Corner Office-Dumb and Dumber Executive Pay
Well, here we go again. The 2009 Great Recession has people looking for places to assign blame, and so the subject of excessive executive pay is in the spotlight. President Obama, Congress, labor union leaders, and some in the media are illuminating the miscalculations and greed of organizations that took excessive risk and assumed that our overheated economy would last forever—and then continued to pay the executives of these failed companies obnoxious amounts of money for their misfires (costing shareholders billions of dollars in value).
Most of the blame is being assigned to the CEOs of these firms. But I am having a tough time figuring out whether the blame lies with dumb executives who felt they didn’t need to deliver performance equal to their pay, or if it lies with their dumber boards of directors for allowing these executives to benefit while shareholder value was eroding. The truth is the blame lies with both.
For example, take a look at the compensation of the former CEOs of three financial firms that went into the toilet last year:
• Angelo Mozilo, Countrywide Financial, $102.8 million
• Lloyd Blankfein, Goldman Sachs Group, $73.7 million
• Richard Fuld, Jr., Lehman Brothers, $71.9 million
Do these extreme amounts bear any relation to their performance? No. That level of compensation was just dumb.
And I’m not alone in this opinion. In Warren Buffett’s 2005 letter to shareholders, he said, “Too often executive compensation in the U.S. is ridiculously out of line with performance. That won’t change, moreover, because the deck is stacked against investors when it comes to the CEO’s pay. The upshot is that a mediocre or worse CEO—aided by his handpicked VP of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet & Bingo—all too often receives gobs of money from an ill-designed compensation arrangement.”
Now, I want to make it clear that I believe in a free market system where individuals should have the opportunity to earn as much money as is appropriate for achieving exceptional results, but not if only one member of the team gets all the reward for doing so. Let’s compare the ratios of the average CEO pay to the average worker’s pay through the years. In 1980, the ratio was 42:1. By 1990, the disparity grew to 107:1. By 2005, it mushroomed to 411:1. In the past few years, the ratio has decreased slightly, in part because the value of stock options has decreased. But there is still a major problem with the executive pay culture in American corporations—a situation that I will hereinafter refer to as “America’s Dumb and Dumber Executive Pay Culture.”
American workers have lost their jobs at a rate higher than at any other time in the past 25 years. Personal wealth has eroded by nearly 20 percent, outsourcing has moved jobs overseas, health care benefits are decreasing, and retirement benefits from Social Security might be nearly nonexistent someday. Does it make any sense that, in this environment, executives are getting paid nearly 400 times more than the average worker? It’s just dumber than dumb!
Lest we think that America’s Dumb and Dumber Executive Pay Culture exists only in Manhattan, be aware that we have the disease right here in Minnesota as well, only to a lesser degree. In a 2008 CEO compensation report looking at Minnesota’s public companies, the average pay for the top five CEOs was $15.5 million, which was an average increase of 113 percent over their 2007 compensation.
These compensation amounts are not as extreme as those on Wall Street. But keep in mind that while Minnesota CEOs were pulling in millions of dollars, the average loss in shareholder value in their companies was more than 37 percent. Call me stupid, but I don’t think this seems right, their shareholders don’t believe this is right, and now the government doesn’t believe it is right either.
Reform at the federal government level is being led by the Oval Office. Recently, President Obama called excessive executive pay and bonuses “the height of irresponsibility” and laid the responsibility for the country’s economic crisis in the hands of CEOs.
New York Senator Charles Schumer and Washington Senator Maria Cantwell introduced legislation in May that would require companies to allow shareholders to hold an advisory vote on the amount of compensation top executives receive each year. The bill also says that businesses must seek approval from investors for golden parachutes, and it calls for the separation of the role of chairperson of the board and chief executive officer. The bill calls for the U.S. Securities and Exchange Commission to issue new rules that give shareholders more power to nominate directors on corporate boards.
Shareholders are becoming more activist minded and are demanding to see compensation outcomes linked to sustained financial performance and share price results. This is difficult for executives and corporate directors, who are also struggling to predict an unpredictable future and provide short-term incentives to leaders who are successfully leading their companies through the recession. Also, corporate directors must balance paying executives sufficiently to retain top talent with paying for results achieved while navigating a changing economy.
Even though a reasonable and fair compensation system for executives and workers is fundamental to the creation of long-term corporate value, directors often award compensation packages to executives and CEOs that go well beyond what is required to attract and retain them. The result is a proliferation of poorly designed executive compensation packages that reward executives for decisions that are not in the long-term interests of companies, their shareholders, their employees, or the wider economy.
I currently serve as the chair of two boards and am a member of several other boards, so I know firsthand how difficult it is to find the right balance. However, I adamantly believe that it is up to compensation committees on boards of directors to solve the problem of excessive executive pay before the federal government takes an even larger role.
Corporate directors have a variety of actions they can take to assure that executive pay is in line, decided upon objectively, and is tied to performance. For one, make sure at least one member of the compensation committee has a good working knowledge of executive compensation. Other fair compensation tips: Employment contracts should be avoided; severance pay should be limited to two years (less the value of stock owned); the offices of the CEO and chair should be separate; and the full board should approve majority voting. But perhaps most importantly, corporate directors should ensure that all business strategies are approved only after an assessment of the risk to the company and possible executive compensation payout.
Excessive executive compensation has contributed to the crumbling of the economy. It’s time for executives and corporate directors to stop the dumb and dumber acts and put fairness and employee morale ahead of personal gain and greed.
At one point during the movie Dumb and Dumber, Harry and Lloyd are driving across the country and monitoring their progress on a map when Harry turns to his best friend and says, “according to the map, we’ve only gone four inches!”
On the topic of executive compensation, it’s time to take action and gain some real ground, like Harry and Lloyd.