MODERN CEO COMPENSATION: HEADS THEY WIN, TAILS SHAREHOLDER LOSE?

The compensation levels of CEOs of large publicly traded companies provide regular fodder for discussion in the business and public press. The common perception is that these CEOs get compensated rather generously regardless of how well their companies perform. One often reads about the ratio of CEO pay to that of the average employee. Take this example from a 2015 Fortune Magazine article:

• The ratio of average CEO compensation to average employee salary has skyrocketed from 20-to-1 in 1965 to 300-to-1 in 2014. Inflation adjusted CEO pay, between 1978 and 2014, increased by 1,000% while the increase for an average worker was a meager 11%

If you are tempted to dismiss this perception as the envy of the “99 percent” a recent study released by the investor research firm MSCI may alter your opinion. The authors of the study, Ric Marshall and Linda-Eling Lee, sampled 429 large-cap U.S. companies and covered a 10 year period (2006 to 2015). They were investigating the effectiveness of equity based incentives for CEOs, a feature of CEO compensation packages that came into vogue about 25-30 years ago.

To quote the authors’ punch line:

Has CEO pay reflected long-term stock performance? In a word, “no.”

According to the study, with equity incentives being built into the compensation packages of over 70% of the CEOs in the United States, the authors expected to discover a strong positive link between these awards and the long-term stock performance of these companies. Not only did they not find that, they actually found a “small but consistently negative relationship.”

Given that the average tenure of these CEOs is around 5-7 years, it is not surprising that these incentives create a short-term bias in their decision making. Further, the strategic choices made to drive up the stock prices in the short run may effectively be working against the long term shareholder returns at these companies.

Defenders of these generous packages point out the challenging and complex nature of the modern CEO’s job, and the need to reward them in a manner where their interests are properly aligned with that of the shareholder. I always wonder whether this premise about aligning CEO interests with that of shareholder interests can stand up to academic debate.

Readers of this article may find this little historical comparison of some interest. In 1955, General Motors was the largest company in the United States, employing over 550,000 employees and with revenues of about $9.8b (about $87b in inflation adjusted 2015 dollars). The head of General Motors received around $800,000 in total compensation (approximately $7.1 m in 2015 dollars).

The largest company in 2015 was Wal-Mart with over 2 million employees and revenues of $485b. However, the highest paid CEO in 2015 was the CEO of Discovery Communications, who received a compensation package worth over $150m. His company’s revenues in 2015 were about $6.4b. By contrast, the CEO of Wal-Mart had a compensation package worth about $20m.

At the end of 2011, Wal-Mart stock traded at about $61 while Discovery Communications stock traded around $41. By the end of 2015 the stock price for Wal-Mart was still $61 while the stock of Discovery Communications traded at about $35.

As of August 3rd 2016, Wal-Mart’s shares were valued at $72.94 while Discovery Communications shares traded at $26.83!

In the case of publicly held companies, there possibly are multiple reasons for the super attractive compensation packages.  For institutional investors, who are often the largest block of shareholders, this may not be as salient an issue. There might also be something of an insider’s club phenomenon at work. Board Members, many of whom happen to be CEOs at other companies, may perhaps be inclined towards generosity and self-interest in raising the benchmarks for CEO compensation. The available pool of experienced CEOs may also be a relatively small one.

While I have worked with executive teams at Fortune 500 companies in the past on strategic planning and management development projects, my present consulting interests are primarily in the realm of privately held companies and start-ups. I typically work with Founder CEOs on long term projects involving strategic change and business development projects, or new product and company launches. I have found that they generally compensate themselves quite fairly, particularly given the risk of ownership that they are burdened with.

Interested in contacting me? Send an email to [email protected]