On the one hand, you want your companies to attract and retain top talent so that you can have a great management team; this is a very important feature of a good company to invest in. In order for your company to bag that top-performing executive, it has to offer a competitive (meaning very generous) compensation package.
On the other hand, investors don't want their companies paying too much. Many investors feel very strongly about this -- they would rather see the company spend an extra few million on capital investment or advertising than give it to the CEO, who is often already a very wealthy individual.
Executive compensation at Ford and GM
As an example of compensation analysis, and quite a useful one for auto investors, let's look at the compensation that Ford and GM paid its CEOs for fiscal 2012.
Ford CEO Alan Mulally has headed the American auto giant since he left Boeing in 2006. He is one of the top CEOs in the country, and has received a very high salary each year since joining Ford. In 2012, Mulally earned about $21 million. In order to determine whether Mulally's compensation package is acceptable in the eyes of a Ford investor, we must determine whether it forces his goals to align with shareholder goals.
Of the nearly $21 million in total compensation, $2 million came in the form of direct salary. About $1.3 million came as a bonus on top of that. These two cash payments are alright with me as an investor interested in buying shares of Ford. While the combined $3.3 million in essentially guaranteed earnings is a lot for an investor to swallow, it isn't a huge part of Mulally's total earnings. It is probable, therefore, that Mulally is going to focus on earning the remaining part of his compensation.
The major remaining portion of his compensation comes from stocks and options: $6.8 million and $7.5 million, respectively. These restricted equity grants are wonderful from the investors' perspective. While most grants are restricted for a period of three to five years as a way of forcing executives to deliver long-term and sustainable growth in order to make a profit, others go beyond that and set explicit long-term benchmarks that the company must hit in order for the executives to even receive the awards.
Because Mulally stood to make over $15 million from his stock and option awards if and only if Ford achieved long-term and sustainable success, investors should be comfortable with paying him so much. His goals are aligned with those of his shareholders, and if you look at what the company has done over the last few years then it is clear that Mulally is delivering. Under Mulally Ford has earned an impressive figure over the past two or three years:
Similarly, we can look at what GM paid Dan Akerson in 2012. Akerson, who served as CEO for the period covered in the graph above, recently has been replaced by Mary Barra as CEO. Although Akerson is gone, executive compensation packages are fairly sticky -- they don't change much over short periods of time. Therefore, it is reasonable to assume that Barra's compensation package will be similar to that of Akerson's.
In 2012, Akerson earned a total of over $11 million, with $1.7 million coming from salary and $9.3 million from stock grants (with no reported bonus or option grants). While Mulally's total compensation was higher, both his and Akerson's cash-based compensation (salary + bonus) accounted for about 16% of earnings for that year.
Although both stock and option grants help to align executives' goals with those of their shareholders, I believe that stock grants are the better tool. This is because there are some specific situations in which a CEO may act to maximize the value of his or her options at the expense of the long-term appreciation of common stock. Therefore, Akerson's package seems to be marginally better -- but both look pretty good.
How to interpret these compensation packages
I was a little surprised at how similar these two compensation packages were in composition, if not in size. In general, I like the structure of both packages: being heavily weighted toward equity awards aligns CEO goals with shareholder goals. Investors may find themselves more skeptical of a CEO's motivations if 50% or more of her earnings are guaranteed in salary and bonus, and they should be.
Although a shareholder may be uncomfortable with how much money the top-earning CEOs make, it is smart to remember to keep it in perspective. The biggest companies make a lot of money, and so huge salaries may not make as big of a dent in profits as one may expect. The following graph displays a comparison of selling, general, and administrative expenses (a big category that includes, among other things, all salaries of company employees) to the revenue generated by the companies. While Mulally and Akerson have personally brought in over $30 million per year combined recently, it doesn't look like Ford or GM are hurting because of it:
Investors should continue to look into the compensation packages for the head decision makers of companies that they invest in, or may want to invest in. Remember, companies are run by people, and people need the right incentives!