How Much, Where, And Why
In the following international CEO compensation survey, two major trends stand out: The pay gap between U.S. and non-U.S. CEOs is narrowing; and the restructuring and increased foreign ownership of U.S. firms is introducing a dose of reality into the compensation process.
June 1 1990 by Brain Dunn And James E. Keilley
American CEOs continue to earn more than their counterparts abroad. But the gap is narrowing. Last year, the typical CEO in charge of a $250 million operation earned $350,000 in base salary and annual bonus. A similarly situated executive in
Although U.S. CEOs enjoy the first place position in total cash compensation, they also have the most at risk. Their pay is the most highly leveraged in the survey group; their annual bonus represents 40 percent of base salary. CEOs in
The comparative picture changes somewhat when we focus on employer-provided benefits, including insurance (medical, dental, life, disability, etc.) and retirement income plans. With benefits valued at $53,750, or 37 percent of base pay, CEOs in the
Because most perquisites are taxable in the U.S., and there is no strong cultural bias in their favor, U.S. CEOs are near the bottom of the list when it comes to the cash value of such items as cars, drivers and club memberships. Hong Kong CEOs are at the top of the pile, receiving perquisites valued at $105,700-some 75 percent of base salary.
Despite lower rankings in the benefit and perquisite categories, American CEOs still come out ahead when it comes to total remuneration. Their lead widens considerably with the addition of long-term incentives-the final element of the compensation package.
LONG-TERM INCENTIVES AND TAXES
For the U.S. CEO, long-term awards provide an annualized value of approximately $140,000, some 56 percent of base salary. The value of such long-term incentives drops to approximately 35 percent of base salary in
Relatively low tax rates (ca. 30 percent) keep U.S. CEOs in the top four when it comes to net pay. They’re joined by CEOs from
It’s interesting to note that pre-tax pay is considerably more consistent than after-tax pay among CEOs in our study. Salaries and bonuses typically don’t change when marginal tax rates change-witness the absence of pay cuts following recent declines in taxes in both the
COST OF LIVING
Net pay after taxes needs to be adjusted for relative purchasing power to reflect differences in cost of living. We have attempted to compare purchasing power with respect to regularly incurred expenditures on goods and services (excluding housing). On this basis, the U.S. CEO is once again in premier position, followed by executives in
In some countries, company housing-and even servants-can substantially enhance a CEO’s lifestyle. That’s why, at the request of Chief Executive, we’ve included an extra purchasing power measure in this study. It’s based on a basket of executive goods and services, ranging from the cost of a limousine ride to the airport to a custom-made suit, and including a laptop computer and a bottle of the highest quality perfume. While sales and luxury taxes have had an effect on this data, it does provide a second look at the true cost of executive living in the nations surveyed.
The CEO of an Asian company recently asked us how he could justify the fact that the CEO of his newly acquired American subsidiary (whose salary was public information) was making nearly twice as much as the CEOs of other comparable subsidiaries-and even more than he was earning himself. The answer is that’s what the market demands. A more difficult question is, why has the market provided such an answer? We believe that a combination of economic, political, historical and cultural forces are at work, shaping the disparity between executive pay in the
American CEOs haven’t always earned more than their peers overseas. This situation began to change shortly after the Second World War, with the emergence of the professional manager in the
Elsewhere, family ownership, powerful independent directors, interlocking patterns of ownership, government control and even strong trade unions, served to counterbalance independent CEO power. These forces reined in the growth of CEO pay, but this has simply not been the case in the
COMPENSATION IN THE MARKETPLACE
Market forces have also played a role in setting pay levels. In some countries, social contracts between an executive and a company may bestow a lifelong right to employment, as well as a lifelong obligation to serve. By contrast, executives in the
CEO pay levels have been fueled by more than the competitive dynamic, however. Shareholders expect that a CEO will be paid for performance, and will have a large stake in the business being managed. This requires an incentive plan, typically stock-related. But it is rare for incentive plans to actually replace even a portion of fixed compensation. Incentives are usually added to existing compensation packages on the theory that they will activate only when a CEO increases shareholder value.
American accounting practice and tax policy, which encourage the view that stock options are a free lunch (and a tasty one at that), have further contributed to increased upward pressure on U.S. executive compensation. There is no accounting charge for stock options; they are fully deductible with no cash expense at exercise, and they are thought to create parity between executive earnings and shareholder gains. Furthermore, the Financial Accounting Standards Board has been unable to find a basis for valuing granted options. And since accountants say these options have no value, the conclusion is that they must indeed be free.
