What a bunch of pikers. The best-paid chief executive of a public company in 1994 was Charles S. Locke, who last year retired as chairman and chief executive of Chicago-based Morton International Inc. For running the maker of chemicals and automobile air bags, Locke earned a mere $25.9 million last year--just one-eighth of the megamillions that Walt Disney Co.'s Michael D. Eisner was paid in 1993. In fact, 1994's 10 best-paid CEOs combined failed to make what chart-topper Eisner brought home in 1993: an astounding $203 million.
So is executive pay finally coming down from the stratosphere? The last few years have seen a rising swell of public outrage over zillion-dollar CEO paychecks. Swept along by that tide, legislators and regulators pushed through a raft of reforms, from a $1 million cap on the corporate deductibility of executive salaries to improved disclosure to shareholders. And boards of directors were said to be bestirring themselves, sharpening their scrutiny of pay proposals. Is the relative restraint of last year's paychecks evidence that these reforms are at last taking hold?
Hardly. The big news this year isn't in the big numbers--it's in the fine print. Buried in the latest pay contracts chief executives are signing and the lists of stock options they're salting away in the wall safe are the auguries and portents of things to come. And what they're saying is this: You ain't seen nothing yet.
All the public clamor and regulatory maneuverings have been aimed at one goal--forging better links between executive pay and corporate performance. And boards of directors have indeed been overhauling pay practices to tie pay to performance as never before. But as the old saying has it, be careful what you wish for, because you just might get it. True, CEOs these days stand to see their pay shrink if they fail to deliver the goods to shareholders. But when the boss does perform, his pay is more likely than ever to go into orbit.
BIG DOLLARS. Waving the pay-for-performance banner, many companies have been shifting more and more of the chief executive's pay into stock options. The theory isn't unreasonable. Unless they're granted at below-market prices or otherwise finagled, options mean the boss fares well only when shareholders do. But today's proxies offer evidence of tomorrow's treasure. Pay consultants see CEO pay increasingly based on commission-like formulas that award chief executives a percentage of their company's stock appreciation. "Shareholders clearly want to tie CEO compensation to the performance of the stock, and they are willing to pay very big dollars for performance," says Maurice Segall, a director at AMR Corp. and Harcourt General Inc.
That's why the numbers on BUSINESS WEEK's 45th annual Executive Pay Scoreboard represent the calm before the storm. The survey, compiled with Standard & Poor's Compustat, a division of McGraw-Hill Inc., examined the compensation of the two highest-paid executives at 371 companies.
On the BUSINESS WEEK ranking, the compensation of AlliedSignal Chairman Lawrence A. Bossidy looked modest by recent standards. He landed at No.8 on the top-paid list, with $12.4 million. True, the board hiked his base salary 82%, to $2 million a year, and guaranteed him a minimum cash bonus of $1.85 million for 1994. But more important, it also gave Bossidy two huge stock-option grants on a total of 1.8 million shares of AlliedSignal Inc. stock. The company explains that the larger of the two grants--on 1.5 million options--is "in lieu of future annual grants." Still, if AlliedSignal stock rises by 10% annually over the 10-year term of the option, Bossidy stands to gain $100.5 million on those two option grants alone.
AlliedSignal has certainly thrived under Bossidy. The company's market value rose an average of $1.8 billion a year, to almost $10 billion from $4.5 billion, since he joined the auto-parts and industrial products maker in mid-1991. Its return on equity climbed to 29.8% from 10.9%. Delbert C. Staley, the board director who heads AlliedSignal's compensation committee, says the new contract simply makes Bossidy's pay "competitive with compensation packages currently offered to the nation's most highly regarded, sought-after executives."
It's true that he has plenty of company. Kenneth L. Lay of Enron Corp. came in at No.19 on the list, with $10.1 million in total pay. But last year, Enron's board handed him options on more than 1.4 million shares of stock. If he can increase the value of the company's shares by 10% a year over the options' 10-year term, Lay will have a trove worth some $76 million--all by virtue of one year's worth of stock options.
Such prospects are in sharp contrast to the apparent restraint in 1994's paychecks. In a year in which overall corporate profits showed a stunning 34% gain, the average salary and bonus of chief executives climbed only 10%, to $1,399,698. Even more surprising, the CEO's average total pay package, including stock options and other long-term compensation, fell 25%, to $2,880,975. The reason: Fewer chief executives exercised stock options last year, when the weak stock market made their options less lucrative. Once again, though, a record number--537 of the 742 executives--earned more than $1 million in pay last year.
The second-place finisher in the 1994 pay ranking was a newcomer, James L. Donald, chief executive of DSC Communications Corp., a telecommunications equipment maker in Plano, Tex. Donald earned $23.8 million last year, some $15.6 million from exercising a stock option. The company stoutly defends his pay, noting that when Donald joined DSC in 1981 it had only five employees, no commercial products, and a market value of under $10 million. DSC now boasts more than 5,410 employees and a market cap of $3.5 billion. "This gentleman has performed," says a DSC spokesperson. "His pay is a sign of our success."
LEADING THE PACK. The other big winners come largely from mainstream companies in banking and finance, consumer goods, and industrial products. Carl E. Reichardt, retiring CEO of Wells Fargo & Co., got $16.6 million, while Reuben Mark of Colgate-Palmolive Co. pulled down $15.8 million. Compaq Computer Corp.'s Eckhard Pfeiffer earned $14.7 million, and Bear Stearns & Co.'s James E. Cayne made $14.6 million.
