It Worked for Spitzer

EPI data shows U.S. CEO pay in comparison to 13 other countries in 1988, 2003 and 2005 and an index that pegs the U.S. compensation at 100.

October 21 2008 by JP Donlon


This is not a good time to be a chief executive. As a class their approval rating must be barely a notch above that of members of Congress which hit an all time low of 14 percent last month. Former Lehman CEO Richard Fuld recently received a subpoena related to federal investigations into the events leading up to the company’s bankruptcy filing last month. In addition to the Lehman probe, federal investigators have initiated investigations into at least 25 other companies, including AIG,  Fannie Mae and Freddie Mac. The U.S. attorney in Seattle has announced an investigation into the collapse of Washington Mutual, the biggest bank failure in U.S. history.

New York State attorney general Andrew Cuomo sent a letter to AIG’s board of directors last week indicating he would take legal action against the company if it didn’t address his concerns about what he said were “unreasonable” and “outrageous”  payments the company made to executives as the insurer neared a collapse. In his letter, Cuomo mentioned several expenditures he believed were extraordinary, including a March 2008 cash bonus of more than $5 million to former CEO Martin Sullivan and a “golden parachute” of $15 million.

Despite a statement Cuomo made later quoted in newspaper accounts that “These actions are not intended to jeopardize the hard-earned compensation of the vast majority of AIG’s employees, including retention and severance arrangements, who are essential to rebuilding AIG and the economy of New York,” it was clear that he wanted to target CEO compensation.  After all going after CEOs worked for his predecessor Eliot Spitzer who used his office to target generously compensation bosses in his efforts to become governor.

The last 15 years have been very prosperous times for top executives. This is evident in the growing divergence between CEO pay and a typical worker’s pay, which the mainstream media is quick to remind us at every turn. In 1965, U.S. CEOs earned 24 times more than a typical worker, according to the Economic Policy Institute, a liberal research group in Washington. The ratio  surged in the 1990s to 298 and tumbled in to 155 in 2002 after the Internet bubble burst. Nevertheless, according to EPI estimates, the gap between a median CEO and the typical worker more than doubled by 2007, reaching 194-to-1.

But what does this really tell us? For one the survey is based on the 350 largest publicly owned corporations which is hardly a proxy for the thousands of typical firms that are privately owned and in many case have fewer than 50 employees. Also the components of compensation include virtually everything: salaries, bonuses, incentive awards, stock options exercised, stock granted, among other items. CEOs generally do not exercize options every year so those that do will likely take advantage of decent run-ups in the share price. Many leave their options unexercized. Many more have options under water.

The same EPI data shows U.S. CEO pay in comparison to 13 other countries in 1988, 2003 and 2005 and an index that pegs the U.S. compensation at 100. (See chart below) The index shows that American CEOs earn two and a quarter times the average of the 13 other countries. The index tells us nothing about the comparable performance of the U.S. companies versus their counterparts. Interestingly the data also show the rates of CEO pay increase is growing faster outside the U.S. Sweden is leading the charge with 304 percent increase in CEO compensation from 1988 to 2005 compared to Australia (292 Percent) and Italy (232 percent) with the U.S. and Britain at (169 percent) and (161 percent) respectively.

All of this suggests that there is a world market for CEO talent like there is for most talent. Think of the signing bonuses hospitals pay for nurses and technical staff and what some firms in Silicon Valley are willing to pay for engineers-provided they can get the H1B visas in order to hire them at all.

 

There is no doubt that many CEOs  are overpaid relative to the value they have created for shareholders. But surely that is an issue for boards and for shareholders to sort out-not for ambitious attorneys general who wish to substitute their judgment for that of the private parties who have willingly entered into a contractual agreement.

Considering for example how the reckless behavior of Fannie Mae triggered a series of events that led to the recent meltdown I was astonished to learn that former CEO and current Barack Obama advisor Franklin Raines gets an annual pension for $1.4 million and $8.7 million in deferred compensation not to mention a $5 million life insurance policy that converts to a $2.5 million benefit after age 60. Not bad for someone who someone who single-handedly wrecked a company if not the financial system. Wonder why Cuomo doesn’t subpoena him.

Critics of outrageous retirement and severance arrangements have a valid point but the answer lies in greater disclosure-that and toothy clawback provisions–not in attempting to intervene after the fact in private contractual agreements.  More voices should be heard when executive contracts are drafted. Normally only the board is involved. It might be useful to have severance contracts, and CEO compensation more generally, approved by shareholders. More companies should disclose a tally sheet well before the senior executives hits the road. This way there are no ugly surprises when things go pear-shaped.