We hear a lot of rhetoric about executive compensation, the majority of it is critical of CEO pay. Yet CEO pay continues to climb and little seems to be done about it. Is exec pay out of control and if so, why has it not been curtailed?
The issue is complicated, so lets begin with some background. In any publicly traded company, like IBM or Wells Fargo, a Board of Directors is elected by the shareholders. A Board is tasked with governing the company on behalf of the owners or shareholders. This duty includes hiring managers (CEO) to actually manage the company's operations and strategic direction. Part of hiring management and officers is to determine their pay.
Running a large Fortune 500 company successfully is no easy task. It is a 24x7 job requiring not only the ability to manage and lead, but also demands strategic vision. This is the big leagues- just because your were first string in college, doesn't mean you even get to try out for the pros. And much like pro ball, some excel in the big leagues and some don't. There are few pros and even fewer that excel at their task. Just like professional athletes get paid a lot and don't always win, so do CEOs. They won't always be right and they don't always win, but they do play hard despite their scarcity.
It bears mentioning that many of the compensation amounts you see in headlines are not necessarily disclosed in context. For example, you may hear "XYZ CEO received total compensation of $120 million in 2007". What you typically do not hear that their salary was a few million and the rest was "bonus". Not feeling better yet? "Bonus" in the world of CEO pay is not the same as your $1,000 Christmas bonus. This figurative term refers to incentive pay that may have been accumulating for a decade and just now "vested" or became available to the CEO. Typically these incentive packages are in the form of company stock and subject to meeting certain company objectives like sales and profit targets. In other words, that pay may be the end result from many years on the job and having that bonus ride on the company stock. Not only is that pay at risk, but it aligns the CEO's interests with the shareholders- making the company successful and resulting in a rising stock.
Having discussed CEO pay in a favorable light so far, do not think for a moment that all is right with this scheme either. Too often pay is not tied to the right variables. A board may neglect to put conditions on the targets such as sales growing faster than inflation or competitors. When this happens, the bar is being set too low. Or CEO's can receive golden parachutes which put them at odds with shareholders. In these cases, which are widespread, one must blame the Board.
If you went to your boss and said "you need me, give me a $200,000 raise or I quit", you would expect to be out of a job. But if your boss said "you have a point, we're giving you $150,000 and another $50k that doesn't vest for 5 years", you would take it and convince yourself you deserved it right? I can't blame anyone for trying to get as much as the market will bear. Yet we can blame the boards that give it to them.
So how do the boards justify such pay? Like A-Rod and Jeter, some boards deem the pay worth it to the success of the company. Some boards are successful in getting more for their pay dollar. And some boards ought to be taken out behind the barn and, well you get the point.
Poorly performing boards exist for a variety of reasons, one being the same reason bad presidents do- apathy and ignorance in the [shareholder] voter population. Many of you own stocks, but have you read the annual report and proxy? Did you vote your shares? Did you check to see how the CEO was compensated and whether they were worth it? Mutual funds are another problem- they vote on investor's behalf and must now make their votes public. Ever check to see how your mutual fund voted? What would you do if you disagreed with one or some of their votes?
Another reason is that corporate governance is not always set up to be shareholder friendly. Board seats are often staggered, which means you can only vote out a few at a time. Very often board member candidates are chosen by the Chairman who sometimes happens to be the CEO too, or by other board members. Getting an outsider on the board is difficult. These are the practices most in need of reform, for the other practices stem from an all too comfortable board. In my opinion, more needs to be done in empowering the shareholders directly. Until shareholders collectively say 'no' to CEO pay, CEO's can demand and largely get big pay.
I read a study recently that measured CEO pay relative to company size in terms of sales, profits and market capitalization. Its conclusion was that CEO's today are compensated about the same as several decades ago relative to the organizations they run. (For the life of me, I can't find the study anymore, sorry).
Finally, a comment about "Wall Street" compensation. All news sources I have read recently muddy the water when discussing "compensation", Wall Street and the government's actions. The main cost in financial services is people. Most companies, take Catepillar for example, must buy raw materials and transform them into their final product. Labor costs are only a portion of their total expenses. In financial services such as investment banking, market making, research and trading- Wall Street's main services- the biggest cost is compensation to the troops. There is no "input" such as steel, wheat or energy, only the brains providing service, some real estate and technology (cost of capital is another, but it is primarily a balance sheet item).
Over the decades, Wall Street has honed its compensation practice which amounts to a very simple formula: about half of the revenue generated by people is doled out to workers in the form of compensation (that includes benefits, bonuses, payroll taxes, etc.) Naturally, some of this is skewed toward management and the vast majority to "productive" workers who generate that revenue and not HR, IT, janitors, etc. Most of this comp is accrued throughout the year and given in the year end bonus. Typically, a Wall St bonus might be 50-300% of a trader, banker or analyst's salary. Given how rank and file producers across the board are surely not responsible for the entire mortgage related plight of Wall St, it is fair to reneg on their compensation under the premise that "Wall St enabled this mess"? Surely many in the mortgage securitization business are accountable, but not the other hundreds of thousands who did no wrong?
Once again the issues are not highly transparent and finger pointing is difficult. You can rest assured that comp practices are going to change- not only is there downward pressue on comp levels, but the revenue streams themselves are becoming harder to generate. Many in the mortgage securitization businesses are either out of job or generating only a fraction of past years' revenue. Entire businesses on Wall St have been destroyed along with the value of company stock- another important compensation tool.
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I came across a CNN news report today about the CEO of Japan Airlines who now pays himself less than his pilots and got rid of all his perks. He did this after layoffs and asking employees to take early retirement. American CEOs of failing companies should take his lead.
ReplyDeleteSee http://www.cnn.com/video/?JSONLINK=/video/business/2008/11/02/lah.japan.ceo.pay.cut.cnn