The Truth Behind the Internet Gold Rush
November 1 1999 by Jennifer Pellet
The stories surface daily. A 29-year-old founder of an Internet portal catapults himself from a five-figure annual salary into the Forbes 400 ranks. A business journalist sees his idea for an on-line market-watch zine through to an IPO and sees himself into a $9 million stake.
And founders aren’t the only ones reaping the big money-and the headlines. After rapid early growth spurts, pre- and post-IPO Webcentric start-ups need experienced business leaders to steer them through expansion and into maturity-and their high-risk, high-reward compensation structures are luring leadership talent from all over. Just last month, George Shaheen stepped down as chief executive and managing partner of Andersen Consulting to take the helm of the Internet start-up Webvan Group. Other recent Web converts include Michael J. Jackson, who abdicated the CEO seat at Mercedes Benz
A new study by executive search firm Spencer Stuart confirms that more and more corporate leaders are expressing interest in Web-based start-up opportunities. But is this rush to forsake the safe havens and hefty salaries of established corporate entities for the chance to link fortune and future with the young, highly volatile world of Internet-related businesses-an unprecedented phenomenon in corporate America-justified?
GOLD OR JUST GLITTER?
Even as increasing numbers of executives flock toward Internet gold, the phenomenon is viewed with a mixture of awe and skepticism. The much ballyhooed success tales of early Internet pioneers are alternately seen as portending a new era where the payoff for success can be stratospheric and dismissed as exceptions that are distorting the reality of the business landscape.
“These Internet CEOs, like the businesses they lead, have seen an accumulation of wealth more quickly than any counterparts in business history, amassing paper fortunes in the span of a year that would previously have taken a lifetime,” says Jason Baumgarten, an associate at Spencer Stuart’s Global Internet Practice, who is quick to note that while there are “phenomenal fortunes being made,” nearly all of the wealth exists only on paper-in stock and stock options. “As the recent stock market pullback demonstrated, this compensation is less stable than the cash salaries and bonuses-plus growing equity-of Fortune 500 executives, but the ability to generate exceptional wealth in a short period of time is unparalleled.”
Taking part in the Internet compensation model requires a high degree of risk tolerance. “While Internet executives make more money relative to revenues of their nascent companies than any Fortune 500 executive, they are taking on significant financial and career risks,” says Baumgarten, pointing out that when compensation packages are heavily option-weighted, it’s the market rather than the board of directors that plays a key role in determining total compensation. “They are betting salaries, and often their futures, on the market valuations of their stock rather than on the performance appraisal of a board or a CEO.”
In studying more than 480 Internet executives at 155 different firms across all sectors of the Internet economy, Spencer Stuart found that for every highly compensated star, such as Steve Case and Meg Whitman, there are many unheralded “bench players,” who are successful, but play-and get paid-on a different level. (To factor in the value of accumulated options, Spencer Stuart adjusted for the high volatility of Internet stocks by averaging the companies’ stock prices over three days earlier in the year-April 6, May 6, and June 18.) While the average total 1998 compensation for the top 10 percent of the 155 CEOs surveyed was $191.1 million, the bottom 10 percent earned just $87,251. “The Internet is a winner-take most-if not all-game, with the news-making fortunes generated by the few at the top,” says Baumgarten. “The Forbes 800 Compensation Study in which the top 10 percent of CEOs had an average total 1998 compensation of $38.9 million while the bottom 10 percent averaged $571,425 makes for a striking comparison.”
Why the gap? For one thing, while the importance of stock options as a percentage of pay has been rising steadily across most industries, Internet companies have turned the option-weighted compensation packages into a mantra. “Large corporations have seen a shift to long-term incentives, with 36 percent of CEO compensation in the form of stock options, but Internet companies nearly double this trend, with 62 percent of CEO compensation as stock options,” reports Baumgarten.
Given the often volatile performance of Internet stocks, this option-heavy compensation model complicates pay package comparisons. “All significant wealth recently accumulated by Internet executives has come through stock options, coupled with increases in stock price,” explains Baumgarten. “In fact, much of the wealth has come shortly after initial public offerings.” This phenomenon is evidenced by the study’s finding that the $6.2 million median compensation for CEOs of content-focused Internet companies in fiscal 1998 was far higher than the pay packages for other Internet categories. Why? Likely because 75 percent of content companies sampled completed their IPOs in the last year.
