How CEO pay in America got out of whack

The Economist, 2020-07-11

Widely Held Incorrect Assumptions

  • Generous CEO rewards are the reflection of the companies’ financial performance.

  • Firms must pay top dollar for CEOs as the competition for talent is global.

  • Superior CEO performance is maximizing shareholder returns.

  • Boards are good at hiring good CEOs.

  • Benchmarking CEO pay against other firms is helpful (no, it just ratchets up the pay for everyone. Actually, it’s not a bad idea for first-time CEOs to be paid below median).

Some Numbers (We Love Numbers, Correct?)

  • Median CEO pay in the US is $14m p/a [includes stock grants/options/etc., i.e. “realized compensation”]

  • Realized Compensation grew ~7% YoY in 1978-2019 and grew 14% in 2019.

  • More than 50% of exec comp is bonuses + stock grants and options.

  • In more than 60% of cases between 2007 and 2016 CEO pay was not correlated with 10-year returns.

  • Companies paying CEOs 12x (top quartile) of bottom quartile CEOs only did 2x financial return. Second lowest-pay quartile CEOs got 3x of bottom quartile CEOs with inferior results.

Hypocrisies

  • COVID-related “taking $0 salaries by bosses” is not what it seems. Each “foregone” dollar of salary will be more than compensated for by incentive pay should the shares rebound.

  • Share prices of many companies are back to pre-COVID levels, exec salaries may continue to rise.

  • Energy firms’ CEOs got bonuses for oil price spikes (did they influence those spikes?).

  • Despite the independence of Compensation Committees, CEOs have a huge say in their pay.

  • COVID tempts CEOs to renegotiate performance targets to more easily achievable.

Solutions (?)

  • “Say on pay” by shareholders (as opposed to the Directors).

  • Replace “common pay” packages with 3-year performance measures with 5-year measures or delay payouts from equity grants for 5+ years. However, this may force the increase of the base pay to compensate for the longer wait.

  • Don’t use benchmarks.

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