Friday, August 29, 2008

Executive Compensation

Shareholder groups, a number of politicians, financial analysts and many members of the media have justifiably been criticizing what's felt to be excessive executive compensation for several years. The criticism is especially understandable at a time when millions of average middle-class working Americans have lost their jobs, the economy has been weak, hundreds of thousands have or are about to lose their homes, are struggling to pay their bills, and are very worried about financing their retirement. Why is this an issue worthy of debate? It's because it's usually harmful and not fair to the other shareholders, and can be harmful to the company. Also it looks bad, can damage morale among the other employees and can bring negative publicity to the company, as well as potentially adverse attention by regulators and legislators.

Supporting information is that the median CEO compensation in 2005 was a total of $13.5 million, compared to something like $50,000 for the average worker. In 1991 the average large company CEO earned 140 times the average worker, whereas in 2003 the average CEO received 500 times what the average worker made. Does that sound reasonable and fair, a step in the right direction?

I was reminded about this issue when I read an article in the L. A. Times this morning about the $72 million compensation package awarded to CEO Larry Ellison of Oracle Corporation, the $18 billion revenue Redwood City, California headquartered multinational company specializing in business software products, especially database management systems. As is quite common for CEO compensation packages, a high percentage of the Ellison package, about $59 million, was represented by the value of stock options granted. What was a little unusual, perhaps, was that Ellison requested this package from his company's three person board of directors' compensation committee. Officially they approved it because they thought it was reasonable and justified. However, I'm sure they didn't want Ellison to be unhappy, given his strong control of the company and their likely happiness with their own compensation arrangements, which Ellison is undoubtedly in a position to change.

Notable examples of past excessive compensation packages include the $141 million received by Reuben Mark, the CEO of Colgate-Palmolive some years ago; the $139.5 million retirement package awarded to Dick Grasso, the Chairman & CEO of the New York Stock Exchange back in 2003; the $153.8 million awarded to James Kilts, CEO of Gilette, for supporting the big merger with Procter & Gamble; and the $570 million by Michael Eisner, CEO of Walt Disney, earned in 1998 through exercise of millions of stock options granted him.

One of the challenges facing critics is clearly defining what is excessive when to comes to CEO compensation packages. As a benchmark I would submit that any amount above $10 million annually, except in some rare extraordinary circumstances, should at least tentatively be termed excessive. Another thing is that the government doesn't have any authority to approve or disapprove compensation packages in the private sector. It's up to the the company's board of directors or its compensation committee in the case of CEO's and to the CEO and his fellow executives in the case of workers, unless a union contract governs worker salaries and benefits.

What's happened recently? Since the many, widely publicized compensation scandals over the past ten years, the SEC has mandated much more disclosure of compensation packages for the top executives. That development, plus embarrassment of board members at the negative publicity, and increasing pressure by larger shareholder groups, has led to a great deal more sensitivity by boards and their compensation committees to work towards curbing blatant excesses. One type of generally unjustifiable excess has been the practice in many cases of approving bonuses and salary increases even when a company has reported operating losses and had had a poor year or barely broke even in a mediocre year.

Another development was the passage in the House of Representatives in April 2007 of H. R. 1257, the Shareholder Vote on Executive Compensation Act. This mandates that public companies must ensure that shareholders are allowed an annual nonbinding advisory vote on executive compensation plans. This also applies now to a situation where a company awards what's called a "golden parachute" package (a great deal) when negotiating the purchase or sale of the company.

What else is being discussed, or could be done to limit excessive compensation, aside from more pressure from larger shareholder groups and the media? One thing, quite likely under an Obama Administration and a Democrat controlled Congress, is higher tax rates, perhaps including an alternative minimum amount, and higher capital gains taxes, for peole earning more than, say, $250,000 annually. Another significant development would be legislation limiting the compensation amounts that would be deductible as an expense for the employer for corporate income tax purposes.

1 comment:

Thomas Dale said...

The amount of compensation some CEOs get is completely insane. While they do have more responsibility, it isn't like they don't have a team of others helping them achieve their goals. Especially if a CEO is leaving a company worse off then he found it, it just doesn't make business sense that he gets rewarded for it. However, I don't think you can put a cap on what they should get paid. I'm sure there are some CEOs that are worth what they get. Tough to create any kind of blanket policy.