Executive Pay Gluttony
Executive compensation is in the news again as the Securities and Exchange Commission gets ready to issue new guidelines on pay disclosures. As mandated by the Dodd-Frank Act, the new rules are supposed to provide “greater transparency and allow shareholders to be better informed” about executive and director compensation.
Transparency is certainly a good first step. But it does nothing to address the underlying and deeply entrenched issue of executive compensation as a wealth-transfer mechanism. Assets get moved from shareholders to the C-suite.
A closer look at the underlying factors that led to these excesses reveals a complex situation, driven by numerous actors. Before we look at some of them, a quick reminder as to how we got here:
Roger Lowenstein’s book "Origins of the Crash: The Great Bubble and Its Undoing" describes the moment when executive pay went off the rails. In 1991, Heinz Chief Executive Officer Anthony J.F. O'Reilly received a then-eye-popping pay package of $75 million, almost all of which was due to stock awards. O’Reilly was the highest paid CEO that year, receiving the equivalent of about $130 million in today's dollars.
When we look around at various compensation packages today, it turns out that O'Reilly was just the beginning. Here's just a short list of gluttonous pay: GoPro founder Nicholas Woodman, $284.5 million; Discovery Communications CEO David Zaslav, who oversees the cable empire that includes the Discovery Channel, TLC and Animal Planet, $156 million; and perennial pay hog Oracle CEO Larry Ellison, $103 million. Next to these mind-boggling salaries it's almost beside the point to note the latest richly rewarded executive: Yahoo’s Marissa Mayer, whose $42 million in 2014 was 69 percent more than a year earlier. The chart below shows where Mayer ranks in the industry based on data compiled by Bloomberg (there may be some discrepancies between news reports and the table because of varying stock-option valuation methods -- but you get the idea) :
And here's a table of the highest-paid executives overall:
Why has pay for senior executives risen so much so fast? Here's is a partial list of the forces at work:
• Shareholder Value: Many trace the enshrinement of this idea to a 1981 speech at the Pierre Hotel in New York by General Electric CEO Jack Welch titled "Growing Fast in a Slow-Growth Economy." As Fortune reported in 2006, “Welch's words marked the dawn of the shareholder-value movement. And GE eventually became its star.” The article noted that Welch's report card was the stock price.
Since then, the credo of shareholder value has lost some of its luster. Analysts and corporate governance experts have derided it as misguided, for -- among other things -- encouraging short-term thinking and an obsessive focus on boosting stock prices. GMO UK Ltd. analyst James Montier issued a new white paper titled “The World's Dumbest Idea.” Cornell law professor Lynn Stout’s book "The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public" further diminished the idea.
If you really want to see examples of some of excesses that resulted from maximizing short-term shareholder value, just look at bank CEO compensation before the financial crisis. Despite risk-taking that temporarily boosted shares, these companies either failed or needed bailouts -- and all the while these CEOs were paid as if they were enormous successes.
• Stock Options: The original theory, related to shareholder value, was that aligning CEO pay with stock performance would also align management's interests with those of shareholders. This turned out to be a flawed thesis, on at least two counts.
The first flaw is based on a simple question: How much of any given stock’s rise is unique to the company itself or the actions of its CEO? Stocks participate in multidecade secular markets, and the actions of any one CEO are almost irrelevant. Look at how closely companies within the same sector are correlated to get a better idea of how much outside forces can and do drive share prices.
Rather than merely looking at stock gains, what makes much more sense is to base a compensation system on how much of the stock performance isn't attributable to the overall market and the company’s specific sector.
The second flaw is even simpler to understand. CEOs are hired by corporate boards on behalf of shareholders. They already get a healthy package of salary, benefits and perks to manage the company. It's absurd to claim that they require some extra incentive that results in an extraordinarily lucrative payday merely to do their job.
• Crony Boards: The cronyism of major corporate boards is a travesty. These rubber-stamp directors, often like-minded corporate peers, use shareholder money to enrich the CEOs who appointed them. The conflict of interest isn't hidden; it's right out in the open. Nor do the compensation committees of these boards serve shareholders well. That might be because they rely upon a class of outside advisers whose job it is to devise novel ways of fattening executive paychecks.
• Compensation Consultants: As noted above, these consultants give boards cover for these ridiculous compensation packages.
Don't underestimate the responsibility this group has had for supercharging executive pay. They function in much the same way that real-estate appraisers did during the housing boom: They offer no real analysis of intrinsic value, but instead devise models that feed off of and reinforce the upward spiral in pay.
• Mutual Funds: It makes no sense for someone who owns 100 or 1,000 shares to police corporate boards for pay excesses. However, the big mutual funds that own most of the shares should be operating on behalf of their investors. They have the staff, expertise and incentive to do what is clearly beyond the limited ability, time and affordability of individual shareholders. When you own millions of shares on behalf of third parties, you should be obligated to not only do the work, but also to vote your proxies and elect boards that represent the interests of shareholders.
All of which makes you wonder what good the SEC's new rules will do.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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Barry L Ritholtz at firstname.lastname@example.org
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