For the first time in eight years, The Corporate Library annual CEO Pay study revealed that compensation for chief executives went down. Given the market declines over the past 18 months, this should not come as much of a surprise to most observers.
What is surprising, however, is how little CEO pay declined. As the U.S. equity markets fell dramatically in 2008, the Standard & Poor's 500-stock index fell more than 37%. Total realized compensation, which includes executives' options and vested stock returns as well as salaries and bonuses, declined just 6.38%. Meanwhile, despite government bailouts and market turmoil, median total annual compensation, which only includes CEO salaries and annual bonuses, fell by less than one-tenth of a percentage point. You could be forgiven for not noticing.
Given such a precipitous plummet in the stock market, why did pay go down by such a miniscule amount?
It's partly a question of timing. The total collapse of the financial sector didn't happen until September 2008, more than eight months into the year. Other sectors weren't hit until even later. Conceivably, many companies could have had three good quarters and one particularly bad one.
But timing can account for only part of the answer to this bewildering question. Boards of directors—unwilling to let unearned bonuses go or design incentives that pay out only if targets are met—hold much of the blame. Many compensation committees admitted in their proxies that financial targets were not met. But rather than holding up the "no performance, no bonus" expectations that many shareholders have, boards awarded discretionary or "retention" bonuses and repriced stock options, and even negotiated generous new employment agreements, replete with guaranteed bonuses. Stock options, unlikely to be worth much in the first half of 2009 because of fallen share prices, were subject to this mitigatory effect, too. Compensation committees just awarded more of them instead of fewer. A lot more.
Bonuses have been annual events for so long that executives expect them always to be so. In fact, they are so habitual that they are even included in severance pay and pension calculations. Other employees aren't treated to the same rich formulas. So it's hard to comprehend why the most highly paid employees need to be.
In the end, 2008 didn't have much effect on pay levels. But surely, with even worse performance to account for in 2009, boards will crack down more this year, right? Wrong. Many companies have reacted to falling income and dwindling earnings by lowering targets for 2009 below the goals set in both 2008 and 2007. In some cases, companies have even set targets that are actually losses in hopes of preventing the declines from being even worse.
This may be a realistic reaction to a poor economy. But in my experience, this easing of targets has not been accompanied by what should go with it: a reduction in bonus opportunity. Shareholders have every right to ask why executives should receive the same target bonus for achieving half the earnings that were gained in 2007. And if shareholders get their say on pay—a proposal supported by the Obama Administration that would let investors vote on executive compensation packages—we hope they will ask that very question.
Such expectations would seem to be common sense. But in the world of executive pay, logical compensation is as much an oxymoron as a guaranteed bonus. What we have instead is a pay structure where the link to performance has become tenuous at best. Incentives are supposed to be "at risk pay," not "expected pay." Does that mean executives are supposed to be "at risk" of not receiving it?
Of course, it is not pleasant to have to tell the CEO that he or she has not earned a bonus. After all, the CEO might claim, possibly even with some justification, that the fault lies with Dick Fuld or Angelo Mozilo or whoever dreamed up credit default swaps and subprime mortgages. If I sat on that board, I'd ask, "When Lehman's and Countrywide Financial's stocks were going through the roof, helping to balloon an already inflated stock market, you didn't refrain from exercising your stock options then, did you?"
Like captains who used to go down with their ships, even when they were not responsible for sinking them, CEOs and other executives must accept that what comes with the perks of the job are the penalties. And boards must accept that those penalties have to be enforced.