There is a longish Sunday NYT article on CEO pay that I plan on reading. But before I get to it, I wanted to share some longstanding thoughts of my own on exec compensation.
While there was a temporary drop in exec comp caused by the market crash, we still have structural compensation issues that need to be addressed. For too long, we have been vastly overpaying CEOs of public firms for mediocre performance . Even worse, we have institutionalized this trend in recent decades. The result has been a massive transfer of wealth from shareholders to corporate execs.
In Europe, pay scales have been increasing modestly — but nowhere near the level of shameless theft here in the States.
Some 50 years ago, the highest paid executive (usually the CEO) made 30 times what the firm’s lowest paid employee did. This has changed over time, shifting upward in the 1980s. It has radically shifted the hi/lo pay ratio at American companies. Since 1999, as the average US paycheck has remained flat, C-level execs compensation has exploded. Just before the credit crisis crushed stock prices, the highest to lowest ratio was near 400 to 1.
Executives of public companies have been making a killing. Even worse, its for mediocre performance.
Roger Lowenstein details a rogues gallery of over paid execs in 2004’s Origins of the Crash. Back in 1991, Tony O’Reilly, CEO of Heinz, got a package worth the then astounding sum of $71 million dollars. Ed Nardelli of Home Depot grabbed a $210 million severance package for essentially losing market share to Lowes. More recently, others — especially in the financial sector — got paid $100s of millions of dollars for essentially destroying their own firms.
Huge stock option grants create perverse incentives. GE’s Jack Welch pocketed over $400 million dollars in salary, bonuses, and options. Lowenstein argued in his book that Welch essentially managed the earnings with very creative accounting and the help of GE Capital’s impenetrable financial black box. The credit crisis caused the collapse of GE’s earnings management, confirming Lowenstein’s thesis of earnings management. Its hard to avoid his conclusion that the greatest industrial CEO in recent American history was little more than a clever accounting cheat.
How does this happen? How are shareholders hoodwinked so thoroughly? I can describe the legal corporate theft by insiders in 5 simple steps. The scam goes something like this:
Five Steps to Shareholder Wealth Transfer
1. The Board of Directors, usually cronies of the CEO (often hand picked by him) forms a compensation committee. To appear “objective,” the committee hires an outside compensation consultant.
2. The compensation consultants are themselves well paid whores, who rather than turning tricks outside the Holland tunnel, offer up absurdly generous comp package. They deliver what they are paid to: They provide cover for the boards to make an otherwise indefensible giveaway of shareholder monies in the form of cash and stock options. It is typically called “Pay for Performance,” but that is a horrific misnomer, as we see in step #3. The comp committee approves the consultants’ nonsense, forwards it to the Board, who rubber stamps it.
3. Here’s where things get interesting: If the stock price rallies, the exec can exercise and cash out, risk free. If the stock price falls, the exec requests a new round of options — or even easier, asks for a repricing of the old ones.
4. After the options are repriced, the exec simply waits. Whether the market rallies or falls . . . you simply go back to step three. Repeat until stock options are in the money. There is no risk or outlay of cash on the part of execs.
5. True “performance” is not a factor. Stock prices can rally for a vast range of reasons having nothing whatsoever to do with management or CEO performance. The market can rally, a sector can come into favor, or even when the Fed can cut rates.
This is not pay for performance, it is pay for stock price volatility.
Actual performance would look at factors such as peer profitability, sector performance, SPX index gains. Bonus payments and stock option exercise should be for gains OVER AND ABOVE these factors — but sadly, rarely if ever are.
There are numerous enablers of this terrible comp system: Crony boards rubber stamp what turns out to be outsized — and oft guaranteed — pay packages for under-performance. An entire class of consultants somehow blesses these absurdities, giving the boards cover for their theft of shareholders. Third, large mutual funds remain mute, failing to fulfill their obligations as stewards of their investors’ stock shares. Instead, their silence is bought with 401k business and syndicate shares (IPOs, secondaries).
Solutions are as simple as they are unlikely: Require shareholder approval of exec comp plans, mandate public disclosure of consultant comp plans (they are embarrassingly ridiculous), and last, cleave the mutual fund asset management business from the rest of the companies. Impose a fiduciary obligation on mutual funds to investigate all Board nominees and vote their shares on behalf of S/Hs.
Just don’t hold your breath waiting for credible compensation reform to take place . . .
