Why CEO pay ragers can't change the system

Posted Apr 6th 2008 9:20AM by Peter Cohan
Filed under: Earnings Reports, Management, Law, Citigroup Inc. (C), Merrill Lynch (MER), Rich in America, Politics, Presidential Elections

Today's New York Times is buzzing with outrage over rising CEO pay. It trots out the usual suspects -- I'll call them pay ragers -- to rail against public company CEOs who get paid more and more each year regardless of company performance. But despite years of outrage, these self-styled pay ragers backed, in part, by union pension funds are not getting the results they seek. And due to their lack of political clout, their outrage is likely to persist.

The problem seems to be that CEO compensation is going up because performance-based compensation is not a big enough part of the total. As a result, even though performance-based compensation goes down, total compensation rises because the bonuses given at the board's discretion are bigger than the ones linked to performance. In 2007, average compensation for CEOs who had held the job at least two years rose 5% to $11.2 million. To be sure, performance-based bonuses were down in 2007, but the value and prevalence of discretionary bonuses rose.

It seems that pay ragers want CEOs to make less money if their companies don't perform. The Times quotes a Calpers portfolio manager who said, "We're not against pay. But we are certainly against pay for failure, or for just showing up." But it's more than that. In an election year, shareholder activists are hoping to tap into a deep vein of populist sentiment to enact policies that will narrow the pay gap between CEOs and their workers.

Ironically, the New York Times lets former Nixon speech writer Ben Stein make this populist case. He cites Congressional Research Service statistics that "average pay for chief executives stood at 179 times average worker pay in 2005, up from a multiple of 90 in 1994. Adjusted for inflation, average worker pay rose by a total of only 8 percent from 1995 to 2005; median pay for chief executives at the 350 largest companies rose 150 percent."

Stein and the other pay ragers can be secure that the conditions that outrage them will persist. And that's because they lack sufficient political clout. If pay ragers could make larger donations to politicians running for election than public company CEOs, they would be taken seriously. But our system gives us the best politicians money can buy. The most skilled among them seek votes by appearing to sympathize with the pay ragers' populist anger. But they still take the corporate money to finance their campaigns.

It's just not clear that there's much of a constituency for politicians to legislate how much money CEOs make. Meanwhile, Stein is right that public company boards are a CEO club that protects its members. But as we saw in the cases of Merrill Lynch & Co. (NYSE: MER) and Citigroup Inc. (NYSE: C), CEOs who put their companies in enough financial quicksand can get summarily thrown out of that club.

That's because the risks that a CEO needs to take to remain in the club these days are immense. With pressure each quarter to beat earnings estimates and raise guidance, CEOs are increasingly taking the blame when the risks they take to satisfy those expectations fall flat. CEOs are well-compensated for living with that pressure. And the ones that succeed should be well compensated.

The CEO club does have a sort of rough justice. Recent CEO firings suggest that the ones who make enormous errors lose their jobs -- in some cases getting booted out with saddlebags loaded with huge severance packages. It's the ones in the middle who make out a little better than they should who stir the pay ragers. But unless their political clout rises dramatically, things will stay pretty much as they are.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citigroup shares and has no financial interest in Merrill Lynch.

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Reader Comments (Page 1 of 1)

4-06-2008 @ 12:11PM

Chris said...

It seems to me that the only people hurt by excessive executive compensation are 1) shareholders of the company, and 2) employees of that company. Both of those relationships are easy to get out of 1) sell your stock or don't invest in the first place, and 2) quit, or don't accept a job with the company in the first place. If no one invests in or works for companies that pay outrageous executive compensation packages, and the boards understand the reason why they can not attract equity or quality employees, then they will adjust to remain competitive.

While there is nothing wrong for empathy towards other shareholders and employees "wronged" by boards of directors, I am convinced that most outsiders who take up the "pay rager" stance, as you put it, are simply jealous. After all, what percentage of the US workforce has a large stake of their own compensation tied to their performance?

I'm not saying there aren't egregious cases of the Board of Directors not doing its job properly, but most who complain don't have a dog in the fight.

Chris

4-06-2008 @ 11:02AM

alan said...

Let's forget about the extremes at both ends of the CEO pay scales for a moment. If all of the excesses of all of the mediocre CEO's was aggregated, I wonder how many THOUSANDS of employees could have remained employed, rather than getting axed in the name of holding down expenses.

Life is tuff and caretaker CEOs will just have to learn how to live on a few million a year. If they can't make it on that paultry salary, well, there is always public assistance

4-06-2008 @ 3:32PM

william lindblad said...

CEO payscales are often outrageous and this is disliked by far more that your so called "pay ragers". I am not one of them nor am I a major shareholder in any company. This does not change my opinion. I have no objection to compensation, even what is deemed excess, to any business leader who produces, both to shareholders and employees. I can't see the opposite, and neither can the rest of the world. This was the realm of the board of directors, but they have been negligent in their duties. Will this change? Probably not. It is both too easy and lucrative for both the board and their selected leaders to join forces. As others have suggested the only options are for shareholders to sell and employees quit ,is a nonsense scenario but it makes a point.

4-07-2008 @ 10:08AM

Frank said...

The rationale that Mr. Cohan gives for supporting obscene CEO salaries is the pressure they are under to beat earnings estimates and raise guidance each quarter. We would all be better off if CEOs and analysts such as Mr. Cohan focused instead on their success in building the long term value of their companies.

4-07-2008 @ 3:07PM

prousa217 said...

so, Mr. Cohen, the motivation comes down to you said "....That's because the risks that a CEO needs to take to remain in the club these days are immense..." Therefore, it is okay to sink a company than losing a CEO membership? What do you teach the kids who staying in college so they can make more money theory? That it is okay to collect big bonus even if you do not perform? So, your students do not perform in final exam it is alright to pass him??!!???!?!?!??!?!?!?!??! Where were you brought up?