In an analysis linking CEO pay and performance over the past three years, BUSINESS WEEK and Compustat found that investor Warren E. Buffett of Berkshire Hathaway Inc. provided the best return to shareholders for his compensation. Laurence A. Tisch, CEO of CBS Inc., turned in the best company results relative to his pay. On the negative side of the pay-for-performance ledger are Disney's Eisner and Ronald W. Allen, CEO of Delta Air Lines Inc. (box).
Last year's comparatively miserly overall numbers disguise a growing view of the CEO as superstar. Some of the folks who are crafting the latest sheaf of pay deals think CEOS should get as much as executives who lead a leveraged buyout--10% to 15% of the equity--or even as much as top money managers, who cream off 20% of the gains they return to investors. "The litmus test is the investment funds managed by the superstar managers like George Soros and Julian Robertson," argues Arnold S. Ross, of New York-based pay consultants Hirschfeld, Stern, Moyer & Ross. "If the most sophisticated investors in the world are willing to give 20% of their gain to a Soros, perhaps the superstar CEO should get the same."
Unlike most chief executives, however, managers in an LBO typically place their personal fortunes--and often those of family members--at risk. Money managers, for their part, earn next to nothing when their strategies turn sour. And the success or failure of an investment fund is usually directly traceable to its top money manager. A hired-hand corporate chieftain, by contrast, is typically living off an established set of patents, trademarks, products, and inventory--as well as the efforts of thousands of employees. Eisner, for example, was the beneficiary of a highly valuable film library and a legacy of characters left to him by founder Walt Disney.
And even Eisner isn't paid by Soros-style standards. If he were, he would have made about $4 billion instead of the estimated $500 million he has collected since taking the helm of the entertainment company. "You can't pay too much for performance," insists Ross. "You can only pay too much for mediocrity." Critics counter that it's unnecessary to dangle such lavish gains as the incentive to perform. "You could have pay for performance if you paid the CEO $1 million or $10 million," says shareholder activist Robert Monks, who runs the investment fund Lens Inc. "God didn't set these huge multipliers for CEOs."
SETTING A MINIMUM. Equally galling to some critics, many of the reforms of recent years have demonstrated the law of unintended consequences: They have served to increase rather than decrease executive pay. Consultants note that new government rules make it harder for boards to increase bonuses above the targeted payouts for executives who exceed their performance goals. As a result, boards are setting easier goals and funding more generous incentives. The $1 million cap on the deductibility of pay is having a similarly perverse effect, according to some consultants: It has become something of a government-approved $1 million minimum salary.
The biggest backfire, however, came from the Financial Accounting Standards Board's effort to require companies to charge stock options against earnings. Many boards handed out hefty stock-option awards, hoping to squeeze them in before the new rules went into effect. FASB decided against its proposal, however, after severe pressure from business interests. "The threat of FASB intervention led a large number of companies to make unusually large grants of stock options to their top executives," says executive pay consultant Pearl Meyer. "The enormous numbers of these grants will raise the overall tide of executive pay in years to come."
Back in the 1970s, most companies would reserve about 3% of their outstanding stock as options for senior management. Today, the 200 largest corporations set aside nearly 10% of their stock for top executives, according to a survey by Meyer. In almost all cases, moreover, it's the superstar CEO who takes the lion's share of these stock rewards. At toymaker Mattel Inc., CEO John W. Amerman alone got 30% of the stock options granted to the company's employees last year. AlliedSignal's Bossidy got 26.6% mf the options handed out by the board; the next-highest awards were just 1.8% each, given to a pair of executive vice-presidents. Alfred Lerner, CEO of MBNA Corp., was given 26.9% of last year's stock options.
Not all that long ago, boards granted stock-option packages on little more than 100,000 shares. Today, directors are commonly handing out options that are three to five times that number--and some grants top 1 million. Last year, the CEOs of at least 45 of the 371 companies tracked by BUSINESS WEEK were given option packages on 250,000 shares or more.
Many of these option grants are being parceled out to chief executives who already hold vast troves of options that have yet to be exercised. About 55 chief executives in BUSINESS WEEK's survey have unexercised stock options already worth $10 million or more each (table). Disney's Eisner still tops this list, with $171.9 million in options waiting to be cashed in. D. Wayne Calloway, CEO of PepsiCo Inc., is sitting on a $64.6 million hoard.
As the piles of cash get higher and higher, few complaints are being heard. Graef "Bud" Crystal, the prominent critic of executive pay, says that he is still surprised at the public's muted reaction to CEO pay packages. "In England, they are having Parliamentary hearings over pay when the CEOs there earn about a third of what American chiefs make," says Crystal. Why is there so little fuss in the U.S.? "People here may be used to the big numbers," he says. "And because people still believe their children can someday make it to the top, there's a tendency not to complain."
A SCORECARD. The other reason, of course, is that by the time these huge sums become more public, the shareholders of these companies will also have gained. "Their greed isn't hurting anybody," says James McKinney, a New York-based pay consultant. "It's benefiting people. It's making the shareholders richer, too."
Many pay observers even argue that it's not greed that has driven CEO compensation sky high. How much the boss makes has become something of a scorecard, an American way to keep track of business success. It is, under this logic, recognition of an achievement among an elite group of executive peers. "Eisner's $203 million in 1993 is the equivalent of Roger Maris' home-run record," says David Swinford, a pay consultant at William M. Mercer Inc. "It's a great accomplishment." The numbers on that scorecard may have taken a little respite last year, but there will be many more such accomplishments in the years to come.