No wonder executives like Home Depot’s Bob Nardelli, UnitedHealth’s William McGuire, Pfizer’s outgoing Hank McKinnell and others who have total compensation packages stretching into the tens and even hundreds of millions are taking heat. Of course, they can always point the finger at ExxonMobil’s recently retired CEO Lee Raymond, who’ll cruise into his truly golden years some $405 million richer.
All the bad press has put activists, politicians and regulators into overdrive. British and European companies have had to beef up their disclosure of executives’ long-term pay packages, and some shareholder groups are calling for even better reporting standards. The SEC is pushing new pay-disclosure laws, a subject that has drawn more attention than any other in the agency’s 72-year history (more than 20,000 formal comments have been registered so far). Democratic Congressman Barney Frank is proposing a Protection Against Executive Compensation Abuse Act, which would limit tax deductions for companies that pay executives more than 25 times the lowest paid worker. But even as the drumbeat for reform grows louder, some new research is questioning just how out of proportion these megapackages really are–and whether more regulation is the best way to scale them down.
First, there’s the issue of metrics. In recent testimony before Congress, compensation consultant Frederic Cook (who advises some of the multinationals under fire) argued that surveys using average pay are not only skewed by the extreme highs like Raymond, but are in fact designed “to produce high CEO pay ratios for maximum propaganda value.” Perhaps. But even using his suggested median salaries, the ratio of CEO to worker pay in 2004 would be 187 to one.
A more effectively contrarian argument comes from a pair of, surprise, French academics in America. Xavier Gabaix of MIT and Augustin Landier of NYU say that since 1980 the pay of CEOs has risen in lock step with the market capitalization of their companies: both are up 500 percent. Using this logic, CEOs like Chevron’s David O’Reilly (who collected some $25 million in 2005) aren’t overpaid, because they are running ever bigger, riskier firms, making decisions that touch more and more people. “The supply of CEOs for large companies is capped, because they need to have experience at other large companies,” says Landier. “Meanwhile, the supply of skilled workers around the world has increased.” No amount of regulation or disclosure, say the pair, will change the fundamental trend of bigger paychecks at bigger companies. “It’s very much like pay for top actors or sports stars,” says Gabaix. “If you have the talent to be among the best 500 in your field, you’ll be rewarded accordingly.”
The findings hold internationally–according to the researchers, market capitalization is responsible for most of the variance of CEO pay by geography (since foreign firms tend to be smaller than U.S. ones, executive pay is lower, too). Still, the study has a few exceptions. Good governance still plays some part in determining pay–the researchers say that CEOs can garner 10 to 20 percent more by going to a firm with a weak board. And cultural mores play some role, too; many of the Japanese firms studied were as big as American firms, but executives were paid less and changed jobs less often. Or compare the pay of Raymond and his British counterpart, BP’s John Browne. Since 2001, BP has posted stronger growth, and better stock performance than ExxonMobil. But Raymond’s pay in 2005, not even including his retirement package, was about $49 million, versus Browne’s $9 million. That 443 percent difference dwarfs the gap between the two companies’ market caps–about 62 percent.
At least in Europe, spectacular examples of pay outpacing performance appear to defy the norm. Last week, consultants Deloitte & Touche issued an analysis of compensation at the FTSE 350, an index of top European companies, which found that the proportion of executive pay linked directly to performance has been increasing over the last three years. Incentives now account for about half of total pay, up from about a third in 2003 (and up to 80 percent in many cases). What’s more, only 38 percent of companies are now using simplistic metrics like share price growth to measure performance. (The measure doesn’t factor in external reasons for growth like, for example, the effect of geopolitics on oil-company shares.) Not surprisingly, banks, which have short performance horizons and plenty of fiscal savvy, have the highest percentages of performance-linked pay. At the other end of the scale are utilities, transportation, commodities, and retail firms that, to be fair, face long business cycles that can make it difficult to judge how well a CEO is doing.
Still, nearly all firms are moving toward heavier reliance on bonuses. The average dollar amount of bonuses has doubled in the last three years, as they make up a growing proportion of pay packages, and that’s a good thing, says Deloitte’s Andrew Page, because it’s a more flexible and transparent way to pay someone than handing out more options or restricted shares. (Interestingly, options are falling as a percentage of pay, a trend that has to have begun before the massive U.S. investigation into the backdating of options packages began.) “The bottom line is that to be more effective, pay structures are going to have to become more industry- and even company-specific,” says Page. “You can’t just look at share price and make a smart judgment.” Nor can you assume one ridiculously excessive CEO payout tars them all, no matter how much we love to resent them for it.
