Zuccotti Park may be emptied and the Wall Street no longer occupied, but the anger of the 99% hasn't abated one iota as they watched CEOs cash in on the recovery and hedge funds make money hand over fist whether the market is going up or down. This shouldn't be a surprise. The fact is, because of the structure of their compensation, CEOs are rewarded for share price volatility not share price performance. And hedge funds make big money on the volatility that CEOs are incented to produce. So while the volatility of the past five years has devastated the lives, savings and pensions of vast numbers of the 99%, it has served CEOs and hedge fund managers very well indeed.
To understand the perverse structures, let's compare the compensation of two hypothetical CEOs, Bill and Sally, appointed on Jan. 1, 2007 and retired five years later on Dec. 31, 2011. The average US large company CEO has a compensation package of approximately $10 million/year made up half of salary/bonuses and half of stock-based compensation, so that is what we awarded Bill and Sally. Typically, the stock compensation is awarded annually on Jan. 1 of each year. If it is in the form of restricted stock, it vests as of retirement. If it is in the form of stock options, they typically must be exercised at the time of retirement. So that is how we structured their stock-based compensation.
It was a wild ride during Bill's and Sally's time. The S&P 500 (which accounts for 75% of US market capitalization) was 1,416 when they took over, shot up to an all-time high of 1,565 on Oct. 9, 2007, then plummeted in the fall of 2008 and bottomed out on March 9, 2009 at 676, then rose to the close of 2011, finishing at 1,258 -- 80% of that all-time high.
CEO Bill managed the company as if it was a proxy for the stock market; its stock followed the S&P500 exactly with the huge ups and downs. On January 1, 2007, his stock price was $100/share, making the share price at the beginning of 2008-2011: $102, $66, $80, and $90, respectively. When he retired, the price was $89. So in five years, he took his shareholders on a wild ride and ended up losing 11% of the investment of the shareholders who stuck with him the whole time.
CEO Sally was able to buck the market trend. She managed carefully and proactively and somehow kept the stock stable at $100/share from 2007 through to the end of 2011. So against the backdrop of five wild years in the market, she avoided giving shareholders scary ups and downs and left them with their investment whole -- 11% better than the market performance and 11% better than Bill.
Who is the more valuable CEO? Whose compensation should be higher? Should it be Bill, whose shareholders experienced massive volatility and a net loss of 11% over the period? Or should it be Sally, who avoided ups and down, protected investors' capital and ended up 11% higher than Bill? The answer, of course, is obvious -- Sally with both better returns and lower volatility. She should have made a hell of a lot more.
But that is not the way it works out in crazy America. Over the period, Bill made $57M in compensation to Sally's $50M if their stock-based compensation was in stock options; $51M versus $50M if it was restricted stock. It seems impossible: how could the valuations end up there when Sally's stock was 11% higher on the day the stock-based compensation was valued? It is primarily because of the huge value of Bill's stock-based compensation given to him on Jan. 1, 2009 when his stock price was languishing at $66.
Therein lays the fundamental problem eating away at the core of American capitalism -- and generating anguish of the 99%. American CEOs are paid to generate volatility -- so they did just great over the last five years while the 99% took it in the teeth. And that wasn't some kind of accident -- it is inherent in the current system.
The 99% would love nothing more than slow and steady growth, but that is not what maximizes incentive compensation for corporate executives. As far as CEO compensation goes, under the current stock-based compensation model, it is unambiguously better to have your stock plummet and then partly recover than to have the stock price stay steady over the same period. In fact, the most bloody-minded and self-interested CEO would be wise to drive its stock down immediately after taking over -- and blaming the prior administration for all the problems found -- and then get the stock back to the initial level. The CEO will make a small fortune doing that -- while shareholders make nothing -- and it is a lot easier than producing stock price increases from the initial level.
Though they wouldn't want to admit it, the crash of 2008 wasn't all that bad for the vast majority of big-company CEOs. With the exception of those few CEOs who were sacked, most had terrific air cover: "Our stock may be down 50% but so is everybody else. Really, I'm doing well, all things considered." Even better, CEOs got tranches of stock grants at super-low prices -- in some cases lots of them to keep the CEOs from being depressed that their existing options were "so far underwater." As the market dragged their stock prices up with everyone else's, these CEOs made out like, well, bandits.
Stock-based compensation has produced a volatility machine and that volatility is wrecking the American economy, while it makes CEOs and hedge fund managers rich. The crash of 2008 wasn't a rogue event and it will happen again as long as our rogue system of executive compensation stays intact.
