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Monday, 08 May 2006 |
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In 2005, the average CEO of a Standard & Poor's 500 company received $11.75 million in total compensation, according to a preliminary analysis by The Corporate Library. This represents a 3.66 percent increase in CEO pay over 2004.[1]
A reasonable and fair compensation system for executives and workers is fundamental to the creation of long-term corporate value. However, the past two decades have seen an unprecedented growth in compensation only for top executives and a dramatic increase in the ratio between the compensation of executives and their employees. Boards of directors are responsible for setting CEO pay. Too often, directors have awarded compensation packages that go well beyond what is required to attract and retain executives and have rewarded even poorly performing CEOs. These executive pay excesses come at the expense of shareholders as well as the company and its employees. Excessive CEO pay takes dollars out of the pockets of shareholders—including the retirement savings of America’s working families. Moreover, a poorly designed executive compensation package can reward decisions that are not in the long-term interests of a company, its shareholders and employees. For example, recent scholarly studies have linked CEO stock options to accounting fraud and other financial restatements.[2] Stock option grants promise executives all the benefit of share price increases with none of the risk of share price declines. For this reason, stock options can serve as powerful incentive for executives to cook the books. Some CEOs may have far greater control over their pay than anybody previously suspected. According to new research, certain CEOs may be backdating their own stock option grants to maximize their value. According to The Wall Street Journal, “Year after year, some companies’ top executives received options on unusually propitious dates.”[3] Excessive CEO pay is fundamentally a corporate governance problem. When CEOs have too much power in the boardroom, they are able to extract what economists’ call “economic rents” from shareholders—the equivalent of monopoly profits. These rents are known as “agency costs,” and arise from the separation of ownership and control. The board of directors is supposed to protect shareholder interests and minimize these agency costs. However, at approximately two-thirds of companies, the CEO is the board’s chair. When one single person serves as both chair and CEO, it is impossible to objectively monitor and evaluate his or her own performance. CEOs also dominate the election of directors. The vast majority of directors are hand-picked by incumbent management. Because of the proxy rules, it is cost prohibitive for shareholders to run their own director candidates. Moreover, even if a majority of shareholders withhold support from directors, they are still elected to the board at most companies. Ultimately, shareholders have to be able to trust their boards of directors to set responsible CEO pay packages. For this reason, CEO pay will be reformed only when corporate boards are made more accountable. Until then, CEOs will continue to influence the size and form of their own compensation, and CEO pay will continue to rise. [1] Pay Growth Slows in 2005, The Corporate Library, March 21, 2005. [2] "Stock Options: Do They Make Bosses Cheat?" The New York Times, Aug. 5, 2005. [3] "The Perfect Payday," The Wall Street Journal, March 18, 2006. |
