Executive Briefing: Global Competition Increases

By Ann Pomeroy Aug 1, 2004
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HR Magazine, August 2004Directors welcome new responsibilities; better hiring practices reduce management costs; stock option awards fall out of favor; more.

The United States is in danger of losing its global technological pre-eminence, warns a recent report to the President’s Council of Advisors on Science and Technology (PCAST). To maintain its technological and innovation leadership, the report advises, the nation must focus on “innovation ecosystems” rather than mechanical end-to-end processes.

The United States has several major advantages compared to foreign competitors in attracting new high-technology investment, the report notes—the best research and development (R&D) system, the best workforce talent and research universities, the most flexible and entrepreneurial business climate, the best government and rule of law, the best infrastructure, and the world’s largest market for high-tech products. Nevertheless, “We are not just competing against foreign companies, but foreign countries,” one high-tech corporate official told the PCAST panel.

Top officials at the National Science Foundation advised the panel that, “The big winners in the increasingly fierce global scramble for supremacy will not be those who simply make commodities faster and cheaper than the competition. They will be those who develop talent, techniques and tools so advanced that there is no competition.”

The report advises maintaining a strong base of university R&D; keeping the workforce, education and economic climate competitive; and responding as appropriate to foreign tax and subsidy programs.

Currency Fluctuations Shift Cost-of-Living Rankings

Appreciation of the euro and other foreign currencies against the U.S. dollar has caused dramatic changes in the cost of living in various world cities, according to the latest Cost-of-Living Survey by Mercer Human Resource Consulting.

Tokyo remains the most expensive city in the world, but London moved up five places and now ranks No. 2 among world cities, followed by Moscow. The least expensive city on the list is Asuncion, Paraguay.

The 2004 survey, which includes 144 cities, measures the comparative cost of such items as housing, food, clothing, household goods, transportation and entertainment to come up with a score for each city. The data help multinational companies and governments develop compensation allowances for their expatriate workers.

New York—No. 12 on the Mercer list—continues to rank as the most expensive city in North America. Other costly American cities are Los Angeles (No. 27), Chicago (No. 35) and San Francisco (No. 38). All U.S. cities dropped in the rankings this year because of the depreciation of the dollar against European, Canadian and Asian Pacific currencies.

Living costs in Australia and New Zealand have risen faster than anywhere else in the world, the survey reports, because their currencies have appreciated significantly against the U.S. dollar.

Corporate Directorships More Attractive Today

The greater responsibilities and challenges involved in serving on corporate boards in the Sarbanes-Oxley era make the job more desirable today than it was five years ago. So said half the 44 corporate directors attending a two and one-half day Columbia Business School Executive Education program on “Accounting Essentials for Corporate Directors: Enhancing Financial Integrity.”

“We had thought that directors would find the current climate more difficult,” says Ethan Hanabury, associate dean of executive education at Columbia Business School in New York. (See “More Fallout From Sarbanes-Oxley Act,” in last month’s Executive Briefing.)

But he was encouraged to find that “many felt that there is a great opportunity to re-insert integrity into corporate America.” He added: “It’s tough to be the watchdog, but many people said that what they are doing is more meaningful, more intriguing now.”

Asked to identify the most important corporate governance issues over the next year, 75 percent mentioned compensation, transparency in the internal audit function and director independence. Other issues targeted included dealing with “deadwood” directors, improving effectiveness and discussions at the board level, and separating the CEO and chairman functions. According to one respondent, the most important governance issue will be “truly understanding the company’s business. I would urge anyone who is on a corporate board to develop a deep understanding of value drivers, risks, management issues and markets.”

Most respondents—65 percent—said the ideal size of a corporate board is between eight and 12 members, depending on the size of the company. A corporate board should be “big enough to share the workload, small enough to communicate effectively," said one respondent.

Cost of Poor People Management Is High

The United States is wasting $105 billion a year—an amount equal to 1.05 percent of the gross domestic product—because of poor hiring and management practices, according to a global survey of 700 managers in seven countries.

The London-based SHL Group, which produces psychometric assessment products, funded a survey to find out if it was possible to quantify the true cost of hiring mistakes. The Future Foundation, the London consultancy and think tank that conducted the research, calculated the overall cost of managing poor performers by multiplying the number of managers working in each country times their average salary times the percentage of time they spend managing poor performance. The average for the seven countries surveyed amounts to $153.5 billion in U.S. dollars.

“We seem to be doing a rather dismal job of managing poor performance” today, says Lawrence Karsh, president of SHL Americas in Chicago. While CEOs continue to insist that people are their most important asset, “at the same time, they put pressure on HR executives to cut costs,” Karsh says.

The hidden costs include the cost of failure due to poor selection of new employees and the cost of managing these poor performers. Researchers found that nearly one in four (23 percent) U.S. employees believe their colleagues are incompetent—“a frightening statistic,” says Karsh. In addition, almost 70 percent of mistakes by U.S. employees are never reported, according to the report.

Hiring based on old paradigms won’t work in today’s new “people economy,” says SHL Group CEO John Bateson. It’s critical to “put the rigor at the front end, rather than trying to fix things after making a poor hire. I’m not advocating slowing down your recruitment process,” he says. “I do advocate injecting much more rigor into the process.”

The report, Getting the Edge in the New People Economy, concludes that the competitive edge today comes not from the capital a company owns but from “the talent of the people it has managed to attract.”

Stock Option ‘Golden Age’ May Be Over

The shift away from stock options as part of executive compensation packages “is beginning to accelerate,” says Ira Kay, head of executive pay practice for human capital consulting firm Watson Wyatt. The value of new stock options given to CEOs at large companies decreased nearly 60 percent between 2001 and 2003, according to Watson Wyatt’s recent proxy analysis.

The decline was softened, however, by a large increase in the value of restricted stock and long-term incentives plus a sharp rise in the “in-the-money” value of unexercised stock options from historical grants.

The analysis showed a drop in the average value of new stock option grants from $10.2 million in 2001 to $4.2 million in 2003. Simultaneously, the value of unexercised stock options rose 58 percent, and the average value of other long-term incentive awards skyrocketed by 80 percent.

In the end, however, these increases were not enough to offset the decline in new grant values. The average total value of new stock options, restricted stock and other incentives decreased by about $5 million, and the number of stock options awarded decreased 37 percent.

Although many CEOs have yet to feel the full impact of this swing because the value of their unexercised stock options from earlier grants has skyrocketed, Kay says, “companies are getting serious about revamping their executive compensation programs.” The proxy analysis found a 79 percent increase in the “in-the-money” value of unexercised stock options from previous grants—from a median of $6.7 million in 2001 to $12.0 million in 2003. The dramatic increase was primarily due to the stock market rebound during this three-year period.

The decline in the value of new stock option grants, says Kay, “has yet to be—and may never be—mitigated by other forms of compensation.” While stock options have played a significant role in helping to create economic value for companies over the years, he says, “the golden age of stock options may be over.”

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