Roundtable: The Boss Is Paid Way Too Much

Earlier this month, a panel of highly paid executives (or former executives) stood before a congressional panel to defend their immense paychecks ... which kept arriving, despite their companies' lackluster performance.

The disconnect between pay and performance seems to have grown wider in recent years, particularly on Wall Street. Is this a lasting trend? What's an appropriate methodology for determining CEO pay? I asked a panel of Fool advisors and analysts to weigh in on the state of executive compensation today.

1. Aflac (NYSE: AFL  ) has put CEO Daniel Amos' pay package up to shareholder vote, the results of which will be released in May. Aflac is the first U.S. company to do so, and some companies have said they're taking a wait-and-see approach to the Aflac experiment. Should executive compensation be put to shareholder vote? Is Aflac asking for headaches, or should it be applauded for remembering that shareholders are, in fact, part owners of a business?

Bill Mann, co-advisor, Motley Fool Hidden Gems: I think it's an admirable thing they're doing, but ultimately I don't think it's a good idea. I want managers to be well compensated for excellent performance, but the more important elements for me are that executive compensation be structured in a way that is (a) aligned with shareholders and (b) transparent and fully disclosed. I applaud Aflac's willingness to experiment with this, though.

Seth Jayson, co-advisor, Hidden Gems: That's a tough call. I've been a pretty vocal critic of pay-for-failure pay packages at companies like Citigroup (NYSE: C  ) or Countrywide Financial (NYSE: CFC  ) , but I'm not sure opening pay packages up to a wider vote is the right, or only, answer. I don't know that dozens of sometimes irate constituencies can do a better job than a more focused compensation committee. The problem is, too many of these compensation committees have become little mutual-admiration societies: I rubber-stamp your pay, you sit on my committee and OK my ridiculous pay package.

Tim Hanson, micro-cap analyst, Hidden Gems: Like communism, this is one of those issues where theory and practice diverge. In theory, this is a fantastic idea. It makes management more cognizant of outside shareholders, and it makes shareholders take a more active interest in the business. In practice, however, this is stupid. I think we all agree that a CEO should be compensated for the lasting value he or she helps create for a business. Shareholders, however, come from vastly different constituencies; who knows what will influence their vote in this matter? Companies should all strive to have independent and thoughtful boards of directors, members of those boards should be elected by shareholder vote, and then those board members should be active in the business and set the CEO compensation in an informed and responsible way. If something goes awry, the CEO and the board members should then be held accountable ... not the system.

2. I recently read that the average CEO of an S&P 500 company took home more than $15 million in 2006. Are executives in corporate America overpaid? If yes, what's the solution? Is there such a thing as an underpaid executive?

Mann: Absolutely. The big problem is that pay packages are negotiated between an interested party (the managers) and disinterested parties (the board). When my father was young, he lived on the same street as the president of a public company. When the company was found to have defrauded shareholders, this guy lost his reputation and ended up nearly penniless. Now, ascending to the CEO position of a public company is a surefire way to wealth -- even if the CEO turns out to be incompetent or dishonest.

Solutions are tough to come by, because most of them require shareholders to stand up in a coordinated manner to resist greed in the executive suite. For example, this past week, homebuilder MDC Holdings' (NYSE: MDC  ) proxy came out asking shareholders to grant managers bonuses, even though the company met none of the targets it had set out, due in no small part to the horrid housing industry environment. This is the kind of thing that shareholders simply have to resist. I think management at MDC is top-notch, and they've done a wonderful job. But they certainly didn't offer to reduce their bonus compensation in the early part of this decade, when the environment for homebuilders was so bubbly that it would have required a big effort to do poorly. MDC is held substantially by institutional managers like GreenLight Capital and Ziff Asset Management, and unfortunately, successful shareholder resistance of such "heads-we-win, tails-we-still-win" proposals will certainly require their participation. In most cases, individual investor indignation is not enough.

Jayson: I think a lot of executives are overpaid, especially by global standards. But what matters more to us investors than absolute numbers is how their pay aligns with outside shareholder interests. Too many pay packages are not only obscene, but they also reward short-term thinking and near-term profitability at the expense of long-term business goals. What's needed is stricter accountability for managers, as well as compensation committees. I'm actually in favor of obscenely huge pay packages, provided they are rewarding behaviors that lead to obscenely huge returns for investors.

