Are CEOs paid too little?

In the course of my work I have to analyse the remuneration of corporate executives, mainly in the US. In these circles it is taken for granted that CEOs are massively overpaid, and that this is an outrage. Clearly there are many cases where the relation between a CEO's pay package and the company's performance seems to be totally unhinged. Nonetheless I am not totally sold on the idea that pay packages are immoral simply because they are especially large.
Recently, The American - a new business bimonthly published by the AEI - had a cover story which makes quite a contrarian, but well-reasoned, argument on this subject. The subtitle states:

Sure, some CEOs aren’t worth their outrageous compensation, but a bigger problem is that large public companies, in many cases, don’t pay enough. The best and brightest minds are increasingly drawn from running key businesses to other pursuits that may not be as socially useful—but pay much more.

Such an argument is also supported by some academic research. Professor Steven Kaplan, of the Chicago GSB, illustrates some of it in the HLS Corporate Governance Blog:

I was shocked (but encouraged) to read the New York Times yesterday. Instead of writing another article about how CEOs are massively [over]paid, dishonest, or both, Andrew Sorkin and Eric Dash make a strong argument that U.S. CEOs are underpaid! According to the article, private equity firms are increasingly successful in luring talented public company executives to run private equity-funded firms. A big part of the reason is that private equity firms pay those executives more.
[...]
Third, despite much that is written, realized CEO pay is strongly related to firm stock performance. In a recent paper, Josh Rauh and I sorted the firms in the ExecuComp database into ten groups based on realized compensation in 2004. We then looked at how the stocks of each group performed relative to their industry. According to the critics, we should not have found much of a correlation. In fact, we found a strong one. Realized compensation is highly related to performance. CEOs in the top decile of realized compensation saw their firms outperform their industries over the previous three years by more than 50%. CEOs in the bottom decile saw their firms underperform by more than 25%. As you go from the lowest-paid to the highest-paid executives, performance always increases.
Fourth, as Xavier Gabaix and Augustin Landier point out, CEO compensation should be tied to firm size. And firm size has increased markedly in the United States over the last thirty years.
It is a fact that top executives of public U.S. companies are paid a lot today, and a lot more than they have been paid in the past. The high pay combined with questionable behavior by some CEOs and boards has led the press and some academics to conclude that average CEO pay is excessive, driven by dishonest, manipulative top executives and ineffective boards.
The discussion and evidence above calls that conclusion into question. One has to wonder how overpaid public company executives are when private equity investors (who do not have an incentive to overpay) will pay them more. And public company boards appear to have been more active in managing CEOs than they are given credit for.

An interesting case in point is the recent firing of Bob Nardelli, the CEO of Home Depot. Kevin Lacroix at the D & O Diary points out:

There is no particular reason why I should bestir myself to defend ousted Home Depot CEO Robert Nardelli: He certainly bagged sufficient swag to soften the blows of even his most outraged attacker. Yet I think it is important to incorporate into the modern morality play that his departure has become a fair recognition that by some measures his tenure as Home Depot’s CEO was successful. From 2000 (when Nardelli joined the company) to 2005, Home Depot’s revenue nearly doubled, from $45.7 billion to $81.5 billion, and during that same period Home Depot’s profit increased, from $2.6 billion to $5.8 billion. Dividends quintupled. The company's return on capital increased almost 20 percent, a full 10 percentage points above its cost of capital.

Further down in the post Kevin points out that some compensation practices at Home Depot were indeed dubious, but, IMHO, those kinds of problems will be addressed quite effectively by the new disclosure rules that have been put in place by the SEC.
Meanwhile, there is a particularly ironic twist to Bob Nardelli's story: it has been touted as a shareholder victory. Why is this ironic? Well, it is a consistent refrain among shareholder activists that remuneration needs to be tied to performance, and that share price appreciation is not an appropriate performance measure because it is influenced by too many other factors for it to be considered the CEO's merit if the share price goes up. Apparently this logic flies out the window as soon as the share price goes down. Kevin spells it out:

Nevertheless, the consensus view seems to be that his ouster is a victory for shareholders, and that they have shareholder activists to thank. A typical example is the January 5, 2007 New York Times article entitled "Gadflies Get Respect and Not Just at Home Depot" (here), which states that "shareholder activists could claim one of their biggest prizes yet when Home Depot announced the resignation of its chairman and chief executive." The article also notes that since July, activists have also successfully pushed out the CEO's at Pfizer and Sovereign Bank.
In touting Nardelli's ouster as a shareholder activist success story, the Times article note that he had long been "a target of shareholder ire for his large compensation and the company’s flagging share price." It is this latter point – Home Depot's flagging share price – that really seems to be at the heart of Nardelli's problems. A January 3, 2007 Fortune.com article entitled "Nardelli's Downfall: It’s All About the Stock" (here) makes the connection explicit. Gretchen Morgen[son] made the same point in her January 4, 2007 New York Times article entitled "A Warning Shot By Investors to Board and Chiefs" (here, subscription required), in which she says that Nardelli's compensation was "completely at odds with the dismal performance of Home Depot stock on his watch."
One question that needs to be asked is how much of what happened to Home Depot's share price had to do with Nardelli and how much it had to do with where the share price was when Nardelli took over. As PointofLaw.com points out (here), Home Depot's share price was already at stratospheric levels when Nardelli arrived.
But the more troublesome aspect of the criticisms about Home Depot's share price is the clear implication that Nardelli would still have a job (although he would be $210 million poorer) if he had managed to get the share price to go up. It used to be the conventional wisdom that the market determined a company's share price, not the CEO. Moreover, it has not been that long since corporate America faced a series of crises and scandals because too many CEOs seemed to think it was their job to engineer their company's share price rather than to run their company. Corporate activists may be congratulating themselves for their "victory" at Home Depot, but they should be very careful about the lesson here. The danger, as pointed out on the ContrarianEdge blog (here) is that "the ousting of Bob Nardelli sent a wrong message to America's CEOs : it taught them an incorrect lesson – manage the stock, not the company."

So, the truth is that shareholder activists - if they truly believed what they were saying - should be outraged at the wrong message that Nardelli's ouster is sending the market. If this won't encourage "short-termism" and encourage CEOs to focus on share price, instead of the long-term success of their companies, I don't know what will.

Social responsibility

Forbes reports:

Wal-Mart's low prices haven't helped it gain a high perch in the public's esteem. At least, that's the conventional wisdom. Critics accuse the retail giant of destroying neighborhoods, exploiting its workers and discriminating against female employees. But when American consumers were asked to name a U.S. company that was socially responsible, they named Wal-Mart above all others.
The retail giant trounced second-place McDonald's (yes, McDonald's). In fact, 28% of consumers picked Wal-Mart Stores as the most responsible company, compared with 17% for McDonald's and 16% for third-place Microsoft.

It's funny that three of the corporations that activists target most seem to be so popular. Then again, it shouldn't be surprising considering that when corporate social responsibility advocates move to defend the rights of all sorts of disparate stakeholders, the company's actual customers tend to be overlooked.

When it pays to be gay

This must be the funniest argument in favour of gay unions I have ever heard. GayandRight says:

Another reason why gay marriage is important...

and quotes the following story from the Washington Blade:

Michael Kopper, 41, the gay former Enron Corp. executive who became the first to plead guilty to financial crimes among the company's top management, was sentenced Nov. 17 to three years and one month in prison. Judge Ewing Werlein, of the U.S. District Court in Houston, also sentenced Kopper to two years probation and ordered him to pay a $50,000 fine.
The sentencing came four years after Kopper, who lives in Houston, pleaded guilty to two counts of conspiracy after he admitted that he and his domestic partner, William Dodson, stole about $16.5 million from Enron and its shareholders. Kopper cooperated in the government's investigation into the massive financial scandal that rocked Wall Street and resulted in Enron’s bankruptcy. The Enron collapse also resulted in the loss of millions of dollars to company shareholders and employee pension funds.
Although authorities forced Kopper to return $8 million to the government and to relinquish his rights to another $4 million through forfeiture proceedings, Dodson has been allowed to keep $9 million in funds that Kopper helped him obtain through Enron-related scams. The fact that U.S. and Texas laws do not recognize same-sex relationships most likely prompted authorities against going after Dodson's financial gains in the Enron affair, financial observers have said. Federal prosecutors forced the married spouses of several Enron figures to forfeit money they obtained in schemes operated jointly with Enron executives.

