Are They Worth It?

In 2006, the average CEO of an S&P 500 company received $14.8 million in total compensation, according to the Corporate Library. That's a 9.4 percent increase from 2005. Those sound like some pretty big numbers — especially to the Democratic-controlled Congress.

But, since executive pay includes all kinds of fluctuating inputs — one-off payouts, stock options — the amounts paid year to year fluctuate, sometimes downwards. In 2000, for example, Lucian Bebchuck, a Harvard Law professor and compensation expert, estimates that CEOs earned $17.4 million. It declined to $9.1 million in 2003. We've been in a bull market ever since, and CEO compensation has run up right along with it — as it should since a company's share price (compared to those of its peers, of course) is a solid barometer by which to grade a CEO. And there is no question that a talented CEO can work wonders on a company. Shares of Apple were trading for around $15 a share when Steve Jobs was brought back to the helm. Jobs pulled in $647 million last year, making him the highest paid CEO in 2006. Is that too much? Most shareholders would probably say he was worth it.

Are your company executives worth what they're getting being paid? For the most part, probably yes, given the share price appreciation of most publicly traded securities companies. Of course, it's hard to figure out just how much of the securities industry's record setting $33.1 billion in profits in 2006 — and subsequent $36 billion in bonuses — was awarded to CEOs, what with stock options, deferred comp and other non-cash compensation complicating the arithmetic.

That should get easier: As of January 2007, the SEC now requires a company proxy to provide full disclosure of the pay packages and contingency arrangements (severance or other pay in case of resignation, retirement or termination) awarded to the named executive officer or the five highest paid executives — as well as how and why the firm's board of directors arrived at those numbers.

Over in Congress, populist Democrats claim that CEO pay is not tied to performance and they are introducing legislation to make sure that CEOs don't walk off with millions while company market caps lay flat (Disney, Home Depot) or go bankrupt (Enron).

For example, Congress is considering a bill that would allow shareholders to vote on the compensation packages of executives; a Congressional committee is also investigating conflicts of interest among the compensation consultants that help determine CEO pay at firms; and, there is more than one proposal to amend certain IRS codes to further limit the tax deductibility of certain types of executive compensation. The truth is, most agree the current corporate governance system needs some tweaking, but just how it should be done depends on whom you ask. (Free marketers think government should just keep out of it.)

Say On Pay

The politician associated most with the discussion over CEO pay is Congressman Barney Frank (D-Mass.), whose bill, known as “say on pay,” would force public companies to allow shareholders a non-binding vote on the pay packages approved by the board of directors for the top five named executives — a system that has been in place in the U.K. since 2002. And it could be voted into law here very soon: Frank's bill passed the House on April 20th, the same day presidential hopeful Barack Obama backed a similar bill that now awaits consideration in the Senate Banking Committee. Both versions would take effect in 2009.

It's not just politicians who are calling for reform. The American Federation of State, County and Municipal Employees (AFSCME) — the nation's largest public employee's union, representing more than 1.4 million members and assets of more than $1.5 trillion in public pensions — has been trying to persuade many of the companies its members invest in to adopt a measure that parallels “say on pay.” Included among the list of firms it's targeting are Citigroup, of which union members own roughly 67,000 shares and Morgan Stanley, of which the union membership owns nearly 7,000 shares.

“In our view, senior executive comp at Citigroup has not always been structured in ways that best serve stockholders' interests,” writes the union in the Citigroup proxy. It cites CEO Prince's $87,710 for “tax gross-ups” in 2005 as well as a pay package that included a $12 million bonus and a restricted stock award valued at nearly $10 million, as examples. Similar complaints are lodged by the union in the Morgan Stanley proxy: “In 2005, during the first year of his employment, Mr. [John] Mack realized more than $30 million from exercising options that had been given as long-term incentive.” Shareholders voted down the proposal at both firms' annual meetings earlier this year.

Of course, both companies' boards had advised shareholders to vote against the proposals in their 2007 proxy statements for a number of reasons. For example, the companies' boards said that a simple vote would be inconclusive and that shareholders can already call company directors directly if they want to voice their opinions. (Besides, investors can send the ultimate message by selling shares.) Both boards felt it would also be bad for executive recruitment. The Citigroup board wrote in its proxy that there are “no other U.S. companies with such an advisory resolution.” The Morgan Stanley board wrote, “We currently are not aware of any competitor of ours that has adopted this practice.”

Short Term-ism

While share price and sales and earnings growth are great ways to grade executive performance, Paul Hodgson, a senior research associate in compensation at The Corporate Library, a renowned corporate governance evaluator, says the securities industry tends to fixate on short-term performance when long-term shareholder value is more important. “Many of the investment firms have said they understand that it would be better to look at performance in the long-term but their response has been, ‘Well, nobody else is doing it,’” he says.

Still, many firms in the securities industry have improved some aspects of their corporate governance, Hodgson says. And although he's prohibited from providing analytical details to non-clients, Hodgson did comment in general terms on certain firms. He calls Merrill Lynch a “low concern,” in that he doesn't feel there are any worrisome corporate governance problems at the firm. “Citigroup got an ‘F' [grade for corporate governance] the entire time [Sandy] Weill was CEO, but it has improved since then,” he says. For example, Chuck Prince has increased the independence of the board. He says Morgan Stanley's crony-filled board went out the door with Philip Purcell. And he gives Wachovia and Morgan Stanley points for comparing their performance to their peers in their filings. As for Frank's proposal, Hodgson sees only good in it. “If you have something to be ashamed of, you'd be against the proposal; if you don't, you shouldn't,” he says.

