Executive remuneration is under scrutiny as public backlash from a series of blunders forces decision makers to take the stand. Is a CEO’s salary based on corporate performance or are some pushing up numbers when no-one is looking?
Gordon Gekko, the fictional hustler immortalised by Michael Douglas in Wall Street, Oliver Stone’s 1987 education in capitalism, has a lot to answer for. A character as crass and avaricious would be hard to find in real life, or so we thought at the time. In truth, the protagonist’s infamous line ‘greed is good,’ went on to epitomise an entire generation of traders and could now be said to reverberate around the offices of CEOs today.
Who can forget one of the more infamous remunerations of recent times – the $484m paid over eight years to Richard Fuld, former CEO of Lehman Brothers. The tycoon, who many believe deserves blame for the 2008 collapse, including Time magazine, was called “the gorilla of Wall Street” and in one year alone, raked in over $106m. Fuld still retains property in New York’s Park Avenue worth $21m, real estate in Greenwich, Connecticut, a holiday home in Juniper Island in Florida, as well as a lavish art collection reportedly worth millions. When he was questioned by US Congressman Henry Waxman at a hearing, and asked if he thought it was fair he was able to keep his vast personal fortune when so many people had lost so much, Fuld didn’t admit to doing anything wrong. He said he had in fact lost money, as his stock and shares in Lehmans were now worthless.
Another accoster is John Junker, top dog at Fiesta Bowl for over 30 years. He was unceremoniously fired in March 2011 after an in-depth investigation of his spending habits, which uncovered a variety of cover-ups and fraud. In September 2008, Junker went to a strip club in Phoenix, Arizona, with the intent to entertain some clients. The festivities culminated in a bill for $1,241, which was written off to his company. Junker tried to convince investigators that there was a legitimate business purpose for the visit: “We are in the business where big strong athletes are known to attend these types of establishments. It was important for us to visit and we certainly conducted business,” he said at the time of the enquiries. However questionable this write-off might have been, Junker couldn’t excuse his actions of funnelling money to politicians, and side-stepping the bill for his 50th birthday – a four day soiree that cost over $33,188, charged to Fiesta Bowl company accounts. “One of the most powerful figures in college football,” according to Sports Illustrated, secured his own demise.
Of course these are just two examples of self-indulgence gone mad. The daunting truth is that CEOs rewarding themselves with pay packets, bonuses, corporate gifts, stocks, shares, and incentives is a widespread phenomenon, spiking its hooks in to every continent in the world. The question is how this culture came to be, and whether any other party now has the influence to stop it.
Rewarding ‘special talents’
CEO pay is not as cut and dry as one might think. There are many different types of executive compensation, and the ways in which CEOs are remunerated for their work are vast and varied. Indeed, while some critics firmly believe the way CEOs are paid is inequitable, and possibly corrupt, there are others who believe it is part and parcel of the culture of being linchpin of a company; there are certain perks they are entitled to that go hand in hand with the rigours of the job of running a major company. Others believe that CEOs are worth the amount they are remunerated, but that some take advantage of their situation when in power for a long time.
The board of directors ultimately decides how chief executives shall be paid, typically through a mixture of a high figure salary; shares of and call options on company stock; perquisites like the use of a private jet, limo, corporate credit cards and club membership; benefits; as well as hefty retirement packages. The Wall Street Journal said 68 percent of CEOs had personal access to a corporate aircraft in 2011, according to a report from consulting firm Hay Group, and Las Vegas Sands Corp spent a reported $2.6m on security for their CEO Sheldon Adelson.
There are often long-term incentive plans (LTIPs) written into contracts that encompass all compensation tied to performance for tax purposes, including deferred compensation, where payouts to CEOs will be claimed at a later date, but one of the more controversial types of remuneration is the ‘golden parachute,’ which some CEOs have locked into their contract – entitling them to cash bonuses or stock options once they leave the company, or if a job is lost due to a takeover. It was widely reported former CEO of News International Rebekah Brooks was awarded a £5.6m payout as part of her golden parachute clause, and despite losing 40 percent of stock value during the five years he was in charge, Henry McKinnell, former CEO of Pfizer, walked away with a cool $180m in 2006.