For exactly the opposite reason, the pay packages of some CEOs of “older” Internet companies are equally deceiving. “Many of the founders of Internet companies have become fabulously wealthy and have individual incentives very much in tune with those of their companies, so they can afford to pay themselves very little,” notes Spencer Stuart’s study, in explanation of the surprisingly low median compensation for Internet CEOs of $558,065.
For example, William Melton of CyberCash reported $0 compensation in fiscal 1998, having volunteered not to draw a salary until the company becomes profitable. Yet, Melton, as the company’s largest stockholder, owns a 13.14 percent stake in CyberCash worth $35 million. Similarly, Jeff Bezos of Amazon.com was paid only $82,000 last year, but is worth more than $8.5 billion. The 16.2 percent stake in Broadcast.com held by Mark Cuban, the company’s co-founder, president, and chairman, is valued at more than $350 million, but Cuban was paid only $120,000 in 1998.
Removing founding CEOs from the equation brings the median pay up to a handsome $4.5 million. This figure reflects the fact that many experienced outsiders are being brought in to run post-IPO, fast-growth Internet firms. These nonfounding business leaders tend to have higher salaries coupled with a relatively low percent ownership and market value compared with their founding counterparts, as they haven’t been with their respective companies long enough to accumulate large interests.
Nonfounding Internet CEOs also tend to be older than founding CEOs, with educational backgrounds and career experience centered in management rather than technology. For example, 56-year-old Ellen Hancock, who was recruited from Apple to run Exodus Communications, reaped $151.1 million in total 1998 compensation, $156,213 in salary and more than $151 million in options.
“While the Internet industry is not entirely dominated by whiz kids, there is some truth to the 29-year-old billionaire stereotype,” reports Baumgarten, who points out that 21 percent of the Internet CEOs in the study were under 35. “Not surprisingly, more than 80 percent of these young CEOs are entrepreneurs who started their own companies, and a significant majority of founders are under the age of 40. On the other hand, less than 20 percent of nonfounders are under 40.”
WHERE’S THE MONEY?
Despite increasingly flat organizational models, “the compensation distribution of Internet executives remains a steep pyramid,” reports the Spencer Stuart study, which found that CEOs of Internet firms had a median company ownership of 7.06 percent and a median market value of $35.6 million, as compared to the president/COO’s 1.35 percent ownership and $11.8 million in market value.
While well-paid relative to the traditional business world, the CFOs, CIOs, and vice presidents of Internet firms are farther down the compensation ladder and typically don’t enjoy nearly the same levels of percent ownership as the top players. In many cases, these key executives are brought into the fold after an Internet company’s initial growth surge, and therefore have a considerably lower percent ownership and market value than those executives who have been on hoard from the company’s inception.
“Less important in the initial stages of development, the CFO becomes more important when the companies shift from bookkeeping to serious accounting and from being start-ups to publicly traded companies,” says Baumgarten, who explains that CFOs in the study reported median compensation of $1.2 million and a mere .31 percent company ownership. “Although there were-somewhat surprisingly-three founding CFOs, most were recently brought in from the finance industry, or from finance positions in related industries, with very few having worked in the Internet industry before.”
Similarly, Internet sales and marketing executives are often brought in from the outside, as evidenced by their compensation structures. Sales division vice presidents in the Spencer Stuart survey rated relatively low ownership levels, but reported having the highest annual salaries and bonuses, a mean of $175,276 and $53,761 respectively, of any post-including the CEO seat. Among the top paid were Sam Mohammad from Exodus and Anil Singh from Yahoo, who received $92.5 million and $28 million respectively in 1998. Since the majority of Internet companies remain in the red with relatively small sales revenue, these higher salaries may reflect Internet companies’ recognition of the difficulties sales executives may face in achieving customary levels of commission-based pay.
The compensation structure for marketing executives also tends to reflect a healthy salary-median 1998 compensation for those in the study was $941,283-and a relatively low percent ownership and market value-a median of .26 percent. As these executives are often brought in from outside firms within the same or a related industry, their compensation packages may reflect the necessity of competing with the salary structures of off-line companies to attract top talent. Vincent Martinellis, for example, left TWA to take the VP of marketing post at Lowestfare.com, while Tim Kelly departed the hallowed halls of Sprint to join Internet travel services company Tickets.com as EVP and chief marketing officer.
A NEW COMPENSATION MODEL?
While cautioning that the concentrated-on-paper wealth accumulated by Internet executives is far less stable than the cash salaries and bonuses of Fortune 500 executives, Spencer Stuart’s study concludes that Internet company executives’ “ability to generate exceptional wealth in a short period of time is unparalleled in any other industry.”
