designed with appropriate checks, balances and controls.

Companies also need to assure their executives longer tenure and horizons – without the necessity of pay guarantees. A CEO who is afraid of being fired for not making short-term financials will not focus on the long term. A board that is actively engaged in strategy formulation and implementation and compensates a CEO for strategy implementation milestones, along with monitoring long-term performance, is more likely to understand, appreciate, and encourage a CEO’s efforts, even if they yield short-term financial results that are below expectations. Thus there is an urgent need for boards to evaluate their executives’ performance annually to determine their progress on long-term goals.

What I like most about Frank’s note is the premise that when it comes to compensation, one size does not fit all. When business strategies differ between companies, their compensation strategies ought to differ as well.

Companies should have the fortitude to set their compensation strategies according to their corporate strategies, not simply based on external markets for pay, and not simply based on internal ideals of what’s “fair.” To accomplish this, you’ll need first to identify how pivotal to your company strategy an executive really is.  For my earlier post on how to do that, click  here.

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