But the argument that options put executives in the same boat as shareholders is flawed. It fails to recognize that option holders have no actual equity interest and therefore no downside risk other than the loss of potential gains, a luxury that individuals who purchase stock in the marketplace do not enjoy. Second, the grant (and subsequent exercise) of an option has a very real cost-that is the actual dilution of the remaining shareholders’ equity that occurs if and when the grant is exercised.
We won’t get into the debate over the value of executive stock options here. It suffices to say that public policy and perception have created a significant and yet seemingly cost-free compensation opportunity. This is something that compensation committees would naturally take advantage of, and they have-with U.S. CEO total remuneration rising accordingly.
THE HUMAN FACTOR
It’s difficult for anyone who participates in the process by which executive pay gets determined-a CEO, a board compensation committee, a human resources manager or a compensation consultant, for example-to be totally objective. Granted, there are cases in which a CEO does play an overly aggressive role in the compensation setting process, but it’s been our experience that most parties try to bend over backwards to achieve objectivity and to exert no undue influence. But even when all parties have the best intentions, a natural bias toward the plus side exists, particularly during robust economic times.
The future may tell a different story, however. In our work, we’re seeing the emergence of assertive and independent compensation committees. Along with this trend, highly leveraged restructurings and buyouts, as well as more aggressive shareholders (e.g., state pension funds), will also bring new constraints to bear.
Finally, generous executive pay packages reflect the American spirit of competition. Quite simply, public companies want their CEOs-whose pay is a matter of public record-to be paid as much as, or more than their peers. One might suppose that public disclosure would lead to moderation, but this hasn’t been the case. When it comes to CEOs, a modest compensation figure is a source of embarrassment, not of corporate pride. The pay situation is exacerbated by the distinctly American trait of excusing or explaining away poor performance, while richly rewarding superior performance.
A recent study of senior executive pay policies confirmed that virtually all large public companies in the
EFFECTS OF GLOBALIZATION
Globalization has resulted in cross-ownership, and-with respect to CEO compensation-a degree of cross-referencing. Today, many non-U.S. companies look to their
The reason is that multinational business goes beyond national boundaries. This globalization has had its effects on compensation, and these effects can be expected to continue, with a profound impact on pay practices worldwide. One executive told us: “As the role of the
In the U.S., foreign ownership has brought some American companies back full circle, to the time of the individual owner-now seen as the foreign parent corporation-an owner who is directly concerned with compensation issues. This phenomenon, to date, has only rarely resulted in a pay freeze or wholesale reduction. But it has clearly resulted in some moderation of compensation escalation. We’re seeing rigorous performance measures for annual bonuses (often tied to shareholder returns). Another important change is a trend among foreign-based companies toward trimming back longterm incentive programs. That’s because stock is unavailable in certain instances, which forces the use of performance plans, or so-called phantom stock, which on an accounting and cash basis more closely reflects true cost, and thus serves to check liberally granted incentives.
Looking ahead, we think the spread of compensation programs which separate performers from non-performers is a positive development-along with the use of stock to make executives true owners. And worldwide, the continuation of the sense of moderation that has helped companies avoid excessive, improperly calibrated, or counterproductive compensation programs is important. We believe that concentration of ownership will play an important role in the policing of pay plans, and we support the expansion of knowledgeable and credible board compensation committees. Both can inject a healthy dose of reality into the compensation process.
Globalization inevitably will mean a much greater degree of consistency in CEO pay worldwide. One CEO has commented: “It’s increasingly important that we establish total compensation levels for chief executives on a global basis because their companies and their thinking must be multinational.” Although linguistic, cultural and geopolitical differences will continue to pose barriers to a truly free market for executive talent, pay practices are destined to incorporate the best elements of existing programs in the
ABOUT THE STUDY
Respective current compensation databases available to Towers Perrin through its network of international offices are the source of all statistics. Compensation data is given for CEOs of firms with 1989 sales of $250 million or more.
Exchange rates are as of
Brian Dunn specializes in executive pay and incentive plan design for Towers Perrin and manages international compensation consulting. James E. Kielley, chairman and CEO, has served with Towers Perrin in consulting and management positions for more than three decades.