Ratcheting Up CEO Pay -- Or Competing For Talent?

If you were on the compensation committee of a public company board how would you set the CEO's pay?

There is so much written about fat cat CEOs and their unfair pay packages that this is a question worth pondering (if you care). The really hard part about it is judging what is a) fair, b) necessary to get the talent you want and c) the market.

One tool compensation committees use is the "peer group." This is the list of companies that are "like" your company. They are supposed to be similar in size, similar in market reach, something you can compare with to figure out what your CEO should be paid. But as the Wall Street Journal points out recently, the very use of the peer group can cause CEO pay to ratchet up.

The problem goes like this. Most companies are planning to grow and want to have a CEO that can grow the company and make it larger and more competitive. As a result, they pick peer groups that, while they have some companies that are smaller, include many companies that are larger, and have higher paid CEOs than the current executive -- two studies cited by the Journal confirm this. (The SEC only started requiring companies to publish their peer groups in 2006, so there is now enough data for the pundits and researchers to start to dig.)

At the same time, over 40 percent of companies say that they want to pay their CEO's above market average -- numbers like 60 percent and 75 percent of market are often used.

So, if your peer group is larger companies where the CEO pay is higher, and you want to pay your CEO above market, you will take CEO pay up. It's a compounding phenomenon.

Sounds like a conspiracy, right? Well, sitting on two very quality compensation committees, I can tell you from experience it isn't. It's a very real challenge for boards to figure out the right level of pay. High enough to attract a great CEO who can take the company on the growth journey you want (which takes both smarts and courage) and not so high that it hurts the financial results of the company or creates too great a gap to other executives and the employees.

The good news is the peer group is just one tool we use. We also look carefully at internal executive pay to make sure we are not creating an internal problem, and more importantly at the job the CEO is doing and how he is conquering our strategic objectives.

Most senior executives' compensation is now made up of three major components -- base salary, variable bonus based on company performance, and some form of stock (stock options or restricted stock grants). Having these levers allows the board to align the CEO's pay directly with the interest of the shareholders. This has happened to most technology companies over the last year -- there are very few bonuses being paid because performance hasn't been there as a result of the recession.

Of course you do still see companies that offer their CEO compensation that doesn't seem very aligned to shareholder interest to me: use of the private jet, special health care, tax advice, golf club membership, etc. -- and even a key to the executive washroom. Something I don't understand, but I guess I am an egalitarian when it comes to building company culture.

Follow Penny Herscher on Twitter: www.twitter.com/pennyherscher

Comments

[Gover]

As a current CEO making an outrageous salary I think it's important for people to understand one or two things about me before passing judgment on my outrageous salary and ridiculous benefits.

The first is that absolutely no man, living, dead, or yet to be born can do my job. I'm the only one. When I'm dead and gone you will all be like ronin, wandering the countryside aimlessly, your lives stripped of all meaning. Many of you will take your own lives and the lives of your children for a chance to join me in the hereafter immediately. The inevitable manic searching for a replacement Lord to serve has no chance of succeeding and once this is accepted self destruction is the only reasonable course of action.

The second is that the poor disgust me to such a degree it can be medically classified as an extremely serious allergic reaction. Projectile vomiting is the most common symptom whenever I touch, smell or see anything shabby or non-luxurious. A man on the street brushed up RIGHT AGAINST me once and I had to lock myself in my penthouse vomiting for days, heaving for so hard and for so long that all the vessels in my eyes burst and I looked liked I'd lost a fist fight. I must remain isolated at all times from the vile paupers which roam the streets like cockroaches at all hours of the day and night.

[schatsie]

Wow great post!

[userw014]

Defending the indefensible by claiming:

(*) This is the way we've always done it.

(*) We're all above average.

(*) We want to buy an above average CEO

(and, secretly: "We've got to pay the new guy more than the old guy".)

[BP1]

Oh, please. While Penny does a good job of presenting her point of view in this well-written piece, reading it and the comments only reinforces my opinion that our system of executive selection and compensation is ridiculously corrupt, flawed and harmful.

Who can't see the inherent problems with having the majority of the members of compensation committees drawn from the same high-paid privileged peer group, rather than talented, well-educated middle-class people? That in itself, and the cycle of "competitive" compensation it creates, are enough to invalidate the whole system.

I've known a number of CEOs, and a much larger number of extremely capable people who could be good CEOs, if given a fair opportunity. Are you really telling me companies can't find able leaders who will work for less? I bet if you set pay and benefits at a reasonable level (e.g., 11x that of the average worker), you'd still have many great candidates apply. If they want to make more, they can raise performance and employees' salaries.

