Too Many Turkeys - Executive Pay

Too many turkeys - Executive pay

1328 words

26 November 2005

The Economist

ECN

377

English

Are America's bosses over paid?

Executive pay is on the rise again—and so are complaints that ordinary performance is attracting extraordinary rewards

AMERICA'S top executives had plenty to celebrate as they tucked into their turkey this Thanksgiving—a resurgent stockmarket, record profits and, above all, their own ever-expanding pay packets. In the years immediately after the bursting of the dotcom bubble and the scandals at Enron and the like, executive pay fell—at least by some measures. But that, it is now clear, was but a blip, mostly reflecting managers' reluctance to cash in share options in what was then an unattractive stockmarket.

Executive compensation in America—already far ahead of the rest of the world, despite the best efforts of overseas managers to catch up—is now rising inexorably again. In fiscal year 2004 the total compensation of the median American company boss rose in every industry, by between 9.7% in commercial banking and 46.1% in energy, according to a new report by the Conference Board, a research organisation. In the big companies that comprise the S&P 500 index, median total chief-executive compensation increased by 30.2% last year, to $6m, compared with a 15% rise in 2003, according to a study published last month by the Corporate Library, a firm that tracks corporate-governance data.

Recent higher profits are part of the explanation for higher pay. But there is a longer-term trend at work. In 2004 the ratio of chief executives' compensation to the pay of the average production worker jumped to 431 to one from 301 to one in 2003, according to “Executive Excess”, a recent study of 367 big American firms by the left-leaning Institute for Policy Studies. That is not quite a record: in 2000 the ratio reached 525 to one (see chart). In 1990 the ratio was 107 to one and in 1982 a mere 42 to one. This year's numbers seem certain to show the gap widening still further.

But while unionists and left-leaning politicians are worried about social equity, investors typically have a different sort of concern. They are happy to pay for exceptional performance; but less delighted when mediocre managers get lavishly rewarded. The contrasting cases of James Kilts and Michael Eisner make the point.

Mr Kilts, the boss of Gillette, has publicly accused critics of the $165m bonus he got for selling his firm to Procter & Gamble for $53 billion of “unsubstantiated, inaccurate and irresponsible criticism” and of treating him like a “piñata”—a sweet container that American children bash at parties. Piñata Jim may have a point. He did a lot to restructure Gillette—allowing it to be sold for a fancy price, to the huge benefit of its shareholders. It is when vast payments are the reward for poor performance that it is time to cry foul. Michael Eisner was an outstanding manager during the first part of his more than 20 years at the top of the Walt Disney Corporation. But as Leo Hindery points out in a new book (“It Takes a CEO”), he was also paid $800m over a 13-year-period during which the company's shareholders would have done better by investing in Treasury bonds.

The populist end of the debate has led to some action in Congress. Barney Frank, a left-wing Democrat, has just introduced legislation intended to tackle the “problem of runaway executive compensation”. Wisely, he is mostly seeking to improve disclosure, rather than actually to cap pay at a specific level, which experience suggests would encourage creative ways around the cap.

A 1994 reform that limited tax deductibility of executive pay to $1m merely turned the $1m maximum into the de facto norm, and inspired the rapid growth of share options as an alternative form of tax-favoured compensation. Some experts now blame the peculiar risk-taking incentives created by share options for many subsequent corporate scandals. Although Mr Frank's legislation is not expected to become law, it is adding to the pressure on the Securities and Exchange Commission to make better use of its powers to demand full disclosure.

Even some businessmen are now calling for restraint. Edgar Wollard, a former boss of DuPont, recently proposed that a chief executive's compensation should be indexed to the pay of the senior vice-presidents that head his firm's divisions. At DuPont, he was limited to 150% of the average pay of those other top executives. Mr Hindery, a serial CEO in the telecoms and media businesses, says he has published his book partly because greed in corporate America is now damaging capitalism.

Many experts see the continuing rise of executive compensation—and the continuing lack of a demonstrable link to performance—as a symptom of a massive failure of corporate governance. Greater pressure from shareholders is generally regarded as the only real antidote. But critics of perceived executive excess have been frustrated by shareholder passivity, which is sometimes blamed on the short time horizons of many investors.

So is there a cure? Certainly, fuller disclosure would help, argues Lucian Bebchuk of Harvard Law School and co-author of a recent book, “Pay Without Performance: The Unfulfilled Promise of Executive Compensation”. If there were proper disclosure of forms of executive pay such as pensions, supplementary pensions and deferred compensation, then it would be easier for shareholders to see whether chief executives are being rewarded for genuinely good work.