Tony “I would like my life back” Hayward was awarded a total of $18m when he stepped down from the helm of BP after the 2010 Deepwater Horizon spill disaster that claimed 11 lives and has since churned out around 100 million gallons of oil in the Gulf of Mexico. And most recently in early July, Bob Diamond resigned as CEO of Barclays amid the Libor scandal. At the time, BBC political editor Nick Robinson said: “Libor is to banking what the Milly Dowler case was to phone hacking.” Diamond has since reportedly turned down £18m in bonuses.
However, Businessweek editor Rebecca Reisner believes “to criticise golden parachutes is to mock a free-market economy,” and the reason why CEOs are entitled to high levels of compensation is because they have the leadership skills to back up their asking price. “The Tigers, Oprahs and Barbra Streisands of the world command top dollar because they work hard to make the most of their special talents and possess the savvy to market themselves for maximum profitability,” she said. “Ditto for CEOs.”
The 686 percent conundrum
A number of analysts have refuted the notion of CEO remuneration as a meritocracy, saying it ultimately comes down to a cosy relationship between the CEO and who decides how much they get paid. Reporting on an Economic Policy Institute study in July 2010, the New York Times said corporate boards “routinely use compensation peer groups to artificially inflate pay for their chief executives,” and “pick out other overpaid CEOs and use them as examples of why they need to overpay their own.” This system of corporate governance is all a process in which companies are directed and controlled, where associates are already very familiar with each other – and sit on each other’s boards.
Senior producer of MSNBC John W Schoen explains: “Corporate boards usually include a subset of the board called the compensation committee. The problem is that many corporate directors, so called ‘inside’ directors, report to the CEO. So their judgement is not exactly impartial. There is not a lot of evidence that CEOs with pay packages larded with goodies do a better job than those with more modest paycheques. CEOs pack their boards with friends and cronies, so the board’s final decision is not always, well – above board.”
Senior editor of Forbes Neil Weinburg explained in a report with ABC’s Nightline in 2008: “It’s all very incestuous. People are on each other’s boards; they’re hired by the chief executive, and they’re happy to be part of the club. Being a CEO in corporate America is great work, if you can get it.” In 2010, Carola Frydman of MIT and Raven E Saks of the US Federal Reserve published a report that found CEO pay hardly increased at all from the 1930s up to the 1970s, at a time when raises were based on annual performance. Since then, it’s risen by 686 percent.
Terry Smiljanich, from The Consumer Warning Network reported there was an 11 percent increase on CEO wage in 2010, an average of $9.3m awarded by their respective boards of directors, and asks: “When did CEO compensation turn into pure greed?” According to the annual Executive Excess report from the Institute for Policy Studies, the average S&P 500 CEO makes over $10m each year, which according to an analysis from the Associated Press, is up more than six percent from 2010. UK Business Secretary Vince Cable condemned these figures in a 2011 Department for Business, Innovation and Skills (BIS) report: “Ridiculous levels of remuneration are going unchallenged as the norm, when there is no clear evidence of a correlation with performance,” he said. “At a time when real wages are being squeezed, it is right that we ask why this is happening.”
Associate fellow at IPS Salvatore Babones explains why CEO pay grows at such extraordinary rates every year – it’s all due to a multi-million pound game of leapfrog. In an article for inequality.org, he says the process of evaluation and comparison to other CEOs at successful companies is carried out by the corporate boards. “They leave out failed officers and bankrupt companies, and find their CEOs to be slightly better than these already better-than-average peers. As a result, they leapfrog their executives’ pay to the top third of the industry pack; the next year other boards leapfrog their executives and so on, and so on.”
