Is Your CEO Grossly Overpaid?

Earlier this month I asked the simple yet maddeningly difficult-to-answer question: "What's a CEO Really Worth?"

I made the promise that I would be digging into the companies in the S&P 500 to find some of the highest- and lowest-paid executives and determine whether those top dogs were worth the money that investors were spending on them.

However, in advance of that, we need a baseline. That is, we need to be on the same page as far as what it means for a CEO to be "highly paid." To do that, I spent a few hours getting nerdy with financial data from all of the S&P 500 companies.

But first, does it work?
While my initial article might have been long on interesting thought experiments, it was short on hard data. This time around I was specifically digging into the data and, therefore, can share some thoughts on whether statistically it makes a difference if a company pays its CEO a lot of money.

In short, the answer is no, it doesn't matter.

If we measure compensation simply by the absolute number of dollars that the highest-paid executive of each company got in 2010 (including stock, options, and other non-cash comp), then we can find a small but positive correlation between higher comp and better performance -- whether that means higher total stock returns, a better return on capital, or stronger revenue and profit growth.

However, as you might expect, higher absolute comp correlates very highly with the size of the company. For example, ExxonMobil's (NYSE: XOM  ) Rex Tillerson made roughly $29 million in 2010, while M&T Bank's Robert Wilmers made just $2.5 million. But Exxon is a $377 billion company, while M&T is valued at just $9.1 billion.

So the correlation above may simply tell us that large companies performed better than small companies over the past few years, and that's not really helpful.

What's more interesting is when we look at relative compensation. For instance, the correlation between compensation as a percentage of the company's market cap and various performance metrics. And what happens when we do that? There's a slight-to-moderate negative correlation across the board when looking at total stock returns, returns on capital, revenue growth, and profit growth.

In other words, the best thing we can probably say about high CEO pay is that it has nothing to do with a company's performance.

Back to the original question
Of course I still haven't answered the question I started with: What exactly is high executive pay?

Let's take a look at a few pertinent statistics. First, on the basis of absolute compensation dollars, the S&P shakes out like this:

Source: S&P Capital IQ and author's calculations. Uses data on the highest-compensated named executive, which in most cases is the CEO.

Again, this isn't all that interesting because, generally speaking, larger companies simply pay more than smaller companies. Though some investors may find it interesting that the lowest-paid CEO was (surprise, surprise) Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) Warren Buffett, while the highest paid was Viacom's Philippe Dauman.

Once again, it becomes a lot more interesting when we look at relative compensation.

Source: S&P Capital IQ and author's calculations. Uses data on the highest-compensated named executive, which in most cases is the CEO.

One other interesting comparison that I looked at was compensation as a percentage of dividends paid. I particularly like this one because it measures what the CEO is getting versus what shareholders are receiving themselves. However, with 165 companies in the S&P 500 that don't pay any dividend, it's not as comprehensive of a measure.

But for those who are curious, the average compensation/dividend is 9.5%, while the median is 3.7%. As far as specific executives go, it ranged from Harman International's (NYSE: HAR  ) Dinesh Paliwal and Janus Capital's (NYSE: JNS  ) Richard Weil, who received far more in compensation than the company paid out in dividends, to Randall Stephenson at AT&T (NYSE: T  ) and Louis Camilleri at Philip Morris International (NYSE: PM  ) , whose pay was a fraction of a percent of the dividends paid.

Is your CEO overpaid?
Now armed with some benchmarks, we have a baseline to judge whether a CEO is getting paid more than his fair share. So go ahead and dig in to the companies that you own and chime in below with what you find. And be sure to keep your eyes peeled as I start digging into individual companies and what their pay schemes mean to you.

In the meantime, you can lock in on the companies mentioned above by adding them to your Foolish watchlist. Don't have a watchlist yet? Don't fret, just set one up for free by clicking here.

The Motley Fool owns shares of Berkshire Hathaway and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International and Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway and AT&T, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (4) | Recommend This Article (8)

Comments from our Foolish Readers

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 November 16, 2011, at 5:35 PM, Sketch71 wrote:

    If I discovered that a company I owned stock in paid its CEO total compensation worth 73.8% of Net Income in I would promtly sell said stock.

  • Report this Comment On November 16, 2011, at 6:30 PM, Latinus wrote:

    It is not only the CEO who is overpaid. The author of this article ought to include the other overpaid officers of a dividend-paying corporation.

    The author is on the right track when he considers compensation/dividend.

  • Report this Comment On November 16, 2011, at 7:10 PM, jfrankh57 wrote:

    The compensation packages of this day and age have gone too dramatically to extremes. I am a proponent of keeping it smart and the only CEO due large pay, is the CEO that owns his/her own business. Decent compensation is a must, obscene compensation, say $84.5M a year...a status symbol I can do without and so, probably, would the majority of investors in the USA. CEO's have many resources at their disposal and even the "best" have bad days and bad decisions. Most managers can run a profitable company in good times and few seem to manage even a breakeven company in bad times, much less a profitable one.

  • Report this Comment On November 20, 2011, at 12:24 PM, chrispnet wrote:

    Let's be frank. This same analysis applies equally to many highly compensated individuals...individuals whose current compensation may often times have no relationship to current performance. Think major league baseball players, NFL coaches, movies stars, etc. Has A-Rod brought home a World Series Trophy? Won the triple crown? Over compensation isn't limited to CEOs. In short...what's new?? Are you suggesting some sort of artificial governance? If so, how broad should THAT brush be?

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