Time to Make CEO Pay Match Shareholder Performance
This should have been as easy as voting in favor of mom and apple pie.
Nonetheless, in the sharply divided ranks of the Securities and Exchange Commission’s board, the five members split straight down party lines when it came time earlier this week to put forth a new proposal. The issue at hand: helping investors more easily and rapidly compare their returns from a company to the returns that its management team pocket in the form of compensation. In other words, as an investor in a company, do your rewards measure up to those that a CEO is awarded for running that company?
It shouldn’t be all that controversial an idea. The job of every chief executive, and members of his or her management team, is to run the company on behalf of all shareholders, a.k.a. investors.
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In practice, it doesn’t turn out that well. Consider Aubrey McClendon, the founder and former chairman and CEO of Chesapeake Energy. Back in 2012, when the company’s stock plunged 24 percent and it reported a loss of $769 million, he earned total compensation of $16.9 million. Richard Fuld, who ran Lehman Brothers straight onto the rocks during the financial crisis of 2008, had made the list of highest-paid U.S. CEOs for eight years running before that. Mary Barra of General Motors earned $16.2 billion last year, in spite of the fact that the automaker had a record number of recalls.
There’s ample academic research showing that the more a CEO gets paid, the worse his (or her) company is likely to do in the coming years. And superstar CEOs who collect the most massive paychecks of all, as a group, returned less to shareholders than did their peers. These are studies based on large sample sizes and covering rolling three-year time periods over a nearly 20-year span.
Yet the SEC’s two Republican members opted to turn thumbs down on the new proposal, which would require publicly traded companies to disclose how much executives receive in “actual pay” (excluding share or option grants that haven’t vested yet) and compare that to annual total shareholder return, and to the returns of companies in their peer group. Companies would have to provide a specific dollar figure for their CEOs’ compensation, but could use an average for the compensation of their four other highest-paid execs.
Of course, that’s not going to be welcome news for many companies, and critics say the rule would impose another unnecessary regulatory burden on businesses. But creating a uniform standard will have real benefits for shareholders. The new rules would require all companies to use the same format and layout, which should appeal to many investors — especially institutional investors who have large portfolios and want to be able to digest this information rapidly, without having to dig into footnotes in order to understand how it’s being presented. Everything would be uniform, systematic and easy to analyze.
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That’s good news for investors — who, after all, are the actual owners of the businesses. Technically, they hire the CEOs. In practice, the longer a CEO stays in the corner suite, the more he is able to stack a board of directors with friends and allies (it’s a committee of those directors that votes on his pay) and the less connection there is between the thousands of individual investors and the single, powerful CEO. A CEO protecting his compensation simply has to drive wedges between those shareholders, ensuring that he remains working with a friendly board of directors.
The next stage of the SEC’s process is to gather comment letters; then the agency’s commissioners will vote again on whether to give the proposal force.
The opposition to this relatively benign proposal is all the more daunting since there are far more significant and far more controversial compensation-related proposals out there, from a measure requiring companies to disclose the pay gap between CEOs and their employees to ones that regulators hope will rein in excessive risk-taking by removing compensation-related incentives to behave foolishly.
The pay gap data is particularly significant. While pundits bicker over the precise figures, there is little doubt that as companies have shifted from paying purely cash bonuses to stock-market linked compensation, that gap has widened. By one calculation, CEOs took home nearly 300 times the salary of an average worker in 2013, up from 20 times that salary in 1965. How motivated are employees likely to be if their earnings are flat or declining (or if they are being hit with waves of layoffs in order to boost profits), even as they see their CEO take home ever-larger pay packages?
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The topic that isn’t even being raised yet is the extent to which it makes sense for companies to rely so heavily on stock-based forms of compensation and tie the totals to the performance of the company’s shares. Obviously, it’s been a windfall for CEOs, especially in years when the stock market has roared higher and when compensation consultants cherry-pick which indicators to use as a basis for “performance.”
The liberal Economic Policy Institute points out that from 1978 to 2013 (adjusted for inflation), CEO compensation skyrocketed 937 percent. Put to one side, for a moment, the fact that average employee pay rose 10.2 percent in the same period. Even by the preferred corporate metric of tying compensation to stock performance and investor returns, that doesn’t compute: It’s more than double the rate of growth in major market indexes, the think tank notes.
In this context, to find that SEC commissioners are so divided over the most basic and banal of compensation-related initiatives is dismaying. It certainly doesn’t bode well for anyone who’s hoping that one day we might have a substantive conversation about the relationship between shareholders, stakeholders and CEOs, as it relates to compensation. Sure, the majority on the SEC won the vote and the battle, for now. Greed, complacency and arrogance still have plenty of room to triumph in the long run, alas.
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