How Ceo Paychecks Got So Unreal


Norton -- 272pp -- $19.95

It was one of those pivotal moments in U. S. business history that go unnoticed at the time: Some 40 years ago, a young McKinsey & Co. consultant named Arch Patton completed the first study of executive pay for the American Management Assn. Little did he know that his survey and subsequent variations would be used to help justify decades of huge pay raises for CEOs.

As one executive discovered another who made more money, pay went up and up, thanks to Patton's surveys. Today, by author Graef S. Crystal's reckoning, CEOs at the largest American companies are paid 150 times more than the average U. S. worker. In Japan, by contrast, the boss gets only 17 times the pay of an ordinary worker. For American CEOs, the average paycheck is $2.8 million; for Japanese CEOs, $300,000.

Crystal, who viewed Patton as a role model, was for 18 years a compensation expert with consultant Towers Perrin. He rose to the top of the field, striding into boardrooms armed with the facts and figures to justify big runups in pay for chief executives. But in recent years, increasingly disturbed by the system he served, he "walked across the street" to become the leading critic of excessive pay. He retired in 1987 to write and consult with shareholder-rights groups.

In a new book, In Search of Excess, Crystal fesses up to how the game he once played works. If a company wanted to pay its executives above the going rate, he says, he generally went along -- after all, it was usually the CEO who hired him. Concedes Crystal: "I helped create the phenomenon we see today: huge and surging pay for good performance, and huge and surging pay for bad performance, too . . . I acted in full realization that if I didn't please a client, I wouldn't have that client for long."

But In Search of Excess goes beyond confession. It's a hard-hitting analysis of what's wrong with executive pay in America. Crystal takes on all the big corporate moneymakers, from Coca-Cola Co.'s Roberto C. Goizueta to Paramount Communications Inc.'s Martin S. Davis. He reveals the tricks used to obscure how much CEOs stand to make -- deciphered by reading hundreds of proxy statements detailing public companies' pay practices. He raps the knuckles of directors who load the kitty with restricted stock that pays off regardless of performance, and he decries the repricing of stock options when poor results send a company's shares into a tailspin.

Executive compensation hardly seems to lend itself to book-length treatment. But Crystal draws readers through the exotica of a proxy like an ebullient tour guide on safari. He brings a passion and understanding to his subject that make even the minutiae fascinating.

This is particularly true of Time Warner Inc.'s Steve Ross, whom he terms probably "the highest-paid CEO of a publicly owned company who ever lived." Crystal devotes 33 pages to Ross's income, estimating that from 1973 through 1989, Ross made about $275 million. He guides readers through a dazzling array of pay schemes: an investment partnership, restricted stock, deferred compensation, "A" and "B" bonus plans, equity plans, consulting fees, and what Crystal believes is history's largest stock option -- 1.8 million shares.

In fairness, Crystal acknowledges that during that period, Ross engineered a 24% compounded annual total return for shareholders. Only 17% of 407 companies in Crystal's sample did better. But even if the company had performed modestly, Crystal complains, Ross would have made a pile.

In fact, Crystal isn't against big pay altogether: His gripe is big pay for poor or average performance. He labels Walt Disney's Michael D. Eisner, Reebok International's Paul Fireman, and H. J. Heinz's Anthony J. O'Reilly "good guys," even though in recent years, each has ranked among the highest-paid CEOs. Crystal argues that each made his money honestly -- by tying his pay to performance and delivering results. But there should be a limit to what even successful managers earn, and these guys have topped it. Eisner, for example, made $59.5 million over the last three years. (Crystal doesn't mention that Disney and Heinz used to employ him as a consultant.)

As a critic, Crystal can be prone to hyperbole. Consider his assertion that American CEOs earn 150 times more than ordinary workers. BUSINESS WEEK's analysis shows the disparity to be closer to 85 times. Why such a difference? Crystal places a value on CEO stock options that haven't yet paid out. For Ross alone, that sum came to $35.8 million last year, even though his options are "under water" -- the price at which he could exercise them is higher than their current market price.

Whether the right number is 85 or 150, though, is almost academic. The point is that too many chief executives exclude themselves when they talk about the need to control costs and compete globally. While they lay off workers and cut pay and benefits, their own pay goes up. And while many CEOs speak enviously of cheaper labor costs abroad, few would settle for pay like that of their counterparts in other leading industrial nations.

Meanwhile, the credibility gap between the leadership of American corporations and its managers and rank-and-file keeps widening. What to do? Crystal says that board pay committees should have their own consultants with no ties to management. He also believes accounting standards should be altered to require the cost of stock options to be charged to a company's earnings. And he urges the Securities & Exchange Commission to demand better disclosure.

These prescriptions may not make fat paychecks leaner. But they would certainly slow the obscene spiral set in motion by Patton, Crystal, and the legions of consultants who followed.

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