Thinking About Executive Compensation

THINKING ABOUT EXECUTIVE COMPENSATION

I was recently asked by the publisher of my articles in India for my perceptions of excessive executive compensation in the US.  I thought about it for a while and came to two conclusions along with several thought starters worthy of further discussions:

  1. In America, executive compensation schemes are hopelessly complex and seem to have gotten out of hand proportionate to the value delivered.  Even the most revealing proxy statements leave the reader bewildered about how compensation is calculated and how it ties into performance;  
  2. Congressional activity is generally ineffective in addressing the symptoms contributing to this problem.  They frequently make things worse or fail to stem the events resulting in excessive compensation.  

Over the past two decades, CEO compensation has moved from incomprehensively high to incomprehensive.  My pay is simple:  Salary + bonus + a 401(k) match (maybe).  A CEO’s pay includes these items, plus additional bonus plans based upon short, medium and long term goals, restricted stock grants, deferred compensation, a special retirement plan, and a slew of perks that may or may not be reported as income based upon rulings with the IRS.

Worldwide, the pool of capable executive talent is small and highly competitive. It is difficult to find competent executives who know the business well, are willing to take on the risks of running a large, diverse, and complex organization, and operate under extreme pressures with inordinate legal and fiduciary liabilities.  Talented executives are not willing to take on these responsibilities without significant compensation and job protections to lure them into the new position. They have bargaining strength and weak boards succumb to the “Savior Executive” syndrome and pay them what they ask. 

This is not just an American problem. According to Mercer, a financial services consulting firm,  in their  May, 2011 report on Global Executive Remuneration Trends, “Average executive compensation salaries in Asia have surpassed those in Europe in 2010, and they are on track to surpass those in the US in 2013”. It is a global issue.   

A lot of corporate performance is beyond the control of the CEO.  Many well-run and profitable companies took major hits during the recent and continuing economic downturn. Anticipating economic disruptions that are arguably beyond the control of the CEO, compensation contracts shield them from responsibility with guaranteed payments regardless of performance. 

Warren Buffett once commented that “Getting fired can produce a particularly bountiful payday for a CEO”.  Robert Nardelli, the former head of GE Power Systems in Schenectady, unquestionably was a highly competent operational executive during his tenure at GE.  Yet he was subsequently fired as Home Depot’s CEO for failing to improve on the numbers that mattered most to the owners.  For his failure, he was awarded a $210 million severance package!  This is flawed and embarrassing logic.

Regarding Congressional oversight, Congress’ record in solving issues like this has been generally ineffectual. In 1993, Congress passed legislation that restricted a firms' ability to deduct, for tax purposes, excessive executive compensation - defined as nonperformance-based compensation of more than $1 million.  Compensation experts and tax accountants took this to heart and moved over to stock and other pay options that were taxed under different and much lower rates. The disease went merrily along.  

There are promising activities in the works.  The Dodd-Frank Act which, among other things, mandates executive compensation reforms, includes a “say-on-pay” with a non-binding advisory vote by shareholders. Although this say-on-pay may appear to be a toothless gesture, shareholder activism is increasing as is the number of lawsuits brought against the Boards for substandard or unacceptable corporate performance.  Shareholders are beginning to realize their power to conduct on-line campaigns against CEO pay packages, particularly using social media. 

 Executive compensation is just the visible symptom of the widening income gap among the classes being experienced around the world.  Neither the free market nor government offer perfect solutions to this problem.  It is a subject that requires clear thinking from multiple perspectives in order to provide rational direction to a complex subject. I have no quarrel with elevated compensation for executives who deliver high value for their company’s stake holders.  But we must stop rewarding failure in such a spectacular fashion.

Congressional outrage seems to be directed at private corporations, but not directed at other agencies, e.g.:

  • In the US, the current contracts paid to baseball’s top five stars average $16,275,000 per year or $100,462 per game.  Should Congress regulate these salaries or is this the rightful responsibility of the franchise owners based upon their best business judgment?
  • In Hollywood, movie stars like Harrison Ford, John Travolta and Tom Cruise all make at least $20 million per movie regardless of box office performance!  Should Congress regulate these salaries or does this parallel baseballs’ free agency concept? 
  • Bill Gates and Warren Buffett have become two of the world’s richest business men.  Should Congress have a say in their corporate incomes or should we celebrate them as business visionaries who have employed thousands of people and improved the lot of millions of people around the world? I prefer no to all three examples

 

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