It is the issue of aligning incentives and rewards—rather than the absolute level of pay—that tends to concern professional investors most. “There is no right or wrong number”, says Bob Pozen, chairman of MFS Investment Management, which has $160 billion under management. It is hard to judge the merits of a package without looking carefully at the details, he says, which is why he has little time for Mr Frank's proposal for shareholders to vote each year on the executive compensation package. In Britain, where shareholders now get a non-binding vote on compensation, it has had no real impact, he reckons.

Blame the consultants

Mr Pozen reserves his fiercest ire for the kind of executive pay package that rewards bosses generously even if they fail. And he is extremely critical of the role of compensation consultants. They, he says, tend to be chosen by the chief executive, and to drive up pay by recommending that the top man should be paid more than his peers, having chosen a group of peers whose pay errs on the high side.

Ira Kay, an executive-compensation consultant at Watson Wyatt, strongly disagrees, pointing out that the compensation committee of the board increasingly hires the consultant—a change he regards as “revolutionary”. Moreover, in the past few years many American firms have changed their approach to executive pay, he says, improving disclosure and changing the composition of pay packages so that they provide stronger incentives to manage for the long run. In particular, share-option grants have fallen sharply, while there are more grants of restricted stock (that pay out only over time or when a performance target is hit).

Even so, a survey Mr Kay is working on suggests that there is now as “large a gap as I have seen between what institutional investors and boards think about executive compensation”. Boards think they are doing a good, shareholder-friendly job; institutional investors do not. Mr Kay fears that if the institutions do grow more militant about executive pay, there is a “risk of a return to the 1970s”, with bosses paid like bureaucrats and talented managers seeking more rewarding work elsewhere.

That would indeed be a bad thing. But judging by recent trends—and the continuing failure to reform board elections to make it easy for shareholders to vote out directors who are too friendly to management—hell is more likely to freeze than bosses' pay.

Compensation culture - Boardroom pay

414 words

26 March 2005

The Economist

The Economist Newspaper

374

English

The pay gap between British and American bosses is shrinking

COMPANIES, sales and profits are all bigger in America than in Britain, so it's not surprising that bosses' pay is as well. But, according to a new paper,* the Brits are catching up—though they've still got a long way to go.

In 1997, the average British chief executive of one of the top 200 British companies took home £955,000 ($1.56m). The typical boss of a comparable sample of American companies was paid £2.68m, nearly three times as much. By 2003, the gap was down to 1.7 times: British bosses' pay had risen 77% to £1.69m ($2.76m), compared with only a 6% rise (to £2.83m) in America (see chart). Looking at the median rather than the arithmetic average (ie, mean) shrinks the gap even further: by 2003 the figures were £1.29m and £1.55m , a difference of only 20%.

As the totals have got more similar, so have the pay structures. Although salaries for British chief executives are about 20% higher than for Americans, they are becoming less important as a component of pay, accounting for 52% of total compensation in 1997, but only 41% in 2003. That's closer to the American model, where CEOs are paid relatively small salaries and make most of their money from variable pay like bonuses and stock options.

So what's changed? The authors make several suggestions. New tax rules in Britain have made stock options an attractive option for boards, and new corporate governance laws, enacted earlier than America's Sarbanes-Oxley act, may have led chief executives to demand higher pay in return for extra responsibilities. Seeking talent from outside a firm has become more common, and tends to be more expensive.

But the main reason, says Graham Sadler, one of the authors, is globalisation. The market for CEOs has become one of the world's few truly global labour markets, and price differences are therefore eroding. British firms must pay more to keep their bosses, who may be lured by American companies with fat chequebooks. But globalisation should help to keep American pay deals down, too, as bosses there face price competition from cheaper foreigners.

* “How does US and UK CEO pay measure up?” Martin J. Conyon, University of Pennsylvania, and Graham V. Sadler, Aston Business School, March 2005.

