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Be Careful What You Wish For

A few years ago a Business Week cover story screamed, “The Party Ain’t Over Yet. Reform May Be in the …

A few years ago a Business Week cover story screamed, “The Party Ain’t Over Yet. Reform May Be in the Works. But So Far You Wouldn’t Know It.” Each year, as the proxies are released, so is the harangue about CEO pay levels. Not long ago critics demanded that executive pay should be tied to performance, which at the time meant the share price.

They got their wish. As confirmed by CE’s 12th annual analysis of CEO compensation (see p. 39), CEOs own larger amounts of stock, and companies are recording higher CEO ownership levels. The rise is due to shareholder pressure to tie executive and board director compensation to the fortunes of the shareholders themselves. Many companies now have guidelines indicating the depth of management’s commitment through the ownership of a specific number of shares.

But this has not silenced the critics, who, after several years of a strong bull market, claim that pay is still “excessive.” The run up in share prices fueled by a strong stock market is said to be a “windfall,” having little to do with managerial effort. Attacks on corporations are nothing new. Executive compensation is reported on regularly, frequently with the implication that board members are neglectful or even delinquent in their fiduciary responsibilities.

To be sure, abuses exist-and will no doubt continue. But the notion of greedy CEOs easily swaying compensation committees are proving the exception, not the norm. As Jack Lederer and Carl Weinberg point out, the reward-for-risk mandate often results in CEOs who become net wealth losers despite a buoyant market. The directors who gave Sunbeam’s Al Dunlap the boot were at risk of seeing their own shares decline in value. It will be interesting to see how pay alignment stands up to a market that turns bearish.

To some degree this is beside the point. Alignment is less of an issue than the broader, more strategic question of wealth creation and how it is shared among employees. The table nearby shows the top 10 leaders that have made substantial option grants to their employees and the laggards that concentrate their grants among the top five corporate officers. Institutional investors can get worked up about the dilutive effects of widespread option grants, but tend to overlook the wealth-creating effects that offset this.

The fundamental issue underlying executive pay schemes is not who gets what, but, is this the right way to spend this resource? Recently Ralph Nader called upon Bill Gates to chair a conference on wealth inequality in the U.S. (As if Bill didn’t have enough problems with the Department of Justice treating Microsoft as the Standard Oil of infotech, the social levelers want to make Gates into a poster boy for Rockefeller-like heartlessness.) Nader, of course, is trapped in his own zero sum world, because the choice of Gates exhibits quite the opposite. More than any other CEO living or dead, Gates has hugely diluted himself by offering options throughout his enterprise, creating not only millionaires but centimillionaires. Despite the mega-dilution, somehow Microsoft struggles with a 62 p/e and a $104 share price. What will the institutions say?

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