Executive Pay Takes a Turn

Now that the data on executive pay is in, some compensation experts are breathing a sigh of relief. After years of promising that executive pay was being linked to performance, many were actually glad to find that overall compensation declined during the shabby stock performance of recent years. This trend has not, however, put to rest the criticism being leveled against executive pay in general and stock option grants in particular.
Generally speaking, chief executives enjoyed some awfully good days in the 1990s. In 2001, according to BusinessWeek, the CEOs of large corporations made 411 times more than the average factory worker. Over the last ten years, the pay of CEOs grew by a whopping 340%, reaching $11 million, while the wages for other workers grew 36%. Even during the good times, when stockholders were doing well, executive pay was widely criticized as exorbitant.
But as the economic downturn hit in the U.S., the number of critics grew, asking why executives should be getting rich even as many stockholders absorbed losses. So it was actually a form of good news when various studies reported that median executive pay was also on the skids. Watson Wyatt Worldwide's "Executive Pay in 2002" report, for example, shows that median total actual pay for the CEOs at 1,350 large publicly traded corporations was down 32% in 2000 compared with 1999. About 75% of the CEOs in the study who had been in that job in 1999 had lower pay in 2000.
The pay of CEOs also took a hit in 2001. CEO pay dropped 4% in 2001, according to a survey of 50 large corporations by Pearl Meyer & Partners. The average corporate executive officer took home $10.46 million. And BusinessWeek's "52nd Annual Executive Pay Scoreboard" reports that the average CEO's pay declined 16% in 2001. If the study excludes the pay of Lawrence Ellison of Oracle, CEOs' pay dropped almost 31%, reaching $9.1 million.
While it may be comforting to know that the pay-for-performance system works to a degree, this has not caused the critics to fall silent in regard to the sheer magnitude of executive pay and the role that stock options (now 58% of U.S. CEO pay at large firms) have played in expanding total compensation. One of their principal arguments is that stock options tend to be overused as a reward, sometimes diluting per-share earnings growth. This occurs, it's argued, because such options aren't treated as a compensation expense on income statements. Some studies suggest that this fact makes companies look more profitable than they are, reports The Economist magazine.
This may change, however, if the International Accounting Standards Board (IASB) has its way. In a discussion paper, "Accounting for Share-Based Payment," the IASB has argued that there should be a profit-and-loss charge for the fair value of employee stock options.
Another critique of stock options is that compensation committees are too willing to give executives more options, or trade in the old worthless ones for new ones, if the company's stock falls. "It's a sort of heads you win, tails we flip again," quips Peter Clapman, chief counsel for the world's largest pension system, TIAA-CREF. Over the last two years, nearly 200 large companies swapped or repriced executive stock options.
A third objection is that, by making stock options such a huge part of executive compensation, companies are making it too tempting for top managers to engage in fraud. That is, if there's a failure of internal control systems, executives may be able to temporarily manipulate stock prices to their advantage. The fraud allegations at Enron have made this a hot-button issue, raising other questions about corporate leadership in general. But many experts believe that, even if the Enron allegations prove true, such fraud remains the exception rather than the rule.
Whatever the problems with stock option plans, the last couple of years have shown that they can effectively link executive pay to market performance. "If you tried to think of any other instrument that is better than a stock option, I bet it would have a legion of flaws," says management professor Martin Conyon in Knowledge@Wharton. It's possible that more companies will reform parts of their compensation plans - such as by indexing stock options so that an executive is rewarded only if the company's stock outperforms the market or an industry group - but it seems unlikely that stock options are going to disappear as a major component of executive pay.


To read BusinessWeek's article "Executive Pay," see
http://www.i4cp.com/VMGGJ8
For a Hewitt Associates report on executive bonuses, see
http://www.i4cp.com/WFA0cM
For information on Watson Wyatt's research on executive pay, see
http://www.i4cp.com/0BnAfv
and http://www.i4cp.com/MfAWXY
For more on the Pearl Meyer & Partners study, see
http://www.i4cp.com/GEeS5B
For more on the Economic Research Institute, see
http://www.i4cp.com/eCtk0f or
http://www.i4cp.com/OvP26n
For information on the William M. Mercer survey, see
http://www.i4cp.com/VyhEIr
For more on how business leaders are being criticized these days, see
http://www.i4cp.com/X7mpUE
For more on the International Accounting Standards Board, please see http://www.i4cp.com/VW3Ua0 The Web site contains, among other things, comments on the notion of share-based payment.