“As of today, much of the hype is true-there are tremendous fortunes being made-many- of them by very young executives,” adds Baumgarten. Furthermore, while most of the accumulated wealth is concentrated at the upper echelons, at many Webcentric businesses it’s also distributed across the executive teams.
This trend toward stock- and stock option-heavy compensation packages centers around the recently embraced concept of tying executive pay to company performance. But ironically, in the case of many Internet firms, executive pay is tied not so much to company performance as it is to the perception of company performance.
In some cases that perception is strongly aligned with the talent on board, points out Baumgarten. “Companies are increasingly being valued based on their intangible assets,” he says. “This is more true of Internet companies than perhaps any others, so it’s quite fitting that human capital is valued so highly by both the company itself and the public markets.”
Yet it’s success stories of Internet CEOs that have given new weight to the idea of incentive-based pay at traditional corporations, which are grappling with the heightened challenge of competing with Internet companies for executive talent. “It’s interesting to note the extent to which high-profile Internet CEO compensation packages are finding their ways into
SHAHEEN & CO. – An Internet-Spawned Corporate Brain Drain
In the realm of high-tech start-ups, stories of 20-something Internet company founders scoring huge payoffs abound. But now there’s a new trend-that of the experienced business leader who abandons the safe haven of an established Fortune 500 firm to gamble on the prospects of a start-up in the highly volatile Internet sector. In fact, players from virtually every business sector-from Big Five accounting firms to Big Blue-are abandoning the hard-won security of a steady climb up the corporate ladder for a ride on the dot.com rollercoaster.
Just last month, Andersen Consulting CEO George Shaheen left a 30-year tenure at the $8.3 billion privately held firm to steward Webvan Group, a Foster City, CA-based start-up. Webvan, which filed for a $345 million IPO in August, handles next-day or same-day on-line grocery and drugstore deliveries to consumers. To say that Webvan isn’t in the same league as Andersen would be a dramatic understatement; the company reported a mere $395,000 in revenues and a net loss of $33.5 million in the first two quarters of 1999. It reportedly took an option to buy 15 million shares of Webvan at $8 each for Shaheen to walk away from his formidable retirement package. Webvan’s growth potential? Clearly, Shaheen is betting on the firm going the route of start-ups like Ebay, Amazon.com, and Yahoo. Will it deliver? Maybe. While Webvan currently only serves the
Shaheen isn’t the only big company veteran who’s gone to sift for Internet gold. Andersen veterans Rudy Puryear and Greg Owens left to join dot.com firms-Web consulting services company Lante and supply chain software firm Manugistics, respectively. Gary Moore of EDS jumped ship to join a
AT&T has lost a slew of management talent to the allure of dot.com and Webcentric businesses, including Alex Mandl, COO and president, who left in 1996 to head Teligent as chairman and CEO. In September, Bill Malloy resigned as executive VP of AT&T Wireless, leaving an 11-year AT&T tenure to take the president and CEO post at Peapod. Others who have flown the AT&T nest for Web ventures include consumer markets’ Daniel Schulman, who went to Priceline.com as president and COO; business services’ Robert Annunziata, who joined broadband provider Global Crossing; and Lucent’s Curtis Crawford, who took the president and CEO post at Zilog.
Whether these moves will pay off for the latest batch of risk-taking Internet converts is anyone’s guess. Certainly hopping onto the Web train has proved lucrative for other former outsiders. Ebay’s Margaret Whitman, who hailed from the staid toy firm Hasbro, picked up options at 7 cents a share when she took the CEO post early in 1998 and became a billionaire.
For more traditional firms, the exodus is intensifying the twin challenges of attracting and retaining top talent. “I’ve lost several executives that I wish were still here,” AT&T’s Michael Armstrong told CE recently, adding that the revolving door swings despite efforts to compete. “We put a retention package in place, so people don’t leave for financial reasons. But if someone gets an offer that’s just astounding, such as an executive did who recently left, there’s nothing I can do about it. So you just have to shake the guy’s hand and say, ‘I understand. Good luck to you.’ “
It’s the exploding demand for and limited supply of Internet leaders that’s spawning these extraordinary and creative packages, says Jim Citrin, managing director of Spencer Stuart’s Global Internet Practice. “The critical challenge for traditional firms is to create a proposition-both financial and otherwise-that will attract the right executives, not only with the dot.com allure, but with all the resources of the organizations. Doing so can help swing the pendulum back and reverse the brain drain.”