Hanson: Some executives are absolutely overpaid. Former Home Depot (NYSE: HD  ) CEO Bob Nardelli fits this bill. He received millions in compensation -- and a controversial $210 million severance package -- despite leaving a legacy of alienating shareholders, gutting the company of a competitive advantage by getting rid of knowledgeable workers, and compromising a brand that had taken decades to build. Merrill Lynch's (NYSE: MER  ) Stan O'Neal is another interesting case. The guy made $48 million combined in 2006, even though his professed strategy of making riskier bets would eventually cause Merrill to write down some $8 billion of value. This is why executives shouldn't be judged on an annual basis, but on something more realistic for natural business cycles -- like a rolling-three-year basis.

As for underpaid executives, I don't have a problem with someone getting paid what they're worth -- as long as the board is independent and competent enough to determine that number.

3. Options warrants, restricted stock, or cash: Which is best for shareholders?

Mann: All else equal, cash is best. Portfolio Recovery Associates (Nasdaq: PRAA  ) has a requirement that managers purchase shares at a value equivalent of two years of their base salary, and do so on the open market, which I think is fantastic, because it creates better upside-downside risk-matching than straight incentive stock options. Companies like granting options, though, so I have two suggested improvements to the current practice. First, incentive stock options should be granted at a premium to the current stock price, so they'd be valuable not just if the company's shares go up at all, but if they go up by a reasonable amount. The second is that companies should avoid "supergrants," where managers know they have a giant slug at one set price, and instead make grants that are dribbled out as often as once per week.

Jayson: Again, the Devil is in the details. All things being equal, I think you reward reasonable near-term performance with reasonable cash, but you peg long-term performance to restricted stock, issued underwater, with a very nice return for managers who get the job done right for the long run. I think you need to tie these bonuses to the right operating metrics, too. EPS [earnings per share] is a bad yardstick, because it can be fudged by levering up the balance sheet and buying back stock. I would like to see incentives that hinge on metrics like economic value added, return on invested capital, or meeting specific strategic goals.

Hanson: It's a bit of a cop-out, but it depends. Options were a great idea until Silicon Valley started granting them excessively and not taking any charge against earnings for doing so. Of course, there is no free lunch.

I don't particularly care how the CEO of a company I own is compensated -- as long as it's done transparently. Then it's up to me to determine whether the CEO in question is honest, responsible, and dedicated to creating lasting value. That's one of the reasons we like to see long-tenured founder owners when we recommend small caps at Hidden Gems.

MDC Holdings and Portfolio Recovery Associates are Motley Fool Hidden Gems recommendations. For more from Bill, Seth, and Tim, and for their top five stock ideas for new money, check out Hidden Gems with a free 30-day trial. Click here for more information.

Brian Richards does not own shares of any company mentioned. Bill Mann doesn't, either. Seth Jayson owns shares of Home Depot and Portfolio Recovery. Tim Hanson owns shares of Portfolio Recovery. Aflac is a Motley Fool Stock Advisor recommendation. Home Depot is an Inside Value selection. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (21)

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 March 28, 2008, at 5:01 PM, dimaio811 wrote:

    Wow! This is a no-brainer, not something to agonize over. Of course CEOs are overpaid. Compensation committees are broken. This system is broken. Shareholders should be the ONLY persons to determine CEO pay. If they don't get enough, they leave. If it is enough, they stay. Or maybe we should stick to a system that treats entire corporations as booty for the guys with the leverage at the top, and the hell with the business, the customers, the employees and of course, the shareholders. Hope I'm not unclear.

  • Report this Comment On March 30, 2008, at 1:35 PM, newbie3858 wrote:

    Executive pay is out of control at many US corporations. I think legislation is the answer. A formula including net profit, number of employees, and a percentage range might do nicely. I believe executives are highly replaceable, and that shareholders are entirely too vulnerable to executive whims. If a company is privately held, then they can blow money any way they want, subject to our legal system. But if a company is publicly held, there should be protection for the public from the executives.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 609001, ~/Articles/ArticleHandler.aspx, 11/28/2014 1:10:15 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement