There is a longish Sunday NYT article on CEO pay that I plan on reading. But before I get to it, I wanted to share some longstanding thoughts of my own on exec compensation.

While there was a temporary drop in exec comp caused by the market crash, we still have structural compensation issues that need to be addressed. For too long, we have been vastly overpaying CEOs of public firms for mediocre performance . Even worse, we have institutionalized this trend in recent decades. The result has been a massive transfer of wealth from shareholders to corporate execs.

In Europe, pay scales have been increasing modestly — but nowhere near the level of shameless theft here in the States.

Some 50 years ago, the highest paid executive (usually the CEO) made 30 times what the firm’s lowest paid employee did. This has changed over time, shifting upward in the 1980s. It has radically shifted the hi/lo pay ratio at American companies. Since 1999, as the average US paycheck has remained flat, C-level execs compensation has exploded. Just before the credit crisis crushed stock prices, the highest to lowest ratio was near 400 to 1.

Executives of public companies  have been making a killing. Even worse, its for mediocre performance.

Roger Lowenstein details a rogues gallery of over paid execs in 2004′s Origins of the Crash. Back in 1991, Tony O’Reilly, CEO of Heinz, got a package worth the then astounding sum of $71 million dollars. Ed Nardelli of Home Depot grabbed a $210 million severance package for essentially losing market share to Lowes. More recently, others — especially in the financial sector — got paid $100s of millions of dollars for essentially destroying their own firms.

Huge stock option grants create perverse incentives. GE’s Jack Welch pocketed over $400 million dollars in salary, bonuses, and options. Lowenstein argued in his book that Welch essentially managed the earnings with very creative accounting and the help of GE Capital’s impenetrable financial black box. The credit crisis caused the collapse of GE’s earnings management, confirming Lowenstein’s thesis of earnings management. Its hard to avoid his conclusion that the greatest industrial CEO in recent American history was little more than a clever accounting cheat.

How does this happen? How are shareholders hoodwinked so thoroughly? I can describe the legal corporate theft by insiders in 5 simple steps. The scam goes something like this:

Five Steps to Shareholder Wealth Transfer

1. The Board of Directors, usually cronies of the CEO (often hand picked by him) forms a compensation committee. To appear “objective,” the committee hires an outside compensation consultant.

2. The compensation consultants are themselves well paid whores, who rather than turning tricks outside the Holland tunnel, offer up absurdly generous comp package. They deliver what they are paid to: They provide cover for the boards to make an otherwise indefensible giveaway of shareholder monies in the form of cash and stock options. It is typically called “Pay for Performance,” but that is a horrific misnomer, as we see in step #3.  The comp committee approves the consultants’ nonsense, forwards it to the Board, who rubber stamps it.

3. Here’s where things get interesting: If the stock price rallies, the exec can exercise and cash out, risk free. If the stock price falls, the exec requests a new round of options — or even easier, asks for a repricing of the old ones.

4. After the options are repriced, the exec simply waits. Whether the market rallies or falls . . . you simply go back to step three. Repeat until stock options are in the money. There is no risk or outlay of cash on the part of execs.

5. True “performance” is not a factor. Stock prices can rally for a vast range of reasons having nothing whatsoever to do with management or CEO performance. The market can rally, a sector can come into favor, or even when the Fed can cut rates.

This is not pay for performance, it is pay for stock price volatility.

Actual performance would look at factors such as peer profitability, sector performance, SPX index gains. Bonus payments and stock option exercise should be for gains OVER AND ABOVE these factors — but sadly, rarely if ever are.

There are numerous enablers of this terrible comp system: Crony boards rubber stamp what turns out to be outsized — and oft guaranteed — pay packages for under-performance. An entire class of consultants somehow blesses these absurdities, giving the boards cover for their theft of shareholders. Third, large mutual funds remain mute, failing to fulfill their obligations as stewards of their investors’ stock shares. Instead, their silence is bought with 401k business and syndicate shares (IPOs, secondaries).

Solutions are as simple as they are unlikely: Require shareholder approval of exec comp plans, mandate public disclosure of consultant comp plans (they are embarrassingly ridiculous), and last, cleave the mutual fund asset management business from the rest of the companies. Impose a fiduciary obligation on mutual funds to investigate all Board nominees and vote their shares on behalf of S/Hs.

Just don’t hold your breath waiting for credible compensation reform to take place . . .


See also:
Bargain Rates for a C.E.O.?
NYT, April 2, 2010

Few Fled Companies Constrained by Pay Limits
NYT, March 22, 2010

Category: Really, really bad calls, Wages & Income

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

36 Responses to “American Pastime: OverPaying CEOs”

  1. Ken M. says:

    Not enough coffee yet, Barry. GE CEO is Jack Welch.