I also agree with raising taxes on compensation above a certain amount, and removing the caps on payroll deductions. As we hired more "normal" CEOs who lacked the callous greed and inflated expectations of their predecessors, these changes would create downward pressure on CEO pay, and employees would be better off.

Let's use our vast majority to end this disgusting system and and bring about some long-overdue changes and fairness in this country.

[schatsie]

Exactly, I want to see the tax rates where they were under Ike....91% for all income over 1 milllion and forget about the inflation factor, we have been screwed so badly for the last 30 years, and they can afford it....and cap deductions to 50 grand, after all that is what the median family income is and I don't see why they need the deductions...Let them watch their pennies like the rest of us.

[jinsei]

Oh dear Penny, please stop defending the indefensible.

American CEOs make more money (often 200-300x more) than CEOs anywhere else in the developed world, and you dare say that there are no companies equally, if not more competitive than any of the Fortune 500 companies? That's what you imply anyway.

http://www.nytimes.com/2007/06/21/automobiles/21nissan.html?ex=1340078400&en=3aacc70c99118bb4&ei=5088&partner=rssnyt&emc=rss

[Frank Smith]

Companies that go after free agent CEOs run the same risks as sports franchises do when they pursue big ticket UFAs, getting ripped off. With the athletes, it's usually because they had passed their prime or injuries slowed them down. With the CEOs . . . they were just never that good.

[JustThisGuy]

Even with peer based compensation, for all but the largest companies, it might also be insightful to look at compensation for peer equivelent divisions, and see what the rates are for equivelent responcibility without the CEO title.

[Senzasord]

Four thousand dollars a minute. Four thousand dollars a minute. Some of these executerrorists earn up to four thousand dollars a minute. Nobody and I mean nobody has talent that would enable them to earn four thousand dollars a minute. These leeches should be treated to an extraordinary rendition to the South Pole in June under the Patriot Act or presented with a huge bundle of toxic assets as a bonus. They have caused the ruination of this country and now expect to be rewarded for it by being handed the key to the U.S. treasury.

[DiogenesOfAlaska]

A much simpler criticism consists in pointing out that

- if by some cosmic coincidence you can find somebody who is actually able to earn four thousand dollars a minute,

-then how do you know he wouldn't work for $3.995 a minute? Or even, let's say, for $2487?

The point is that the mechanism which sets the price simply doesn't contain enough information to determine the difference between what the salary turns out to be and ... well, strictly less than that.

If there WERE a market for talent, this would be ruled out by competition and by an auctioning process. That's what a MARKET is. But there is no such thing.

[audadvnc]

Executive compensation has long since become uncoupled with job responsibility or personal talent. All these high dollar executives learned at the same schools, on the same curriculum. They all made their reputations in companies that were sailing through business upswings, and they all think they were personally responsible for their good fortune.

Now, the economy is in a shambles because these big thinkers were only good at making money when making money was the only option - "the market can only go up!" Yet, according to Ms. Herscher, the same fools that drove our economy into the ditch are the ones most uniquely qualified to get it straightened out and flying high again. What do they put in your coffee anyway?

[SShaw490]

The CEO of my company makes $500K in salary, $500K in bonus and owns $32 million in stock. Guess what his focus is?

Most of Americans started their work lives in some small business in which the owner was the boss. The owner cared about the business and wanted it to grow year after year, and we had the nostalgic notion that this is what high level management still wants. We couldn't be more wrong. High level managers don't care one whit about the business in 10 or 20 years. They care about one thing, and one thing only - what's the stock price in two or three years? Is his $32 million going to become $40 million? $50 million? They'll sell anything, fire anyone, hamstring the company any way they can, if they can move the stock price. No matter what their actions do to the long-term viability of the company, they'll do it without a second thought; because they don't work for the company, they work for the investment community in general and the company stockholders in particular. The CEO of my company wouldn't get out of bed for a mere $500K per year. That's chump change to him.

Anyone who thinks their CEO cares one iota about the company is a fool. He doesn't. He cares about the value of his stock holdings.

[schatsie]

Grest example!

[research]

I can tell you from experiences that CEO pay is unrelated to CEO performance. Except at the very high end, where it is correlated with failing businesses.

