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Back to Subjects - Economics

CEO Pay

CEO Pay The lead story in the March 31, 1997 issue of The Wall Street Journal was an in depth study of the life of a seventy-three year old man. This man is still forced to punch a time clock and his duties involve demanding manual labor. His Social Security benefits aren’t enough to cover his monthly expenses therefore, retirement is not in his plans (Ramirez 1). In the same issue of The Wall Street Journal there was an article covering the details of PepsiCo’s’ Chief Executive Officers compensation plan. In 1997 PepsiCo’s’ CEO was paid $2.2 million in salary and bonus plus stock options for 1.7 million shares (Quintans 6). These stock options may be exercised over the next eight to ten years. If PepsiCo’s stock rises at five percent per year, these stock options will be worth around $32 million by the year 2006. Over the past ten years, the American economy has enjoyed a level of success it has never seen before. Businesses report record profit levels and hold expectations that profit levels will continue to rise. The stock market continues to rise and in doing so increases businesses bottom line. Americans have always assumed that when their company succeeds, all employees will share in that success. However, for most, that assumption has not proven to be true. As a matter of fact, only those at the top level of management have seen an appreciable increase in their compensation. The combination of employee compensation being held flat and top-level management compensation spiraling upward has served to increase the income gap to an almost unconscionable level. Over the past decade CEO compensation has increased by 212% while the average factory worker has seen his/her wages rise by 54%. In the latter part of 1997 Business Week reported that executive pay is “out of control”(Butoyi 91). Take for example the case of Green Tree Financial Services CEO Lawrence Coss. Green Tree finances mobile home loans. In 1997 Mr. Coss earned $102 million. A minimum wage worker living in a Greentree financed mobile home would have to work for 7500 years to earn the equivalent of what Coss earned in 1997. In 1998 CEO Donald J. Carty earned $1,789,919 in salary, bonus and other compensation from AMR Corp. (the parent company of American Airlines). In 1998 the average pilot for American Airlines earned $60,000. Mr. Carty earned about thirty times more than the average pilot did. However, when Carty’s stock options are figured in, his bottom line increases from $1,789,919 to $9,598,031 about 160 times what the average pilot earned (AFL CIO). Stock options have become an increasingly important part of CEO compensation packages. Stock options are shares of the companies stock. The idea is that the companies performance will have a direct effect on the companies stock price, this relationship will directly link a CEOs ability to make a company perform to his compensation. The explosive stock market has made that idea obsolete. Stocks of mediocre companies have risen recently just by virtue of the fact that they are in a strong industry and not because the company is performing well. The average CEO earns a salary that is over 200 times what the lowest paid employee in his/her company earns. The CEO also receives bonuses, pay incentives and perks that the lowest paid employee will not receive. Allowances for items such as clothing, automobiles and housing are all part of the CEOs compensation package. The corporate reasoning is that, the CEO will interact at social events with other corporate leaders and must have a proper wardrobe to put forth a proper image of his/her corporation. Furthermore, CEOs will entertain at their houses and must live in a house equivalent to the expectations of his/her guests. The use of company owned vacation properties and luxury hotel suites is another perk the average CEO receives. Another interesting aspect of CEO compensation is a concept called the “golden parachute”. A “golden parachute” is a contractual exit compensation package, in the event of a change of ownership of a company (Richards). In other words, if a company is sold or involved in a hostile take over the CEO will automatically receive a predetermined sum of money, thus allowing his or her descent from employment to unemployment to be buffered by a “golden parachute”. These “golden parachutes” usually involve millions of dollars. According to the executive compensation consulting firm Pearl, Meyer and Partners, stock options make up two thirds of a CEOs pay up from one third in the 1960s. Any increase in stock prices will cause an increase in the CEOs compensation. In 1996, thirty firms announced lay-offs of between 2,800 and 48,640 workers (Butoyi 92). Analysis of the leading job cutters revealed that their top executives, for the most part, were handsomely rewarded for wielding the axe. In 1996 the lay-off leaders enjoyed an average increase in total direct compensation of 67.3 %. Most of the job cutters increase in compensation came in the form of gains from stock options, reflecting Wall Street’s trend to reward downsizers ( Mullican 66). Defenders of run-away CEO pay argue that market forces are at work determining CEO compensation levels and that CEOs are entitled to their compensation packages for increasing profits and raising stock prices. Human resources consultant William M. Mercer Inc. estimates that only one quarter of all stock option grants contain any sort of link to performance. On May 21 1998 Computer Associates gave its CEO Charles B. Wang shares totaling $670 million. This enormous stock grant exercise turned Computer Associates’ first quarter earnings of $194.2 million into a loss of $480.8 million. When the news reached Wall Street the company’s stock price fell 30.7% in one day (AFL CIO). Boards of Directors are supposed to select and compensate CEOs. When it comes time to discuss compensation the golden rule is often remembered Do unto others, as you would have them do unto you. It is not uncommon for members of the board of directors to be personal friends of the CEO. The board will select three or four of its members and appoint them to the compensation committee. The committee is composed of members who are usually white, male and almost always fellow corporate officers from other companies. These members will seldom pay the CEO anything less than what they themselves make; they don’t want to insult him. The committee tends to set the CEO’s salary at the high end of the comparative pay scale (what other CEOs from competitive firms make) and then attach a premium to cover what competitors might pay to hire away their prized executives. One benefit companies derive from higher CEO salaries is that; current tax codes allow a company to deduct a reasonable allowance for salaries or other compensation. The code defines reasonable as 1 million dollars, which is more than 99% of the American workforce earns in one year. Companies have therefore been able to deduct salaries that are vastly disproportionate to those of their lowest paid employees. Companies don’t have to pay outrageous CEO salaries. There isn’t a shortage of acceptable capable executives in the United States. Corporations abroad do not seem to encounter problems with motivating their CEOs with normal compensation packages. According to international human resources company Towers Perrin, the average CEO in the U.K. makes $645,540, in Japan $420,855 and in Germany $398,430. When Germany’s Daimler-Benz acquired the smaller American car manufacturer, Chrysler, Chrysler CEO Robert Eaton earned eight times what Daimler- Benz CEO Juergen Schrempp earned. In order to effectively reign in run-away CEO salaries we must exert control from every angle. Salary tax breaks should be limited to thirty times the salary of the lowest paid employee. The fraternal relationship between the CEO and those who make decisions regarding his/her salary should be eliminated. Expand membership on compensation committees to include worker and stockholder representatives. Limit stock options given to CEOs. The goal is not necessarily limiting pay at the top but rather bringing them in line with those at the bottom and in effect, bridge the income gap. Bibliography:

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