    BR: Doh! I’ll fix above . . .

  2. MayorQuimby says:

    Great post Barry. Another reason for Americans to be careful with their spending and investing.

    The problem is – as the lower class gets poorer, they get desperate for whatever chump change they can get their paws on. Consequently they chase overvalued stocks and even mediocre dividends.

    Finally – 401K plans are the death knell of accountability with regards to CEOs. Millions of Americans support all this stupidity without even knowing it.

    The whole she-bang needs to come crashing down somehow.

  3. Lugnut says:

    Probably one of your more useful, informative posts in a while. On a Monday AM, no less. Kudos.

    What is left unsaid but implied is sadly this. That which occurs as ‘standard practice’ across the majority of these firms, gradually loses its veneer of ‘unethicacy’, and becomes more accepted, and rarely called out for the being the crap that it is. Instead of being reported with an air of wrong-doing upon discovery with a cooresponding share drop and calls for ouster, instead these folks are called upon to serve as guests on CNBC to offer their considered guidance on how great their firm is doing (regardless of the case).

    In an age of underperformance in a diminishing capitalist republic, ethics and accountability were the first two victims.

  4. greg says:

    The Government should have required that the entire Board of Directors of every Bank be fired before any firm qualified for TARP money, and further that any member of those Boards be prohibited from ever sitting on any Board anywhere, ever again. As for Jack Welch, I liked him better when he called himself Al Dunlap, at least I think they’re the same person.

  5. catman says:

    When I lived across the river in Mannwich land we had a congressman by the name of Olaf Sabo. He would propose limits on CEO pay every session. Just another European style socialist. To red for the red white and blue.

  6. speaking of GE, there are 6 “Shareowner Proposals” on this year’s Proxy..

    among them, for: “Independendent Board Chairman”, “Advisory Vote on Exec. Compensation”, and “(limit)Pay Disparity”

    surprisingly, or not, “Your Board of Directors recommends a vote AGAINST this proposal” (for all 6)

    further details may be here

    Finally – 401K plans are the death knell of accountability with regards to CEOs. Millions of Americans support all this stupidity without even knowing it.

    they, certainly, aren’t receiving the Proxy that I’m looking at..

  7. Marcus Aurelius says:

    Any corporate exec — officer or board member, who suggests that if they don’t pay themselves and their cronies more, their “talent” will go elsewhere, should be caned in the public square and summarily fired.

    There has never been a greater pool of criminal talent at the top of so many public and private enterprises as we are witnessing now.

    That’s how we got here, and they are preaching that more criminality is the cure.

    They should not only be punished, they should be humiliated.

  8. Dennis says:

    The compensation consultants really are whores: Paid for by the Boards, they end up fucking the shareholders, all for the same low low price . . .

  9. jpm says:

    The exec comp issue is a sign of a bigger problem. Shareholder interests are no longer well-represented by BoDs. It is the BoDs that have become clubby and who are failing to mete out exec comp with economic sense.

    Eventually, some large mutual fund guy is going to make a career out of being a badass shareholder.

  10. greg says:

    Marcus….I think the events in the past months should finally put to rest the argument that “talent” will go elsewhere. There was no talent, and even more sadly a lot of that “no talent” is still in charge. Real talent would have assembled their management team and asked one question..”How are we making all this money”. And when they were told it was mostly from buying and packaging mortgages taken out by people who couldn’t hope to pay them back in two lifetimes, real talent would have fired people, lots of people.

  11. newbie says:

    If we want an “investment” economy rather than a “casino” economy, it’s beyond me why shareholders of publicly-traded companies don’t demand executive compensation packages based on the company’s long-term performance as an actual business rather than its stock price. We’ve seen what the “greater fool” theory of stock buying got us first in the Internet bubble and then as a result of the credit bubble (homebuilders, mortgage originators, banks, insurers, etc.). Investor-shareholders look for rising dividends and a long-term increase in the value of their investment, which rests on improvement in the underlying business (i.e., real, as opposed to fictional, profits and net worth; products or services consumers want to purchase, regardless of government incentives; etc.). Paying execs of public companies based on factors similar to those of their counterparts in private companies, rather than pay based primarily on the stock price, could go a long way toward both bringing exec compensation back down to earth and help cure the gambling mentality that’s been developing for at least the past two decades.

  12. cognos says:

    The PROBLEM is their is a perceived SHORTAGE of board of directors people and CEOs.

    How do you fix this?

    You either -

    1. Take more ecclectic, “less qualified” candidates. Younger managers. People from non-traditional sources (hedge funds?).

    2. Make it MORE attractive in terms of comp.

    3. Create a system where they all groom more successors (“vice-presidents” who can take over)

    You cant just say — “we’ve had a business cycle downturn, MOST managers are bad”. This is just what I call “cycling the chairs”. You have a certain set of bank execs. If you fire 1/2 of them everywhere… then they all just go fill each other positions right? Frictional costs are high. Same execs. You need to see the root and also accept that most of your conclusions just mirror the business cycle. Execs are NOT awful today. They were NOT geniuses in the 80s and 90s. Its the business cycle.

  13. DeDude says:

    With corporations becoming “persons” who can throw their money against any unruly politician, it is not likely that we will get that very needed and sensible reform.

    We have mutual funds that use a “social” screen, where are the mutual funds that use a “compensation” screen. It is so obviously bad for a company if the CEO is unchecked and greedy. So a fund with such a screen would be very likely to outperform the rest of the market.

  14. Brad says:

    Bring it on Barry! Nice one on a sunny Monday.

  15. nofoulsontheplayground says:

    I think if you look back at the divergence in executive compensation, I think you can trace it to the Reagan capital gain tax cuts that made it more lucrative to be compensated in stock than wages.
    The stock grants were also a convenient way to circumvent public anger over high CEO salaries.
    Combined with the bull market in the 80′s, this created a unique convergence.

  16. rileyx67 says:

    Wonder what current ratio of CEO to lowest paid is in the EU or China, India, etc.. Used to be only 30 to 40 times, but that may well have changed?

  17. Transor Z says:

    A few thoughts:

    Gaming the accounting along the lines of what Welch is accused of doing to boost CEO compensation seems to be the norm.

    Shareholder rights won’t solve the problem. Some companies are 51% owned by parent companies that have an agenda to have the smaller company act as feeder or toxic asset/risk repository. Does “buyer beware” for shareholders cover this in a “black box” situation?

    A related problem is short-term performance incentives presenting a financial conflict of interest between CEOs and longterm investors. Shareholder revolts don’t seem to be making any headway into solving this problem either.

  18. greg says:

    Cognos, an executive who didn’t see the business cycle is awful, that’s what he’s being paid for. Take the auto industry. It would appear not one executive questioned why the annual run rate of vehicles went from 12-13 million a year to 16 million a year, cause if they had, they should have figured out that it directly coincided with people using their homes as ATMs and that this trend would be temporary, and they could have positioned their company accordingly. Instead they did what every other auto CEO did and ramped up production, increased the workforce, and blindly led their company to the abyss. That is awful, and stupid, and in my opinion unforgivable. On another note, one of the twits on CNBC just asked a guest if we are in danger of losing “talent” if any type of pay caps are enacted.

  19. Bob A says:

    This is a very difficult problem to tackle and I’m not sure what the solution is. Shareholders rarely – check the data – vote against management recommendations. Compensation committees rely on consultants who rely on market data looking at comparable companies all with the same overpayment scheme so it is a vicious circle that feeds on itself. Someone – perhaps the SEC or perhaps some non governmental entity with credibility – needs to come up with a model compensation structure that shareholders can demand that their company’s plans be compared with and shamed into modifying. There needs to be something that breaks the vicious circle.

  20. MRegan says:

    Is there a causal link between many companies’ recourse to debt markets in order to finance operations and expansions and the significant pressure on cash flow resulting from imbalanced executive compensation regimes?
    That is, is there a parasitism endogenous to the corporation which promotes and abets an exogenous parasitism?
    Is their drawn on resources and income a necessary condition to support the out-sized debt levels in the US economy?

  21. farmera1 says:

    Bogle (Vanguard Founder) wrote a book called THE BATTLE FOR THE SOUL OF CAPITALISM about this sort of thing. His basic point was that we’ve moved from ownership capitalism (where companies were managed for the benefit of owners/shareholders) to managerial capitalism (yes you guessed it, companies are managed for the benefit of the management). CEO compensation is a major piece of supporting evidence for his case.

    I’d recommend the book. By the way, Vanguard has started charging loads (didn’t know this until after I purchased two new Vanguard funds) for at least some of their funds (both front end and redemptions ). They don’t call these loads but they call them “fees”. Vanguard is moving over to the dark side.

  22. falcon says:

    This is how the pay of CEOs climbs continuously…believe me, I know.