[ThePeoplesKey]

Comment in fo-ur parts

Part III

Instead, the House of Representatives should be allowed to expand past its current limit of 435 members and be re-allocated by population without state borders to reflect the representation of ALL citizens instead of some representing millions and some representing a handful of constituents. No representative should represent more than about 300,000 people. That's what the founders intended. Not this bureaucratic mess ruled by monetary influence that we have now.

Public campaign finance based on some definable formula of public interest is the only way to go. Campaign contributions from any source beyond determining two nominees should be strictly outlawed. Lobbying elected officials by anyone other than individual citizens, outlawed.

As far as compensation for so called “Public Service” goes, for federal service, I would limit compensation to twice the average income of the constituent population represented by the representative plus reasonable expenses. This would account for the necessity of maintaining two residences and still be incentive enough for most capable citizens to consider serving. Secondly, their income would rise or fall based on their performance as a representative of their constituents. If their constituents’ incomes rise, so does theirs and vice versa. State and local reps income levels could be capped on an average based somewhere between fed reps and their constituents average income in order to produce the same incentives to serve locally.

[ThePeoplesKey]

Comment in 4 parts

Part III

Instead, the House of Representatives should be allowed to expand past its current limit of 435 members and be re-allocated by population without state borders to reflect the representation of ALL citizens instead of some representing millions and some representing a handful of constituents. No representative should represent more than about 300,000 people. That's what the founders intended. Not this bureaucratic mess ruled by monetary influence that we have now.

Public campaign finance based on some definable formula of public interest is the only way to go. Campaign contributions from any source beyond determining two nominees should be strictly outlawed. Lobbying elected officials by anyone other than individual citizens, outlawed.

As far as compensation for so called “Public Service” goes, for federal service, I would limit compensation to twice the average income of the constituent population represented by the representative plus reasonable expenses. This would account for the necessity of maintaining two residences and still be incentive enough for most capable citizens to consider serving. Secondly, their income would rise or fall based on their performance as a representative of their constituents. If their constituents’ incomes rise, so does theirs and vice versa. State and local reps income levels could be capped on an average based somewhere between fed reps and their constituents average income in order to produce the same incentives to serve locally.

[ThePeoplesKey]

Comment in four parts

Part I

old timer 37:

I agree with much of what you've written here which I've posted previously on this site. My idea is to limit income taxation from any source up to an amount that would be considered "Self Insurable." That is, an amount of annual income generally considered to be high enough for the individual to not require insurance to remedy financial losses incurred in a catastrophe, would be taxed at normal progressive rates. However, amounts of income exceeding that ceiling would be taxed at 95%. I estimate that amount to currently be somewhere between 3-5 million annually.

I would also include intangible inheritance income in that formula. I have absolutely no problem with someone lucky or smart enough to make billions of dollars in their lifetime hording or spending their money as they wish. However, once they are gone, the capital not left to insure the perpetuity of their business(s) should be returned to the economy so that productive citizens with good ideas can access capital for the betterment of the next generation.

There are currently way too many "trust fund babies" running around who do nothing and contribute nothing while enjoying a 15% income taxation rate while the general working public is paying around 35-50% of their income to the government if you include SS, Medicare, disability, deductions, etc.

[ThePeoplesKey]

Comment in four parts

Part II

I would remove the approximately $100K cap on wage deductions for necessary social programs in order to fully fund them and reduce the tax burden for such programs on the average income class with any remaining funds, if any. This would probably solve any problems with adequately funding SS and go a long way towards shoring up any Medicare funding deficiencies.

What employment has to do with health care escapes me. Universal, single payer, health care is the only way to go. Everybody in, nobody out, everyone pays something into the risk pool to insure that no one receives better treatment based on luck or who their parents are. This would free up untold billions of capital and return this nation to a population of potential entrepreneurs. One of the core principles it was founded on.

The US senate outlived its usefulness long ago and should be eliminated from the congressional branch of government. That act alone would save us Billions upon Billions of wasted dollars caused by "snails pace" change, and obstruction to needed legislative change. Creating the senate was a useful tool to bring about unity of the states 223 years ago. We now have a country with defined borders. Time to eliminate this bottleneck.

[Hildagard1903]

Thom Hartmann, in his new book - Threshhold - gets it about right: You have to be a sociopath to lead a company with the purpose of maximizing short term profits, becoming personally filthy rich, hurting millions of people - and still able to sleep at night. Most sociopaths do not make it through Harvard Business School. So there IS a limited pool of Harvard educated sociopaths willing to do the dirty deeds necessary to screw the poor and enrich the already wealthy. Makes sense to me.