That the compensation structure is now 'perverse' is clearly evidenced by the information you've presented here. That this structure is now 'obscene' becomes evident when you consider/contrast/compare the pace at which CEO pay has risen since 1990 (this is not ancient history) against the pace at which the minimum wage has risen:
"Ratio of CEO pay to average worker pay now 411-to-1
• Since we first started tracking the CEO-worker pay gap in 1990, it has grown from 107-to-1 to 411-to-1 in 2005. Today’s gap is nearly 10 times as large as the 1980 ratio of 42-to-1, calculated by Business Week. If the minimum wage had risen at the same pace as CEO pay since 1990, it would be worth $22.61 today, rather than the actual $5.15."
http://www.faireconomy.org/files/ExecutiveExcess2006.pdf
http://www.faireconomy.org/files/executive_excess_2008.pdf
It's the stock itself that ought never have been paid. That stock/money = incentive only. At a base salary of $25-mil over 10 years, no incentive whatsoever ought be required...especially if it makes no appreciable difference whether one CEO is smart and careful while another doesn't even bother.
Quite frankly, one could have taken a bus boy out of the company cafeteria, given him a six-week certification course to become a stock-broker and placed him raw into the CEO's position with the instruction to learn as he goes and try not to screw-up. This kid could have been paid only $1 mil over the entire ten years and would have produced results no better or worse than Sally or Bob.
Perhaps the biggest secret which CEOs don't want you to know is this: their position could just as easily be performed by a chimpanzee tossing a coin.
I'd be more than willing to bet $10,000 on that...and I'd be happy to implement the experiment to prove the point.
On average they are employee for five years. Good CEOs ought be in office twenty years--if there were actually valuable. However, they aren't--they're largely shooting craps and as replaceable as an oil filter.
Thanks for pointing out that the owners of the company determine what the CEO is paid based on market fundamentals. This is the way that it should be.
Though I am not sure why you are making this a 1% v 99% issue since a majority of Americans own some stock, either directly or through their 401K, pension, etc.
And why do you call the 99% the 99%, less than a third of Americans want anything to do with a group that claims to be ‘the 99%’., better to call them the ‘uneducated 30%’ or the ‘not-listened-to 30%’.
There is nothing wrong with the way CEO’s are priced since the people paying them are the shareholders and if they are fine with their CEO getting windfall profits then what does that have to do with anyone else?
Kai
If they are just renting the governments balance sheet with a small amount of equity then they don't deserve anything other than a government salary similar to Obama.
Steve Jobs get's what he makes.
Jamie Dimon can go pound sand for $400K per year.
You state, ‘It just depends on whether or not the company produces something or is just some 100% insured by the government bank.’
Actually they do not have to produce anything. They could be, in fact, wealth destroying…but as long as the shareholders support the CEO, it is their company and their money and they can do what they want with it. let me guess, you do not believe that over 50% of Americans should have the natural rights of liberty and property? Typical statist progressive.
I agree with you though that the government should get out of the wealth transfer and insurance business. They should not insure auto union, public union pension funds, bad life decisions of people on welfare, unemployed people, people that build their houses under seal level in New Orleans, green energy, old people, poor people, disabled people, and even the occasional bank and wall street firm. Thanks for supporting me on this point about getting government out of the take and redistribute business.
Are you talking about the auto unions, subprime borrowers, green energy companies, high-speed rail, public housing. I agree, anyone that is getting this type of government help should not be allowed to collect wages. It is almost like you are in my mind…you must really hate the government more than I do.
You state, ‘Steve Jobs get's what he makes.’
As do most of the 1%. Thanks for making that clear. Most millionaires are self made.
You state, ‘Jamie Dimon can go pound sand for $400K per year.’
Or his bank could have probably been one of the only two three banks to come through the crisis nearly intact and have even a bigger paycheck…the government robbed him of being able to compete in a largely competitor less market.
To be clear, I have no getting the government out of the insurance business…all of it!
Kai
Sure they are. I love my 401K. I WANT exposure to the market since in general it pays out at a higher rate than a defined befit plan. I can move my investment profile anytime I want if I feel that a company or industry or CEO is not performing to my expectation. Something I cannot do in a defined contribution plan…which pay less and are worse, in general.
401Ks are better the poor too.
You state, ‘In reality Directors and CEO's neither of whom directly invest their own money in the businesses they run have long since interposed their interests for those of the shareholders.’
So you claim.
Kai
http://movetoamend.org/start-group
In Phoenix AZ
Maricopa County, an affiliate of Move to Amend, is holding a citizens gathering at the Sandra Day O’Connor Federal Court House, 401 W. Washington Street on January 20th from 11am - 5pm.
The real problems are insider trading, poor regulation of compensation, and
low taxes on compensation.
