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CEO Pay: Finally Worth It?

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Sit down, take a breath, and get ready for some shocking news reported (subscription required) by The Wall Street Journal: "Chief executives increasingly are being paid based on their companies' financial results and share prices." Finally! Fantastic CEOs will be paid what they are worth, while those who destroy shareholder value won't be able to find work, right?

Not exactly
According to the Wall Street Journal/Hay Group study, "for every additional 1% a company returned to shareholders between 2009 and 2011, the CEO was paid 0.6% more last year." For the same 1% decline, it was the same 0.6% decrease in pay. This is a great step in the right direction, but it's only one step. The study also reported that in 2010, there was no correlation. In fact, for a 1% decrease in returns in 2010, the CEO was paid 0.02% more.

Additionally, correlating stock returns with executive performance may work in the long term, but in any single year, the market can easily over or undervalue certain stocks and sectors. Companies may also have special compensation in certain years, making measuring executives' value more difficult. For example, Apple's Tim Cook received $378 million in restricted stock last year, but the company said it "should be viewed as compensation over the 10-year vesting period."

Step by step
No matter the results of this report, it is evident that shareholders are battling the compensation of poorly performing CEOs. "Say on pay" votes, while not legally binding on companies, have given shareholders a chance to admonish boards that may have mispriced the value of executives. This year, shareholders voted down pay packages at several S&P 500 companies:


Total CEO Compensation

2011 Shareholder Returns

Mylan (Nasdaq: MYL  ) $21.3 million (0.9%)
Citigroup (NYSE: C  ) $15 million (46.2%)
NRG Energy (NYSE: NRG  ) $7 million (8.6%)
International Game Technology (NYSE: IGT  ) $8.5 million (2.9%)
Cooper Industries (NYSE: CBE  ) $11.3 million (5.9%)

Source: Company proxy statements, Yahoo! Finance.

Results from these votes have led CEOs like Aviva's Andrew Moss to resign while Sprint Nextel's Dan Hesse gave up $3.5 million in compensation. Additionally, companies have changed policies like staggering director's elections. This policy traditionally protects a company from potential takeovers, but also makes it more difficult for shareholders to vote in swift changes in leadership. Other policy changes have included increasing minimum stock ownership requirements for executives and increasing the time it takes for options to vest.

However, executives who have maintained significant control can easily outvote shareholders. This is just one reason companies with dual-class share structures that limit voting power are troublesome. This list includes LinkedIn, Google, and Facebook. Google's Class A shares have one vote per share, while its Class B shares, owned by the founders, have 10 votes per share. Google recently revealed it was taking it one step further and announced a Class C share with no voting rights whatsoever. While investing in these companies shows faith in the underlying business, it also represents much more of an investment in the quality of founders, board members, and majority owners as opposed to traditional share structures.

Headed in the right direction
While it's difficult to quantify exactly how companies are moving toward performance-based compensation, and eventually better share performance, recent shareholder "say on pay" votes are pressuring companies in the right direction. If you invest in companies that restrict voting, understand how much faith you are putting in the current directors.

If you are looking for stocks that pay shareholders instead of just executives, check out our free report: "Secure Your Future With 9 Rock-Solid Dividend Stocks."

Fool contributor Dan Newman owns no position in any of the above companies. Follow him @TMFHelloNewman.

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

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