In this recent proxy season we’ve seen headlines on CEO pay: “It’s (still) their party,” and “shareholder votes have done little to curb the festivities.” Pay packages have been called “supersized,” “outsized,” “piggish,” “outrageous,” “staggering,” and “embarrassing.”
How is this possible? Critics put forth a number of reasons:
Boards are too close to the company’s CEO, paying virtually anything he or she wants.
Compensation consultants advise compensation committees that, inasmuch as the board is successfully doing its job, then it must have selected a high-performing CEO, in which case the CEO must be ranked in the top quarter of all CEOs.
The consultants select inappropriate peer groups when considering relative CEO pay.
With a rise in stock-based compensation, pay inappropriately skyrockets when the markets make broad-based advances.
Too many CEO contracts still allow huge payouts when there’s a change-in-control.
Boards have other company CEOs sitting in the board seats who are inclined to reward their fellow brethren.
And one more: that directors simply are lazy and not doing their jobs in reining in CEO pay.
Yes, some of the reported numbers indeed are staggering. Discovery Communications’ CEO David Zaslav received a reported $165 million last year. Several other CEOs received packages of more than $80 million. Three of the highest-paid top executives have John Malone on their board, who has a history of giving “outsized” awards to his longtime lieutenants.
And some exiting CEOs get nine-figure paydays. Time Warner Cable CEO Robert Marcus is the latest example; he reportedly stands to reap an exit package of $100 million on Charter Communication’s planned takeover after being on the job only 18 months. (Do I hear echoes of Disney paying Michael Ovitz $140 million after about one year in the CEO seat back in the 1990s?) It’s understandable, at least on the surface, why some observers are incensed with these media-entertainment companies and others more broadly.
But let’s take a deeper look. Reports also show that median pay among the top 200 highest paid CEOs of U.S. public companies this proxy season was $17.6 million, which was up only 1.9 percent from last year. Now that doesn’t sound quite so “outrageous.” And how does this pay scale look in relation to that of some hedge fund managers who cleared $1 billion last year, and heads of private equity firms who took home more than $500 million? One compensation consultant notes that like movie and sports stars who have unique skill sets, high-performing CEOs also should be rewarded for their indispensible contributions.
‘Failure’ of Say-On-Pay
Pay critics are disappointed that the Dodd-Frank Act’s say-on-pay provisions didn’t have the desired downward effect on CEO compensation.
A media report on JPMorgan Chase, for example, said shareholders “narrowly approved … the 2014 compensation packages for CEO Jamie Dimon … in a rebuke from investors over the bank’s pay practices.” The report noted that Dimon was paid $20 million in 2014, the same as in 2013, but more of his incentive bonus was in cash, and that Institutional Shareholder Services took exception to the “lack of a compelling reason” to move part of the bonus from stock to cash. It said “only” 61 percent of votes cast favored the compensation.
Maybe I’m missing something, but isn’t 61 percent more than a majority? Yes, some observers say a vote must be more than 80 percent positive to show meaningful shareholder support, but where was that legislated or written in stone? And although $20 million certainly is a significant amount, it is reasonably close to the aforementioned $17.6 median pay—and this is for a financial institution that is huge, complex, and in an industry undergoing upheaval on a number of fronts. I don’t know about you, but I can’t think of anyone I’d rather have running my bank.
There’s good reason say-on-pay is advisory rather than binding on a board. In this instance it seems Congress did something reasonable without doing what too often occurs: causing unintended negative consequences.
Boards Getting It Right
Compensation committees have among the most challenging board responsibilities. They need to deal with a multiplicity of competing forces in an increasingly complex environment. They’re keeping an eye on shareholders’ say-on-pay votes and engaging better than ever with major shareholders to understand what those investors are thinking. And these committees need to balance calls for aligning CEO pay with stock price, with the potential that rewards may be outsized when the broad markets are on the rise. (For more on this, you may want to take a look at chapter 12 of my book, Governance, Risk Management, and Compliance, Wiley & Sons.)
Boards and their compensation committees are positioned and obligated to use their business judgment to make the right deal for the company and its shareholders—and that means providing compensation that’s reasonable and necessary in the circumstances to enable hiring, retaining, and motivating the right person to run the company.
There are important reasons boards and compensation committees—not shareholders or other observers—are in the best position to make pay decisions:
The board has information not available to any other parties. The directors know and have signed off on the company’s strategic plan and the incentives and motivations for the CEO for effective implementation.
Most large-company boards understand the need for both short- and long-term performance measures. They recognize what past decisions drove performance, and what future ones will. The focus is not only on financial measures that will immediately drive the stock price—such as revenue growth, profitability, return on capital, and economic profit—but also on interim and forward-looking actions needed to position the company to excel going forward. These might be related to such factors as the company’s culture, customer and employee satisfaction, compliance and risk management processes, development of high performers, new product development, use of technology, opening new markets, and new alliance partners, to name a few, which are factored into development plans and pay measures to get “pay for performance” right.
The board focuses on the need to motivate and retain the current CEO. There is a free market for executives out there, and retention of a high-performing CEO can be critical to ongoing corporate success.
When a CEO must be replaced, it’s usually best to select from a number of internal candidates who have been carefully developed and groomed for the top job. Boards generally recognize this and place emphasis on the need for the senior management to bring those individuals along—at every management level—and provide face time to directors. But on those occasions when it is necessary to go to the outside for a new chief executive, the board recognizes the reality that it needs to replace pay packages, including shares and other awards, that will be forfeited by a top candidate, and will do what it must to acquire the individual who has the best likelihood of leading the company to future success.
The board recognizes that if it is stingy with the current CEO, not only does it risk losing that individual, but quality internal candidates may well decide there’s little point in staying with the company. Why would they want to spend most of their waking hours working toward a goal that is already badly tarnished? And attempts to recruit outside candidates in such an environment are all the more challenging.
Even in the face of a forthcoming Securities & Exchange Commission regulation requiring disclosure of the CEO’s pay in relation to the pay of other workers, the board keeps a crucial fact in mind: that decisions made by the CEO will indeed determine whether the company succeeds going forward, or falls by the wayside. Yes, the board will oversee what strategic decisions are made, but the reality is that the CEO is, by far, the most important individual to corporate success. And if it’s necessary to pay millions of dollars to attract, retain, and motivate the right top executive, then it needs to be done.
If these aren’t sufficient reasons why the board is best positioned to determine CEO performance, consider one more that overrides all the others. It is the members of the board of directors who have a fiduciary responsibility to do what is in the best interests of the company and its shareholders. They have embraced duties of loyalty and care that mandate that they do what is right. No other party has these obligations and responsibilities.
Despite the critics, just maybe the vast majority of shareholders “get it.” According to one recent analysis of some 2,545 companies, at 92 percent of these companies, at least 70 percent of shareholders endorsed the boards’ pay practices. Another report says that only 2 percent of the 3,000 largest U.S. public companies failed to win a majority of shareholder support for executive pay packages.
So, is CEO pay “over the top”? With some exceptions, evidence and rational analysis says no. Boards and their compensation committees are positioned and obligated to use their business judgment to make the right deal for the company and its shareholders—and that means providing compensation that’s reasonable and necessary in the circumstances to enable hiring, retaining, and motivating the right person to run the company.