As the panic stricken market slashes share prices and cuts company valuations, boards of directors are whispering about a new and surprising stress factor: CEO retention. CEO exits reached a record 1,132 through to September this year, according to a report by outplacement consultancy Challenger, Gray & Christmas. What frightens boards is that even in this dire economic environment, CEO migration to new companies accounts for 9 percent of the turnover, the same level it was amid happier times last year. Boards normally use equity options to protect against talent poachers and adhere management teams to the company. But as share prices drop below the level at which equity options were issued, the options become worthless, leaving boards helpless and CEOs free to seek greener pastures. “This idea may be counter intuitive, but it’s particularly attractive now for executives to consider moving because all of their equity might be under water,” said Nora McCord, a consultant with executive compensation advisory Steven Hall & Partners, in New York.

Stock options form a sizeable portion of most CEO compensation packages, said McCord, who helps boards design executive compensation plans. “You use equity as a form of glue to keep people locked in place,” she said. Because option issues are subject to vesting periods, there is a delay between when a CEO is granted options and when they can execute which works like a retention mechanism.

The credit crisis, and accompanying stock market plunge, has disrupted this system. The Dow Jones Industrial Average recently sank over 45.1 percent off its October 9, 2007, record high of 14,164.53. The decline in share value echoed across all listed stocks in varying degrees. “Our most recent numbers show 42 percent of companies in the Fortune 500 have under water equity,” said McCord. This means even firms with their dream management team are seeing share price erosion, which puts their talent retention under pressure at the worst possible time.

But before boards succumb to fears of managerial mutiny, they should take a deep long breath. “Don’t panic,” said Carl R. Weinberg, a principal in the Global Human Resource Services practice at PricewaterhouseCoopers LLP. “The need to jump and do something immediately in most situations is over stated.”

Given current market volatility, one option boards of directors have is to shift CEO rewards from a focus on stock performance to achieving operational goals. The move helps to retain management by providing a more secure workplace, as for many executives this is a risk-averse move that shifts attention back to running the business.

This is by no means an umbrella solution, as different industries have different benchmarks, said McCord. A client in the transportation business, for example, tied executive pay to lowering the number of lost items. “They have identified that it’s bad for business, and as an organization everybody is doing everything that they can to lower that rate.”

Another client makes money by renting out assets on a daily basis. “You want to make sure that you have those assets in use for as much time as possible,” said McCord. So the firm links executive pay to extending the time assets are in use.

Some risk-averse executives prefer boards to issue restricted stock in place of equity options, because the shares retain value better than options. By contrast, executives with a healthy risk appetite might increased option issues because today’s low equity prices pose the most potential to increase in value. Either way, Weinberg counsels his clients to be prepared. When a major pharmaceutical company expressed concern about retaining their management talent, Weinberg helped the board explore different alternatives for both bolstering compensation of existing employees and designing packages for replacement ones. “They’re now educated on what the menu of choices is, and what the financial impact of those different choices might be, and what the legal, tax and accounting constraints might be. So that when they are ready to make a decision, they don’t have to spend time on any research or education,” Weinberg said.

And while some CEOs are happy to jump ship, “There is an ample demand amongst senior executives for attractive CEO roles,” said Ravi Srivastava, partner with executive search firm Egon Zehnder International.  “We’ve certainly not seen a drop in terms of people who are willing and able to take on the CEO spot.”

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