Babones believes CEOs’ high pay cheques all result in a ‘Lake Wobegon effect’ – a natural human tendency to overestimate one’s capabilities, thanks to inadequate corporate governance, and pay benchmarking. “The effect runs especially strong in companies that hire pay consultants to benchmark their CEO’s salaries against others in their industries,” he said. “Companies that use pay consultants pay their CEOs more and pay them more in stock, compensation that’s less visible in company accounts. These effects appear even after appropriate statistical controls have been made for company performance and CEO experience.”
The lifeblood of the economy
American business magnate Warren Buffett believes CEO pay got out of control because there is an unbalanced set of incentives. “Some CEOs cannot bear the idea that they are not getting the same money as others,” he said on his blog channel in 2011. “As CEO compensation rises across the board, they use that as a bargaining tool, and so the salary continues to get ratcheted up. No company wants to be in the bottom quartile as far as CEO pay goes either. Envy is a huge factor – it’s bigger than greed.”
Sir John Buchanan and former CEO of BP believes CEOs are driven by status and fault primarily lies with US investment banks: “I think it’s got to a level that’s basically unsustainable,” he said. “If you keep having higher and higher multiples of CEOs versus. the average labour workforce, what are we doing? It’s not the money; it seems to be the amount. It’s got out of control, and the boards need to be more robust in their approach and need to take a more honest line.”
However, there are a number of analysts who criticise the culture of vilification that CEOs seem to endure when handed their pay packets. Broadcaster and host of independent blog Your Biz, Randy Thomas said he’s ‘sick and tired’ of hearing that CEOs get paid too much money. “Most people have no idea what it takes to be a great leader, or what it takes to lead a multinational company. Not to mention the stress it takes on their family life, their health, or the pressure they place on themselves every day to excel. In our society, compensation and pay is based on education, experience, and past performance. Any job earning more than minimum wage is based on this principle. It’s not enough of an incentive to work to say compensation be based solely on performance. If companies thrive, it is based on their leaders – don’t ever make the mistake of thinking anything else.”
“CEOs rightly consider their skills to be in demand,” agrees columnist Holman W Jenkins, writing in the Wall Street Journal. “Boards can’t just ignore this consideration and hope to get and keep the executives they want.” There is also a strong argument CEO pay is designed to benefit society and capitalism keeps the economy ticking over. Rudy Giuliani said that when he was Mayor of New York, Wall Street bonuses ‘balanced his budget’. “They are wonderful from the point of view of getting the money you need to run New York City, particularly when they were paid in cash rather than stock,” he told Fox Business News. “It contributes to the life blood that makes our economy work. Wall Street is enormously vital, not just to New York, but the world economy.”
Adjunct professor at Harvard Business School Raymond V Gilmartin also believes CEOs have an important role to play in the system. “Shareholders benefit most when CEOs and boards maximise value for society and act as agents of society rather than shareholders,” he said in a 2011 blog for the Harvard Business Review. More than ever, wealthy CEOs seem to be aware of their responsibility to society. PNC Wealth Management recently surveyed 555 millionaires and found that 83 believe ‘those who have attained the kind of financial position I have’ should keep investing by way of societal improvement, into various business and industry. The survey also found 24 percent had donated more than $25,000 to charity in 2010.
Allegations of tax dodging
In a 2011, Daily Conversation reporter Bryce Plank said the American tax code needs changing after it emerged 25 of the 100 highest paid CEOs earned more in 2010 than their companies paid in federal income tax from information released from the Institute for Policy Studies. The think-tank said that some of the US’ highest paid CEOs ran companies which were dolling out more in salary than their reported tax expenses, and were reporting global profits of, on average, around $1.9bn that year.
