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CEO Pay: It Just Makes No Sense

Think of all the terrific, growing companies out there. There's Best Buy (NYSE: BBY  ) , for example, which has increased its stock price by a market-pounding annual compound average of 13% over the past five years and 21% over the past 10 years. For Oracle (Nasdaq: ORCL  ) , those numbers are 11% and 19%, respectively, and for McDonald's (NYSE: MCD  ) , 29% and a respectable market-beating 7%.

Wouldn't you agree that companies like these (and there are plenty of other powerful performers) must house scores, if not gobs, of talented executives? There are surely plenty of people in their ranks who earn several hundred thousand dollars per year, if not a million or so. Now, wouldn't you think that many of these folks would love to run their company or a similar one? That they have the smarts and skills to do so? And wouldn't you think that if there were some CEO positions available at major corporations, these folks would gladly vie for the jobs -- and be willing to do them for a mere few million dollars, at most?

Given this supply of potential executives, why on earth do we have so many CEOs making tens, if not hundreds, of millions of dollars per year, even at poorly performing companies? Why are some CEOs collecting huge sums just upon landing their jobs, while others get enormous packages along with a pink slip?

A recent issue of Forbes tackled the topic, noting about Citigroup's (NYSE: C  ) new CEO, Vikram Pandit: "To recruit him the troubled bank paid him $241 million ... since his arrival, the stock has fallen a further 25%." I'm sorry, but it would be hard for me as an investor to have faith in a troubled company that thinks a new CEO is worth a quarter of a billion dollars.

At ExxonMobil (NYSE: XOM  ) , which has been faring well and beating the S&P 500's performance handily for years, outgoing CEO Lee Raymond was given a lovely parting prize worth an estimated $400 million in 2006. Robert Nardelli left Home Depot (NYSE: HD  ) without much love, but with a goodbye gift of $210 million, per his contract. Again, I'm amazed that these companies can't find plenty of able, talented folks to fill these top positions -- folks who would gladly do the job for a mere few million dollars. Those are some retirement nest eggs. (By the way, if your retirement nest egg isn't as big as it should be, let us help you grow it -- read about the $1 million challenge.)

The answer
The explanation for this ridiculous situation isn't a new one: Warren Buffett and his partner, Charlie Munger, have decried it for many years. CEO salaries have been spiraling out of control because boards of directors have been letting it happen. Because as soon as one CEO gets a hefty compensation package, others ask for -- and typically get -- similar ones. ("Everyone's doing it.") Because many directors on compensation committees either don't have the backbone to say no or are cronies of the CEO who selected them, or both. Many directors are former CEOs, as well.

If you add up all the overpayments to CEOs, you'll end up with billions of dollars that could have been deployed elsewhere, helping the companies grow, paying dividends to shareholders, or paying down debt. Lavish executive compensation is rarely the best use of a company's dollars.

At his recent annual shareholder meeting, Buffett again criticized chief executives with large pay packages, saying, "I don't know of any CEO that wouldn't gladly do the job at half the price or a quarter of the price."

Imagine a board of directors saying "sorry" to an executive who asks for a huge raise. Will the CEO leave the company in a huff? There's a good chance the answer is no -- such jobs aren't a dime a dozen, and he's probably already making more than he ever dreamed of.

There's hope
It's hard to be optimistic about this situation, as those in charge seem to have little incentive to change anything, but there is some reason to hope. There have been incremental improvements to the status quo, with more possibly on the way. For example, many shareholders can now weigh in on CEO compensation, albeit via non-binding votes. Presidential hopefuls are also interested; Sen. Barack Obama, for example, supports requiring corporations to let shareholders have a "say-on-pay." Companies are now also required to disclose executive pay in detail, breaking out options and other compensation components, and valuing them.

With any luck, we'll see some win-win reforms enacted. For example, if CEOs are rewarded largely with company stock, they'll have some incentive to help the company perform better.

In the meantime, let's keep an eye on the situation and exercise our say-on-pay privileges when we can.

Longtime Fool contributor Selena Maranjian owns shares of Home Depot and McDonald's. Home Depot and Best Buy are Motley Fool Inside Value selections. Best Buy is a Motley Fool Stock Advisor pick, and the Fool owns shares of Best Buy. Try our investing services free for 30 days. The Motley Fool is Fools writing for Fools.

Read/Post Comments (2) | Recommend This Article (8)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 28, 2008, at 5:08 PM, HungBui wrote:

    I fully agree that Corporate America is setting up bad examples on how to pay an executives. It is ridiculous that we are paying high salary for an executive because we believe he/she will do GOOD things for the company and shareholders. However, we have to pay him/her more when he/she does a BAD job to get rid of him/her (why don't we demand he/she is paying back some of his/her salary if he/she does a bad job). I hope that we, the shareholders, will wake up and stop this nonsense!

  • Report this Comment On May 28, 2008, at 5:36 PM, james27613 wrote:

    I've been working for HD as an associate p/t for 15 years.

    I can tell you why Nardelli got almost .5 billion dollars of shareholder money:

    GREED !

    Langone, Dick Grasso (nyse greed) and Nardelli all on the GE BOD !!!!

    Langone brings in nardelli UNDER THE TABLE, nardelli lawyer inks the deal worth millions, (and inks the deal for the 24 MM HR Man Dennis Donovan to join HD from Raytheon.) Lawyer then gets top legal job at HD !

    OUTRAGE !!!

    Now Nardelli and Donovan are at Chrysler ! He will fail just like he did at home depot, cause damage to the brand just like he did to home depot.

    Going to take us classic associates five more years to fix the damage nardelli and six sigma caused the home depot customer base.

    Nardelli did more for Lowes then HD !

    He got the pay package changed from performace based to earnings based,

    that is how he got mega millions.

    This stuff happens daily at many big companies, we shareholders just don't know about it, gotta read the 10K with a microscope.

    If the HD BOD did an above the table executive search, nardelli would never have made the cut.

    You don't quit GE (twice) and return to be ceo at GE ! Nardelli did but failed to get the top job at GE

    JACK was right about nardelli.

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