I bet the shareholders are not amused, but you can't deny the irony of it all.

Beyond backdating

In the midst of the stock option backdating scandal (also see here and here; may require subs.), Fortune's Justin Fox makes some interesting points about stock-options (via the excellent RealClearPolitics Blog):

Yermack figured that this wasn't just luck, and theorized that companies were timing their grants to precede good-news announcements and follow negative ones. His findings began making the rounds in 1995, sparked a flurry of interest among finance and accounting scholars, and were published in The Journal of Finance in 1997.

Accounting professors David Aboody of UCLA and Ron Kasznik of Stanford followed up with an examination of companies that made options grants on more or less the same day every year, and found a similar stock price pattern. Their theory: Companies time releases of bad and good news to depress prices before the grants and boost them afterward.
[...]
Then there's the realization that, even before Lie's backdating bombshell, scholars suspected that executives were using insider information for financial gain in timing options grants and news releases.
Does that make backdating just the most obviously illegal tip of an iceberg of dodgy corporate behavior? And is anyone going to get in trouble for the other stuff?
Those are questions currently of great interest to securities lawyers, I learned at a late-October conference at Washington's Union Station. "Lucky Strikes" was the title of the event - organized by Stanford's Rock Center for Corporate Governance, of which Grundfest is faculty director - and much of the jargon was along similarly flip lines.
"Bullet dodging," for example, is the term for delaying options grants until just after the release of bad news (or moving up the release of bad news to precede an already scheduled grant). Because the grant comes after the news is out in the open, such behavior is nearly impossible to prosecute on insider-trading grounds.
More problematic is "spring-loading" - timing an options grant to precede the announcement of good news (or delaying the happy announcement to follow an already scheduled grant).
At Union Station, Grundfest divided this into "symmetric spring-loading," where the members of the board of directors who approve the grant are fully aware of the good news to come, and "asymmetric spring-loading," where they are not. Asymmetric spring-loading itself comes in two flavors: "with ratification," when the board says after the fact that it's okay, and without.
As Grundfest reeled off these terms, I and the reporter sitting next to me giggled, mainly because they sounded so much like something from a diving meet. ("She's going to attempt a reverse double asymmetric spring-loader and ... she nailed it!") But the distinctions may make all the difference, legally speaking.

And a proposed solution for boards who want to remain above suspicion:

In the meantime, Grundfest has been advising companies to schedule their options grants three trading days after a quarterly earnings announcement. This minimizes the amount of inside information that executives could possibly take advantage of. It also has the interesting side effect of giving them an incentive to miss the quarterly earnings target set by Wall Street analysts (because that might depress the strike price of their options). Now that would be a shocking development.

Given the current furore, I expect a lot of companies will be following that advice.

Skilling in perspective

The other day Jeffrey Skilling, the former CEO of Enron was sentenced to 24 years and four months in prison. I certainly think the bastard had it coming, but at the same time I think Homocon makes a very valid point:

Rapists, pedophiles and murderers get sentenced more lightly than this -- hell, even Lynn Stewart, who was convicted of aiding an imprisoned terrorist (Omar Abdul Rahman, who was the spiritual leader of a cell that carried out the first World Trade Center bombing and was planning to blow up the Lincoln and Holland Tunnels) and lying to federal investigators, only got 24 MONTHS!
What kind of message is this supposed to send? Rape someone, kill someone or assist terrorists and you'll maybe get a couple of years, but if we find out you're a shady CEO -- watch out!

And what about this case (via GayandRight)? Indeed, what kind of message are we sending?