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The Economist March 5, 2005

March 5, 2005
U.S. Edition

SECTION: LEADER
LENGTH: 714 words
HEADLINE: Fat cats turn to low fat;
CEO pay
BODY:
Bosses' bonuses are booming, but that is not all bad
NOW is the season when American companies file their annual reports with the Securities and Exchange Commission. Among other things, these documents give details of the pay of the companies' top executives. This year these closely watched numbers are being translated into headlines about huge increases in bonuses for the people who run the world's biggest companies. A study by Mercer Human Resource Consulting for the Wall Street Journal shows that last year's bonuses for the CEOs at 100 large American companies rose by 46.4%. The median bonus was $1.14m.
These are big bucks, and there are plenty of instances where the logic of the rewards seems at best warped. Michael Eisner, for example, the controversial chief executive of Walt Disney, who was almost booted out of the job by shareholders last year, nevertheless received a bonus of $7.25m. But there are encouraging aspects to the figures. For a start, corporate profits in 2004 rose significantly—those of big quoted firms in the S&P 500 index by some 20%. If bosses' total pay is (as it should be) related to their companies' performance, the variable part of that pay (which includes bonuses) could be expected to have risen sharply during the year.
The other thing about the bonuses is that, to some extent, they are a reflection of a welcome decline in stock-option schemes. Bonuses are being granted in place of these. A study by the Boston Consulting Group of public companies recently found guilty of fraud calculates that the value of the stock options granted to the CEOs of those firms in the years before the frauds became public was 800% greater than those granted to the CEOs of comparable firms not found guilty of any wrongdoing. Nothing correlated so strongly with corporate fraud as the value of stock options—not the standard of the firms' governance, nor analysts' inflated expectations about their earnings, nor ego-boosting stories about their CEOs in the press.
What's more, in the stockmarket's boom years stock options more or less indiscriminately rewarded individuals with sums that frequently amounted to tens of millions of dollars (and sometimes hundreds of millions). In 2001 nine executives cashed in stock options worth more than $100m, including Larry Ellison, the boss of Oracle (who got the biggest bounty, $706m), and Lou Gerstner, the boss of IBM. Mr Eisner's bonus last year fades in comparison. In 2002, the pay of top American CEOs was over 400 times average earnings; last year that figure is reckoned to have fallen close to 160.
Bonuses are largely in the control of a company's compensation committee, a small group of non-executive board directors. Nowadays many of these committees are being encouraged to talk regularly with leading shareholders about what are suitable levels of compensation for top executives, and they are increasingly sensitive to the reaction to the amounts they award. In Europe, CEOs are being advised that they will be excluded from much-coveted appointments in the future if they have been too greedy during their executive careers.
There remains plenty of scope for compensation committees to improve. On February 22nd, Merck's board awarded a bonus of $1.4m to Raymond Gilmartin, its CEO. Yet Merck's share price fell by one-third last year and it was forced to withdraw the painkiller Vioxx, a potential blockbuster drug.
But even if all compensation committees were to behave impeccably from now on, there will be legacy problems for some years to come. When earlier this year Carly Fiorina was booted out as CEO of Hewlett-Packard (HP), supposedly a failure, she received a leaving present worth up to $42m. This was because of the terms of a contract signed five years earlier. Compensation committees have to wean themselves off these kinds of pay deals, which lavish enormous amounts on executives even if they fail. Designing schemes that only reward success should not be beyond the wit of directors, or the compensation consultants they employ. In a hurry to find her successor, HP looks in danger of making the same mistake again, while Ms Fiorina herself is being spoken of as a future head of the World Bank. Change for the better? Maybe one should just watch those figures a while longer.
LOAD-DATE: March 4, 2005

The Economist October 11, 2003 U.S. Edition

October 11, 2003 U.S. Edition

SECTION: SPECIAL REPORT (2)
LENGTH: 3016 words
HEADLINE: Fat cats feeding - Executive pay
BODY:
NOTHING in business excites so much interest in the wider world as the pay of top executives. And this is never more true than when, as now, a few prominent cases prompt indignant headlines and rouse normally somnolent shareholders to action. The phenomenon is global. Last month Richard Grasso, chairman of the New York Stock Exchange, quickly went from folk hero, for the way he got the exchange running again after the terrorist attacks of September 11th, to the incarnation of corporate greed when it was revealed that he would be awarded $140m in accumulated benefits this year. Mr Grasso tried to stem the tide of outrage by agreeing to forgo another $48m due to him, but that appeased no one, and he was forced into an ignominious resignation.
A few days later it was the turn of Josef Ackermann, the Swiss boss of Germany's Deutsche Bank. He was charged with "breach of trust" and will stand trial in Dusseldorf early next year. His alleged crime was committed in early 2000 when he was on the supervisory board and the compensation committee of Mannesmann. The German mobile-phone company yielded to a bid from Britain's Vodafone, a takeover that it had initially contested. After the deal was agreed, a group of Mannesmann executives was paid bonuses of euro57m ($53m).
The current trial in America of Dennis Kozlowski, the former boss of Tyco, on charges of plundering the public company that employed him of hundreds of millions of dollars has rekindled in the public's mind the idea that extraordinarily high levels of executive pay are tangled up with corporate shenanigans and illegal activity. But that is not necessarily the case. There has been no suggestion that Mr Grasso broke the law, nor that Mr Ackermann, who is indeed accused of breaking a law, benefited personally from the bonuses that were handed out to Mannesmann's executives. Independence on board