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See also: Bargain Rates for a C.E.O.? DEVIN LEONARD NYT, April 2, 2010 http://www.nytimes.com/2010/04/04/business/04comp.html
Few Fled Companies Constrained by Pay Limits ERIC DASH NYT, March 22, 2010 http://www.nytimes.com/2010/03/23/business/23pay.html
Not enough coffee yet, Barry. GE CEO is Jack Welch.
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BR: Doh! I’ll fix above . . .
Great post Barry. Another reason for Americans to be careful with their spending and investing.
The problem is – as the lower class gets poorer, they get desperate for whatever chump change they can get their paws on. Consequently they chase overvalued stocks and even mediocre dividends.
Finally – 401K plans are the death knell of accountability with regards to CEOs. Millions of Americans support all this stupidity without even knowing it.
The whole she-bang needs to come crashing down somehow.
Probably one of your more useful, informative posts in a while. On a Monday AM, no less. Kudos.
What is left unsaid but implied is sadly this. That which occurs as ’standard practice’ across the majority of these firms, gradually loses its veneer of ‘unethicacy’, and becomes more accepted, and rarely called out for the being the crap that it is. Instead of being reported with an air of wrong-doing upon discovery with a cooresponding share drop and calls for ouster, instead these folks are called upon to serve as guests on CNBC to offer their considered guidance on how great their firm is doing (regardless of the case).
In an age of underperformance in a diminishing capitalist republic, ethics and accountability were the first two victims.
The Government should have required that the entire Board of Directors of every Bank be fired before any firm qualified for TARP money, and further that any member of those Boards be prohibited from ever sitting on any Board anywhere, ever again. As for Jack Welch, I liked him better when he called himself Al Dunlap, at least I think they’re the same person.
When I lived across the river in Mannwich land we had a congressman by the name of Olaf Sabo. He would propose limits on CEO pay every session. Just another European style socialist. To red for the red white and blue.
speaking of GE, there are 6 “Shareowner Proposals” on this year’s Proxy..
among them, for: “Independendent Board Chairman”, “Advisory Vote on Exec. Compensation”, and “(limit)Pay Disparity”
surprisingly, or not, “Your Board of Directors recommends a vote AGAINST this proposal” (for all 6)
further details may be here http://www.ge.com/ar2009/proxy.html ~~
Finally "“ 401K plans are the death knell of accountability with regards to CEOs. Millions of Americans support all this stupidity without even knowing it.
they, certainly, aren’t receiving the Proxy that I’m looking at..
Any corporate exec "” officer or board member, who suggests that if they don’t pay themselves and their cronies more, their “talent” will go elsewhere, should be caned in the public square and summarily fired.
There has never been a greater pool of criminal talent at the top of so many public and private enterprises as we are witnessing now.
That’s how we got here, and they are preaching that more criminality is the cure.
They should not only be punished, they should be humiliated.
The compensation consultants really are whores: Paid for by the Boards, they end up fucking the shareholders, all for the same low low price . . .
The exec comp issue is a sign of a bigger problem. Shareholder interests are no longer well-represented by BoDs. It is the BoDs that have become clubby and who are failing to mete out exec comp with economic sense.
Eventually, some large mutual fund guy is going to make a career out of being a badass shareholder.
Marcus….I think the events in the past months should finally put to rest the argument that “talent” will go elsewhere. There was no talent, and even more sadly a lot of that “no talent” is still in charge. Real talent would have assembled their management team and asked one question..”How are we making all this money”. And when they were told it was mostly from buying and packaging mortgages taken out by people who couldn’t hope to pay them back in two lifetimes, real talent would have fired people, lots of people.
If we want an “investment” economy rather than a “casino” economy, it’s beyond me why shareholders of publicly-traded companies don’t demand executive compensation packages based on the company’s long-term performance as an actual business rather than its stock price. We’ve seen what the “greater fool” theory of stock buying got us first in the Internet bubble and then as a result of the credit bubble (homebuilders, mortgage originators, banks, insurers, etc.). Investor-shareholders look for rising dividends and a long-term increase in the value of their investment, which rests on improvement in the underlying business (i.e., real, as opposed to fictional, profits and net worth; products or services consumers want to purchase, regardless of government incentives; etc.). Paying execs of public companies based on factors similar to those of their counterparts in private companies, rather than pay based primarily on the stock price, could go a long way toward both bringing exec compensation back down to earth and help cure the gambling mentality that’s been developing for at least the past two decades.
The PROBLEM is their is a perceived SHORTAGE of board of directors people and CEOs.
How do you fix this?
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