    The compensation consultant looks at peer salaries and develops quintiles. Then they make some boneheaded rationalization for why the CEO of the company deserves above peer (i.e. higher than the middle quintile) compensation. What happens is that this same process happens in every corporation in America, and when every CEO “deserves” to be paid higher than peers, even if it is only slightly higher, the peer average mysteriously goes materially higher in perpetuity. Funny how that works.

    Just another example of how looking at everything in relative terms is destroying every facet of life.

  23. KidDynamite says:

    barry – Carl Icahn’s op-ed, while self serving, is relevant to this topic:

  24. [...] – CEO pay is still way too high and something needs to be done about it. Unfortunately, the solutions are “as simple as they are unlikely,” Barry Ritholtz writes. [...]

  25. winslow says:

    I’ve worked at many corporations and I can atest that there is no “talent” in the upper echelon. If not for having an executive secretary; most would not be able to function on a daily basis. The reason the stock grants and salaries are enormous…is because they are able to get away with it. It is essentially a rape of our system….and it is legal. Until pressure is brought upon these individuals and Boards, either by government or by shareholders, we will not see appreciable change.

  26. philipat says:

    Agree with all of the Post. Additionally:

    1. Stock Options should NEVER be re-set and should not vest for 5 years to avoid the Wall Street disease.

    2.”Performance” should be linked to Industry benchmark performance. This is easier than it sounds because most Industries have a market research global standard which can be used. If an industry shows growth in a given year of, say, 9% and our Exec’s Company grew 7%, sorry Pal, you underperformed and no goodies for that year. Just a Salary, which you are being paid to do the basic job. This should ALWAYS be based on Revenues NOT EBITDA or Operating earnings because the latter can be “Adjusted” (See also The Wall STreet Disease) AND there is, understandably, less competitive data available on profit. For all these reasons, Execs will ALWAYS want to use EBITDA as the basis for bonuses, not revenues versus benchmark which are more difficult to”Adjust” certainly for more than one calendar year (Usually by loading the distribution pipeline at the expense of the following year)

  27. msaroff says:

    Ummm….It’s Bob Nardelli, not Ed Nardelli

  28. vachon says:

    You’re in good company: Paul Krugman lays out in greater detail your bullet points. I would add the incestuous relationship between government and industry also contributes to this mess.

  29. VennData says:

    I wonder have the average Berkshire Hathaway CEO gets in terms of pay.

    We know the Oracle makes six figures, but just. It only makes sense that BKA CEO pay rules are teh gold standard for executive compensation.

  30. [...] linking the employment and personal income situation in the US, I was not aware of the blog post at The Big Picture on Executive Compensation: Huge stock option grants create perverse incentives. GE’s Jack Welch [...]

  31. changja says:


    Apparently from this report, he only makes $100,000 a year from CEO pay. Buy he’s still rich from personal holdings.

  32. dsawy says:

    There’s a couple of easy things that could be legislated that would really go a long way towards controlling this:

    1. A person may not serve on more than one board of directors of any public corporation. No exceptions. So if a CEO of Company A is on his own board, he can’t sit on the board of Company B. Likewise, “professional directors” – these shills and ringers brought in by management to sit on boards, are basically out of jobs as they’re reduced from sitting on 3+ boards to one.

    2. Dictate that mutual funds or other investment vehicles who own shares in a managed portfolio for investors cannot vote to give a proxy to management. They have to vote the directors and issues for the record, and these votes must be reported to the investors in the fund(s). A mutual fund might vote per the boards’ recommendations for the portfolio of stocks they hold, but they must do it in a way that forces the managers of the mutual funds to take a position, make it public and then justify it to their investors.

  33. randomletters says:

    We have all these measures of the value of a business. Or the value of products. We have metrics for many things.

    What is the measure of the value of a CEO? It has long seemed obvious to me that compensation is being confused with value. How do you measure the value of a CEO? How can we disentangle “a lucky stock year” from true value?

    When I was growing up I learned the old chant of “the value of a thing, is what that thing will bring”. But that’s not value, that’s tulip bulb mania. Value is the good that something does measured against the cost of that good.

    What is the value of these CEO’s? Don’t tell me the cost, don’t tell me how much money they made on stock they didn’t buy. What is the value?

  34. [...] what makes so many bearish on the prospects for substantive regulatory reform, let alone changes to compensation structures throughout corporate America, especially on Wall [...]

  35. Blagg says:

    I have to ask how you arrived at the 400 multiplier.
    I’ve looked at three companies I know, and all are about 3000 to 1 ceo compensation versus lowest paid worker.
    That is of course based on total compensation per annum. If you want to go with strictly salary, then the number I have is closer to 100 to 1.


    BR: Its the average, and it was in several recent academic studies