“In a clear sign the US political system favours the wealthy and the corporation over societal prosperity, many of these companies also spent more lobbying political officials than they paid in federal taxes,” said Plank. “Ebay’s CEO John Donahoe made $12.4m but his company reported a $131m refund on its 2010 taxes. Boeing paid just $13m of its profits back in 2010, but showered its CEO with $13.8m. And lastly, General Electric – one of the biggest corporations in the world – gave its CEO Jeff Immelt $15.2m, and received a staggering £3.3bn dollar federal refund.”
Plank stressed IPS “offers an analysis of the various financial policy reforms that lawmakers can enact to rectify the runaway executive pay structure that incentivises CEOs to seek short term gains over longer term corporate stability.” At the time, the Institute said there needs to be a huge rethink of the US tax code due to the findings of their investigation, and a serious overhaul in companies’ abilities to lower tax payments by sending their profits to other countries overseas. In an interview with Bloomberg, one of the authors of the report, Chuck Collins, said: “Tax reform has to close up some of these loopholes and the offshore system. We might be able to lower the overall corporate rate by broadening the base.”
Reuters reported several companies mentioned in the IPS report ‘took issue with its methodology and said they paid all taxes owed’. General Electric spokesman Andrew Williams called the study ‘inaccurate’ and said: “GE pays what it owes” and Boeing spokesman Chaz Bickers said: “the study is simply wrong,” and “on federal cash tax payments (in 2010) we paid in the hundreds of millions”.
Paying for poor performance
Since the 1990s, there has been a huge drive towards ‘pay for performance’ for CEOs but in 2008, ABC analysed why corporate top dogs were reeling in massive pay cheques, even if they were doing a pretty mediocre job. Neil Weinburg compared these actions of corporate boards akin to “a fourth-grade soccer team, where everybody gets a prize. Often a very expensive prize”.
ABC reporter Dan Harris found some of the bigger company players in the US were essentially being paid for failure. “The worst performing CEO in the country is Angelo Mozilo who raked in $66.4m a year, while his company Countrywide nearly collapsed, along with the country’s lending market – dropping an average of nine percent a year,” he said. “Mozilo was under federal investigation after selling hundreds of millions worth of shares in Countrywide stock, much of it before the company’s stock price tanked, and has emerged as the poster-boy for pay- for-failure.”
Neil Weinburg explains it was Mozilo’s modus operandi people found most egregious. “He was selling all this stock while his company was buying it back, and using shareholder money to do so, and earning so much in the process, $112m a year,” he said. Harris went on to say: “Shareholders should be able to vote for who sits on the board. We have something more akin to Putin in Russia at the moment, rather than a representative democracy.”
In June, founder of Pro-Business Against Greed, Sir Michael Darrington told The Observer he despised the ‘because I’m worth it’ attitude and said it was “essential politicians and legislators bear down on these excesses – through encouragement, threat and legislation”.
It could be argued that if the 2008 financial crisis had not happened and austerity measures not enforced in so many countries the extravagance of CEO pay packages would not have received so much attention. It is only when those on middle-to-low incomes get squeezed that eyes are drawn to those better off. But how payment packages have got so out of hand is inexusable. Sir Michael offers a solution: “There should be three elements of remuneration: basic pay for doing a good job – the sort of good job one would expect of the average chief executive – an annual bonus up to a maximum of 100 percent of salary for a truly exceptional performance, and grants of shares to match an individual’s investment in shares, made out of their bonus. To encourage long-termism, these shares should vest between seven and 15 years, and not be saleable until three years after they have retired or left the company, adding: “Politicians and legislators, as well as company boards and investors must keep up the pressure if we are to reduce this gross inequity which has grown up in our society.”
Unless shareholders really have the power to bring CEOs to account if they behave immorally, or until some standard universal code for ethical capitalism is installed, perhaps something similar to a doctor’s Hippocratic Oath, it’s likely the debate for remuneration is set to run and run. However, companies will always need a leader to guide them, and these chiefs will always expect to be properly rewarded. Despite his deplorable character, Gekko does speak some home truths when he tells his protégée Bud Fox it’s time to get back to work: “Money never sleeps, pal.”