The result is the great CEO pay boom. Between 1980 and 1990, cash compensation (not including stock options) of CEOs of major U.S. companies rose 156 percent, reports the consulting firm Sibson & Co. Meanwhile, the average compensation of U.S. workers rose 65 percent. A CEO of a big company now makes $1 million to $2 million in annual salary and bonuses. This is 50 to 100 times the pay of the average worker. In Japan, comparable CEOs earn 16 times the average salary, reports pay expert Graef Crystal.
Payouts are even more astounding when stock options are considered. In 1990, Steve Ross, the cochairman of Time Warner, was paid $74.8 million for his options in the merger of Warner Communications and Time Inc. Fair compensation, Ross says, for the value he created at Warner-and then he got new options to replace the ones he just sold. (Options give an executive the right to buy the company’s stock at a fixed price. Once the stock exceeds that price, the excess is profit.) Typically, CEOs receive options annually worth 30 to 50 percent of their salaries.
What’s wrong here is not the mere bilking of the company: for the firm, the extra payout is fairly small even though it is large for the CEO. (This, of course, is why abuse is widespread and easy.) The real harm is that CEO selfishness undermines U.S. business. To succeed, a company requires a sense of shared commitment among its workers. Instead, the CEO’s message is: hey, I got mine. This spawns cynicism and indifference even among would-be executives–that can hurt a company in dozens of ways from slipshod workmanship to unnecessary costs.
Consider a poll by Industry Week magazine of its readers, mainly middle managers. The survey found that 84 percent think U.S. CEOs are overpaid. “Executives should be willing to set examples,” one middle manager said. “But instead they take bonuses while their employees lose jobs.”
The CEO’s great advantage is that he runs his own welfare department. He doesn’t have to break the rules, because he makes them. CEO pay is set by friendly boards of directors, usually following the advice of “compensation consultants” hired by the CEO. The consultant’s role is to lend “objectivity” to a process that would otherwise seem totally self-serving. The consultants crank up surveys of other CEOs’ compensation, and there’s enormous pressure to interpret the data to justify higher pay.
“If the CEO wanted more money, and I didn’t want to recommend [it] to the board … well, there was always a rival compensation consultant who could be hired,” writes Crystal, who was a consultant for 20 years, in a new book (“In Search of Excess”). What results is a perpetual motion machine for higher pay. Most CEOs want at least their industry average-and many seek much more.
Watch how this works. Consider five CEOs in the same industry. One is paid $1.5 million annually, three receive $1 million each and the last is paid $500,000. If the CEO making $500,000 thinks he should be paid the average ($1 million), then the average will jump to $1.1 million. Now, the other CEOs will want raises to maintain their previous relative positions. So the average jumps again. We’d all like our pay to be set this way.
The surveys are bogus. They presume that underpaid CEOs could easily jump to better-paying CEO jobs. Although a few could, most couldn’t. First, openings are scarce. Second, many CEOs wouldn’t be hired. Some are simply bureaucratic survivors; others have skills that are limited mainly to one company (its workers, customers and products). CEOs are not like baseball players or movie stars who have demonstrable moneymaking powers. Nor are they like engineers or secretaries whose compensation is set by a genuine market process. Higher pay isn’t needed to entice people to head big companies. If IBM’s chairman resigned tomorrow, plenty of qualified candidates would want the job–even at half the pay.
Boards of directors could bring sanity to this process by dispensing with the silly surveys. Instead, CEOs should submit a pay request that answers four questions:
What should you be paid? (If you want to hire a consultant, go ahead–at your expense, not the firm’s.)
If you left the firm, what could you earn and where?
If you died today, who could take your place? (Is she or he well prepared? If not, why not?)
What is the lowest compensation you would accept? (Please attach a letter of resignation in case we offer less.)
This way, CEOs would have to put a price tag on their jobs–and risk dismissal if it were too high. They’d also have to face a basic question: have I groomed a successor?
Top executives ought to be well paid for good performance, but today’s pay packages don’t do that. Most stock options are giveaways that lavishly reward even mediocre performance and supplement excessive cash compensation. One remedy is to convert some of the boss’s annual pay into restricted stock: shares that couldn’t be sold for a number of years. The CEO’s pay would be tied more closely to the company’s fortunes, argues Seymour Burchman of Sibson & Co. As the stock rises or falls, so would CEO pay.
“Every field has its abuses,” says Bruce Atwater, the CEO of General Mills. His point is that some excesses don’t merit branding every CEO a crook. True. But what he won’t acknowledge is that most CEOs receive blatant favoritism, and the glaring excesses merely illuminate the system’s basic flaws. There’s no inclination to correct them. Lobbies like the Business Roundtable oppose steps that would make it easier for dissident shareholders to challenge the clubby ties between directors and CEOs.
This isn’t surprising. If you ran the welfare department, would you surrender control? But it bodes ill for U.S. business. Companies increasingly ask sacrifices of their workers. It’s hard to expect cooperation when the guy at the top, while preaching sacrifice, isn’t practicing it.