On the other hand, Jagadeesh Gokhale, a senior fellow at the libertarian Cato Institute, hopes the “say on pay” legislation and other proposals like it never see the light of day, but not because it isn't well intentioned. “The government can't correctly address market issues,” he says, adding, “If CEOs are being awarded more than they deserve, it's between the stockholders, the board and the CEO. Shareholders can go to the courts if they disagree, it's not as though they don't have any recourse,” Gokhale says.

Chris Ailman, CIO of CalSTRS, the California Teachers State Retirement System, disagrees. He says there are structural problems with the current system and feels the “say on pay” measure might have helped prevent some of the more recent egregious failures of corporate governance. Take Home Depot, where Robert Nardelli got $210 million upon his dismissal from the firm despite presiding over a 20 percent drop in the stock's price during his six-year tenure. Morgan Stanley employees might remember that when chief Philip Purcell resigned in 2005 under intense pressure, he left with roughly $113 million in compensation. During his 23-year tenure as CEO the stock price gained 170 percent, a far cry from the 432 percent increase in the AMEX broker-dealer index in the same period.

Ailman says recent failures have “scared some other boards straight,” but fear of negative publicity isn't enough. “Executive comp is still dominated by the compensation consultants,” he says. “We push for more transparency while they push for more proprietary measures that can't be disclosed.” That may change if Representative Harry Waxman (D-CA) who chairs the House Oversight and Investigations Committee finds anything improper in his investigation of conflicts of interest at six large compensation-consulting firms. But Ailman also says board members he's spoken to privately confess to setting CEO pay based on that of rival firms, regardless of whether it was appropriate for their own firm, a phenomenon known in the industry as “the Lake Wobegon Effect.” It's a reference to storyteller Garrison Keiler's fictional town where all the women are strong, the men are good looking and the children are above average; in short, no firm wants its CEO to be perceived as average or below average due to how much he or she is paid.

ARE THEY WORTH IT?

E. Stanley O'Neal

Firm: Merrill Lynch

Age: 55

CEO Tenure: December 2002 - present

2006 taxable compensation: $38,191,363

2003 taxable compensation: $25,344,265

Percent change: +51%

Stock return from start date to Dec.31, 2006: +69%

AMEX broker-dealer index, same period: +168%

Five-year revenue growth, ‘02-’06: 88.6%

Time is Money: O'Neal's comp breaks down to $734,449 per week, $146,889 per day, $18,361 per hour.

John Mack

Firm: Morgan Stanley

Age: 62

CEO Tenure: June 2005 - present

2006 taxable compensation: $37,350,161

Stock return from start date to Dec.31, 2006: +67%

AMEX broker-dealer index, same period: +64%

Five-year revenue growth, ‘02-’06: +77.5

Time is Money: Mack's comp breaks down to $718,272 per week, $14,654 per day, $17,956 per hour.

Charles Prince

Firm: Citigroup

Age: 57

CEO Tenure: October, 2003 - present

2006 taxable compensation: $19,806,451

2004 taxable compensation: $19,567,064

Percent change: +1%

Stock return from start date to Dec.31, 2006: +33%

S&P Banking Index, same period: +31%

Five-year revenue growth, ‘02-’06: +35%

Time is Money: Prince's comp breaks down to $380,893 per week, $76,178 per day, $9,522 per hour.

G. Kennedy Thompson

Firm: Wachovia

Age: 56

CEO tenure: April 2000 - present

2006 taxable compensation: $10,967,272

2001 taxable compensation: $4,021,023

Percent change: +173%

Stock return from start date to Dec.31, 2006: +76%

S&P Banking Index, same period: +55%

Five-year revenue growth, ‘02-’06: 66%

Time is Money: Thompson's comp breaks down to $210,909 per week or $42,181 per day, $5,272 per hour.

Tom James

Firm: Raymond James

Age: 65

CEO Tenure: 1969 - present

2006 taxable compensation: $3,704,860

1969 taxable compensation: $35,000 (James' own best guess)

Percent change: 10,485%

Stock return after going public July 1st, 1983 to Dec.31, 2006: +6,157%

AMEX broker-dealer index from April 15th, 1994 to Dec.31, 2006: +1,936%

Five-year revenue growth, ‘02-’06: 62.5%

Time is Money: James' comp breaks down to $71,247 per week, $14, 249 per day, $1,781 per hour.

Robert Bagby

Firm: A.G. Edwards

Age: 63

CEO tenure: March 2001 - present

2006 taxable compensation: $3,704,557

2002 taxable compensation: $1,350,047

Percent change: +174%

Stock return from start date to Dec.31, 2006: +81%

AMEX broker-dealer index, same period: +134%

Five-year revenue growth, ‘02-’06: +43%

Time is Money: Bagby's comp breaks down to $71,241 per week, $14,248 per day, $1,781 per hour.