Can We Put the Brakes on CEO Pay?

By Brown, Donna | Management Review, May 1992 | Go to article overview

Can We Put the Brakes on CEO Pay?

Brown, Donna, Management Review

It's a popular rallying cry these days that American CEOs are overpaid. There's Anthony O'Reilly, charismatic chief of H.J. Heinz, whose 1991 pay, including exercised stock options, totaled roughly $75 million; then there's Time Warner's Steven Ross, who garnered $78.2 million in 1990; and John Sculley of Apple Computer, whose 1990 compensation topped $16 million.

Fat pay packages abound across corporate America and, frankly, shareholders and the general public are getting fed up. According to Graef Crystal, a compensation consultant and author of In Search of Excess: The Overcompensation of American Executives, while the pay in real dollars of the average U.S. worker has decreased by roughly 13 percent over the past 20 years, CEO pay has more than tripled. During the new proxy season this spring, the problem may seem to get worse instead of better. "Because of the bull market last year, more CEOs will want to exercise their stock options," says Dayton Ogden, CEO of Spencer Stuart, an executive search firm. Companies have no choice but to pay up.

But media hysteria over the numbers has drawn attention away from the key question in the CEO pay debate: To constructively decide what's fair pay, corporate America must focus not on how much CEOs are paid, but on how that pay is determined.

Unfortunately, current compensation practices often have little to do with the executive's performance. "The major corporations have determined that CEOs deserve pay raises in good years, and they do [deserve them]," says Sharon Cayelli, director of membership of the Council of Institutional Investors. "But those same companies also give their CEOs raises in bad years, under the guise that if the chief isn't paid well, the company will lose him."As a result, even nonperforming firms are shelling out millions to retain the boss, shocking long-time observers of corporate America. "I've never known anyone worth $7 million or $8 million," laments management guru Philip Crosby.


Just how have American CEOs landed themselves such a good deal? Much of the blame lies in the bull market of the '80s. At the beginning of the decade when the market was weak, companies by the dozens set up generous stock option programs to encourage CEOs to increase the value of company shares. Basically, stock options work like this: The CEO is granted the option to buy a certain number of shares--say 100,000-- any time in the next 10 years at the price the stock was selling for on the day the options were granted. If shares were going for $40 when the option was granted (this is called the "strike" price), and are selling for $60 two years later, the CEO could immediately realize $2 million by exercising his or her options.

The problem with this practice is that the market grew so quickly that even mediocre companies-- and their mediocre executives-- were swept along in the wave. Since executives are routinely granted generous stock options as part of their pay, stock options have increased overall CEO compensation substantially across the board. Even a CEO as alert as Rip van Winkle could prosper.

How were boards of directors able to rationalize these exorbitant pay packages? "It's not coincidental that some of the real CEO pay outrages came at the end of the takeover era," says Nell Minow, president of Institutional Shareholder Services Inc. (ISS), and author, with Robert Monks, of Power and Accountability "During the takeover era, CEOs were paying bankers and investment lawyers enormous amounts of money--that made the world safe for eight-figure salaries."

In addition, most companies hire a compensation consultant to analyze where the CEO stands, paywise, in the fold, and make'a recommendation on the CEO's salary. Critics claim that these consultants are biased because the company--led by the CEO-- is footing the bill.

"A lot of rationalization goes on," Crystal writes, "and a lot of high-priced talent is retained to prove a conclusion that the CEO has already made. …

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