CEO pay – has the penny dropped?

Dec 03 2008 by Nic Paton Print This Article

The economic slump may well lead to a wholesale re-evaluation of senior level pay and how to reward performance, both good and bad. But it seems that the penny was already dropping even before the global financial collapse.

According to a study by consultancy Watson Wyatt, compensation committees at U.S companies had been making significant adjustments to how they compensated their chief executives even prior to the current crisis.

As a result – and for the first time in years - executives at companies that were performing well were being granted larger pay opportunities and incentives than their counterparts at weaker companies.

Its annual analysis of executive pay at 1,058 companies in the S&P Super 1500 Index found that "total direct compensation opportunity" or TCO – base salary, annual incentives and new long-term incentive stock and cash grants – for chief executives at high-performing companies was $10.7m from 2005 to 2007, noticeably higher than the $8.1m for CEOs at low-performing companies.

The lack of relationship between performance and reward has long been a source of anger within America, resentment that has turned to cold fury on Main Street in recent weeks as the global downturn has hit home.

But what the Watson Wyatt analysis appears to suggest is that the accusation that U.S CEOs milked the system in the run-up to the collapse and that there was wide-scale excess and rewarding of poor performance may be too simplistic.

"The legislative bailout package and the ongoing financial crisis, coupled with continued pressure from shareholders, the media and executive pay critics, are leading compensation committees to make their executive pay programs more shareholder-friendly," said Ira Kay, global director of executive compensation consulting at Watson Wyatt.

"But many had been heading down that path already, by factoring in recent financial performance when establishing pay opportunity levels for their CEOs, even before the most recent manifestation of the crisis took hold," she added.

Nevertheless, while companies were moving in the right direction, challenges still remained, she argued.

Companies granting riskier compensation packages, such as a heavier mix of stock options with higher stock price volatility, tended to grant higher TCO, $12.5m versus $7.1m for chief executives at companies granting less risky compensation.

"Companies offering compensation programs that reward risk should expect to see significant challenges in the current bailout environment, as the government will want to discourage taking on risk in compensation programs in the future, not encourage it," said Kay.

"On the one hand, some level of risk is beneficial to the company as well as to shareholders and should be rewarded. On the other hand, there will be a need to carefully monitor the overall risk exposure, given the current economic conditions and bailout scrutiny. The challenge for compensation committees will be to walk that fine line," she added.

The analysis also concluded that companies with high CEO stock ownership levels tended significantly to outperform those with low CEO stock ownership levels.

Nevertheless, even though the Watson Wyatt survey nominally goes back to 2005 it does appear that in some sectors the message has taken a long time to get through.

Back in 2006, for example, a study by U.S pay consultants DolmatConnell & Partners suggested that poorly-performing tech firms were continuing to pay their bosses too much.

And it's not as if this is a new complaint, either. In February 2006, Edgar Woolard Jr, former chief executive and chairman of chemicals firm DuPont, warned U.S chief executives were being paid too much as well.

In an interview with the magazine Across The Board, he suggested the idea that CEO pay was driven by competition – one of the cornerstones of the argument for hefty remuneration of the top tier of executives – was, in effect, "bull".