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.
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
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'
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
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
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.