CEO Compensation: A Problem That Just Gets Worse
By Louis Corrigan
Friday, September 05, 1997
The problem of excessive chief executive pay shows no signs of going away. The voices of reason are heard but their recommendations get implemented about as well as one can expect when the proverbial fox is left in charge of the hen house. In an era of cost-cutting, downsizing, and performance-based compensation, CEOs still get a free ride, walking away with an increasing and, in nearly every case, undeserved slice of the corporate profits pie. New tax data released this week by the Internal Revenue Service (IRS) once again point to a trend that only seems to get worse.
The IRS found that between 1980 and 1995, total tax-deductible executive pay rose from $109 billion to $307.6 billion, even after adjusting for inflation. That 182% increase in taxable pay far exceeded growth in either corporate revenues or net income. Revenues grew from $6.4 trillion to $14.6 trillion during the 15-year period, up 129.5%. Corporate profits rose from $246.6 billion to $560.1 billion, an increase of 127%. Due to slightly lower corporate tax rates, the amount of corporate income taxes grew more slowly, at 114%, from $91.9 billion to $197 billion.
Encompassing two recessions and two extended periods of economic expansion, this period also produced a remarkable increase in the value of equities. Even adjusting those gains for inflation, it appears that shareholders have actually done better than CEOs. Yet the IRS stats don't tell the whole story. For one thing, cash compensation can be deferred, allowing executives to avoid declaring it as taxable income, perhaps until they retire. Even more importantly, the mix of executive pay is now heavily weighted toward other forms of compensation, particularly lucrative options packages. According to Graef Crystal, who publishes a newsletter tracking executive pay, chief executives at the largest 1,000 American companies made $1.2 billion last year from the exercise of options but still held options worth about $9.9 billion.
While options are one way to inspire an executive's loyalty and reward long-term performance, they amount to deferred compensation since they generally vest over a five- to seven-year period. That means that today's options payouts don't yet register in the tax data. Besides, even gains from options that have been exercised may not be reported to the IRS for years to come. That's because many companies also establish plans that allow executives to defer their options profits, sometimes until retirement. As The New York Times reported this week, COCA-COLA's (NYSE: KO) very successful CEO Roberto C. Goizueta, for example, has deferred over $1 billion in such profits. No institution tracks such deferrals, but they are believed to total tens of billions of dollars.
Even a quick glance at the bare IRS stats shows that CEOs have done remarkably well for themselves during a period when the average weekly wage for a non-supervisory laborer -- which is to say, 80% of all U.S. workers -- actually declined slightly, after adjusting for inflation and added benefits such as pensions and health insurance. A close look at more recent but less comprehensive data confirm that the discrepancy, if anything, is getting worse. In 1996, for example, corporate profits rose 11%, yet factory workers saw wages grow by just 3%, and white-collar workers experienced a 3.2% boost in salaries. These advances barely kept pace with inflation. Indeed, considering productivity gains, these increases were so modest that they help explain why the American economy is seeing so little real inflationary pressure even after six years of expansion.
CEO pay, however, is a different story. While salaries increased far more modestly than in the past, salaries generally account for a smaller share of CEO compensation today than ever before. One analysis of 56 large U.S. companies, for example, showed that salary made up just 22% of a CEO's total compensation in 1996, versus 27% in 1995. As Business Week reported in April, the S&P 500 companies as a whole paid out performance bonuses that significantly sweetened executive pay packages, boosting cash compensation last year by 39% to $2.3 million. The real payoff for most chief executives, though, came from stock options, which accounted for 45% of total compensation versus 40% in 1995, according to some reports. Including all forms of compensation, the average CEO's pay soared 54% last year, to $5.78 million. Today, the average CEO makes about 209 times what the fulltime factory employee does. Depending upon what stats you use, that ratio amounts to an 8- to 10-fold expansion in executive pay relative to the rest of the workforce in just 25 years.
Some who have studied the numbers suggest the problem is, ironically, an effect of shareholder activists demanding that corporate boards make CEOs more accountable by tying more of their compensation to long-term performance, whether that be growth in revenues, profits, or share price. That trend met up with a period of booming corporate profits and a soaring stock market to produce the extraordinary compensation packages that make the headlines. Pay consultants now say that payment mix (base salary, cash bonuses for performance goals, stock options, and other perks) is greatly improved, but the amount of payments is even more out of whack.
The problem, of course, is not rising stock prices but the amount of options being handed out. Because compensation tied to options is, at least in theory, more risky than getting cash, executives like a truckload of options. That's true even when merely average corporate performance would lead to huge rewards for a CEO. Moreover, numerous companies that have seen their share prices fall have simply repriced their options. The argument is that, particularly in high-tech fields, options are a major way of retaining talent so that, as perverse as it may seem, boards must essentially guarantee against the risk of options by lowering their exercise price if necessary. Even as more companies devise broadbased options plans that apply to many if not all employees, the bulk still go to the CEO and other top executives. One study of 1,353 companies found that about 29% of all options granted in 1995 went to each company's top five executives.
A recent article in The Wall Street Journal pointed out that rising CEO compensation has played a part in the relatively new phenomenon, started perhaps by Chrysler's former CEO Lee Iacocca, of the chief executive becoming a celebrity. Another trend abetting the new cult of celebrity surrounding a Bill Gates, an Andrew Grove, a Steve Jobs, or countless other executives is that as branding has become even more important to a company's success, the CEO's role has changed as well. Even executives who don't literally become pitchmen a la Dave Thomas of Wendy's do, in effect, serve as a corporation's most visible public face, helping it claim mindshare if not market share.
The best executives, of course, still must bring a combination of vision and management skills to the job. But the trend toward becoming corporate cheerleaders takes executives into another realm closer to the overall logic of the mass media. In that realm, wealth reinforces visibility which reinforces celebrity which reinforces wealth. What remains troubling about that realm is that even where personality does not fully substitute for performance, some players are accounted more equal that others.
The question, really, is whether shareholders are getting enough bang for their buck. Awarding performance is one thing, but are the awards being handed out to CEOs actually commensurate with that performance or, like the embarrassing compensation package awarded WALT DISNEY'S (NYSE: DIS) Michael Ovitz, are they more often simply outrageous? Is there really such a dearth of fine talent at the executive level that shareholders must pay out exorbitant amounts for merely decent management? Moreover, is the average CEO truly worth so much more to his or her company than the average employee is?
Baseball fans often marvel at and complain about the salaries paid some superstars. The best that can be said about such deals, though, is that the stars aren't literally paying themselves. The same cannot really be said of corporate executives. Robert Monks, a principal of Lens Inc. and a trailblazing reformer of corporate governance practices, recently told the Times that executives manage to steal away with such lucrative pay packages "only because chief executives are paying themselves. They have all this diaphanous language about performance and all these committee reports on how pay was determined, but the simple truth is that executives are setting their own pay."
If you are a shareholder or an employee of a public company, a CEO who pays himself more than he's worth is ultimately taking money out of your pocket. Given that options packages already granted are expected to dilute corporate earnings in some sectors by as much as 29%, the chances are good you're being robbed blind.