With high taxes on compensation from the richest folks, say Ike 50% over a million and 90% over a billion, even the high fliers admitted they spent more time with their families. Sounds like a good thing. And there were plenty of super rich folks and the USA became the strongest economy in human history with those rates. CEO keep the money in the business rather than take another million dollars at 50% tax rates.
Our economy is a human construct, and it has flaws, the biggest being that lots of money make even more money, those runaway feedback concentrates, clots the money in too few hands, about 1000 families, new monarchs.
Progressive income tax including capital gains, is the cure for that.
Cleverly omitted is the fact that it is unusual for CEO's to be compensated in that range.
This is another attempt to randomly inflame.
http://www.forbes.com/2008/04/30/ceo-pay-historic-lead-bestbosses08-cx_sd_0430flash.html
For 2005 - 2008 average compensation was in the 11 - 16 million range. Not 10.
But what do they know, they are just Forbes magazine.
A random internet board warrior with no citations is a much more trustworthy source.
LOL - joke's on you, kiddo!
The illusion that it is possible to have risk free incremental growth is addressed in Nassim Nicholas Taleb two bestsellers: “The Black Swan” and “Fooled By Randomness”. In practice, history is disruptive. The belief that risk can be engineered out of systems leads to a willful blindness to dangers. People wanted to believe that buying a house was always a safe investment. Investors wanted to believe that government debt or AAA rated mortgage securities would always be safe investments. The love of slow and steady is the enemy of safety. This is how Madoff worked his scam - love of steady and non-spectacular returns led to a willful suspension of scepticism by his victims.
I know of nothing that "churning" and "volatility" would do to help CEO compensation of most companies. And I've never been in a company environment in over 40 years where anyone would hope for volatility, because our job is to maintain, and grow, stock value, not to "churn" it.
What's confusing about this article for most readers is that the author also talks about Hedge Funds and pay for those people where I could understand that "churning" of stock prices in the market can lead to good income if the hedge fund is on the right side of the trades - and that could lead to big compensation numbers. But hedge funds are a very small percentage of all companies in the public marketplace.
All that said, is it possible to put together a scenario, like the author did, where stock options are issued at one price, the stock tanks and a year later new options are issued at a lower price, and before either option grant expires (like 7 years) the stock recovers and the executive makes money on both - yeh, that can happen. But it is more common that the stock price tanks and doesn't recover, and the options become worthless.
Thanks............
I would add an historical element to the picture, however, which, I think,many overlook.
The widespread use of 401's/IRA's/Keough plans had a profound effect in the financial world in that it turned millions of average Americans into investors and brought a flood of money as well.....all looking for upward returns. That trend took root back in the '70's and I've come to believe an unintended effect was that it made American CEO's more focused on stock price, profitability and short term returns......much to the detriment of society. It also gave too much power and attention to financial analysts, who forecast the ups and downs of these companies.
On the surface, these were well-intentioned financial instruments that brought investing to a mass audience. But I contend that these instruments were also the starting point that created the initial pressure on both top management and the financial community to produce ever-increasing returns.
Somewhere along the line, common sense, the common good, and, ethics.....were cast aside.
I don't believe that it was the intent of the tax code legislation that created the 15% capital gains rate to allow individuals to earn huge incomes that could be maneuvered into a capital gains designation.
Congress should consider other revisions to the tax code to the extent we can identify other unintended consequences............
Well guess what. Many Boards of Directors are presided over by the CEO. It is not unusual for the CEO to *put people on the board* ... allowing CEO's to litterally stack the boards in their favor.
http://www.questia.com/googleScholar.qst?docId=5000356368
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Second, work on the subject reflects the fact that not all researchers agree that the board actually evaluates the CEO's performance (e.g., Allen, 1974; Geneen, 1984). In this view, because board members are often chosen by the CEO, it is believed that the board seldom asks penetrating questions, and the actual power to hire and fire lies with the CEO who can replace board members. According to supporters of this view, the CEO influences the selection and retention of directors. As Lorsch notes: "Because the CEO controls the discussion process, he or she can ignore the toughest kinds of questions ..." (1989: 79). Directors are often coopted (Bazerman and Schoorman, 1983). Only those candidates who "can work with" the CEO are initially "handpicked" (Pfeffer, 1972). Once elected, directors owe their allegiance individually to the CEO. Each, in his or her own self-interest or as a form of reciprocity, will do nothing that might lead to dismissal (Allen, 1974).
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Perhaps it is time for individuals to get out of the markets and to push pension funds to do the same. Why continue to support and invest in such a corrupt system? It seemed to work when customers walked on big banks to credit unions. Maybe we could find other investments that are not so manipulated.