Can $30 million a year be fair pay for a CEO? A Q&A with David Becher
November 20, 2013
By Matt Erickson
Since the financial crisis of the late 2000s, the pay and perks given to top business executives have often grabbed headlines. From millions of dollars in salary and stock options to extras such as private jets, helicopters or (in the case of Oracle CEO Larry Ellison) a $1.5 million home security system, CEOs’ compensation can raise eyebrows.
That means the boards that govern those corporations must balance the potential for embarrassing news reports with the need to attract and keep talented leaders. And that was one of the topics covered at this fall’s Directors Academy provided by Drexel’s Center for Corporate Governance.
David Becher, an associate professor of finance, led a session on the issue of CEO compensation at the event, held in conjunction with Corporate and Executive Education. Becher’s research interests focus on optimal governance methods for corporations, in addition to the issue of corporate mergers. DrexelNow talked with Becher about what goes on behind the headlines when it comes to setting CEOs’ pay.
How has the world of CEO compensation changed in the last five years or so?
If you go back, there are headlines from the 1920s that will talk about the “fat cats” of CEOs and how much they’re making relative to the average worker. So indignation about CEO compensation is not new.
How we compensate our CEOs has been evolving, especially since the crisis. Originally, we thought we’d pay them in cash. And then: OK, that doesn’t motivate them enough, and so we were going to provide incentives to get them to work harder. The big thing used to be [stock] options. But now the concern became: Well, if you give CEOs options, they can focus on the short term, make the stock prices go up, they make a whole bunch of money and go off into the sunset.
I think some people are now realizing that it’s not just how much you pay them, but how you pay them. It’s part of an entire package. But that said, firms benchmark a lot more. You have to see who is in your peer group. You have to give more justification for the compensation you’ve been given. It’s no longer enough to go, “Well, everyone else is paying this, so we have to keep up with the Joneses.” Shareholders are demanding more say.
How accurate, or common, today is the idea of the proverbial “fat cat” CEO being paid exorbitantly?
One example I always like to go to is Exxon Mobil in 2010. If you look at a CEO making $28-30 million, and most of that is in restricted stock that vests over the next 5-10 years, there can be a justification for that. But that’s not what the headlines say. When the headlines see one person making nearly $30 million in one year, and you look at the average worker’s salary, it doesn’t seem fair. But if Exxon Mobil makes $31 billion that year? We’re talking about not 1 percent, but less than one-tenth of 1 percent of net profits — not sales. This is actually net income that’s left over to shareholders. To me, one tenth of one percent doesn’t seem that egregious, especially if you structure it so that he doesn’t just get the money and walk away.
Are there CEOs who are overpaid? Yes. Are there boards that are not doing their job? I’m sure there are. But is the average CEO in the S&P 500 making excessive money and pillaging the firm? I don’t think so. I’d like to believe that there is some sort of efficiency in this market, and those executives and firms that continue to abuse it — either through the press, or through regulators, or through institutional investors — are being called out.
At the same time, because of situations that will garner such headlines, how much should boards consider the media’s tendency to highlight those things?
There is an academic study that looked to see: Does the media get it right? And there’s kind of good news and bad news from boards. The good news is, the trend seems to be that — if I can be tongue-in-cheek — even the media can get it now. Everyone’s starting to understand there’s a difference between $28 million for an Exxon that’s earning $31 billion and an excessive pay package where you’re getting $28 million and your company has lost $250 million in the last year.
So more of the attention is going toward the excessively large salaries, as opposed to just big ones. However, windfalls, which usually come from exercising options, still get undue attention, even if somebody’s been building them up for the last 10 years. I think the takeaway for boards is that they have to be careful.
What reasons are there that CEOs might command very high pay?
The average CEO tenure, depending on the study you look at, is six years. Some say five years now. And we’ve seen lots of academic studies that trace these guys and show that they don’t get another job after this, at least at this level. We’re asking somebody to spend four or five years in this job, and it may be the last job you’re ever going to have at that level. Well, if you don’t provide them with enough compensation, why would they want to do it?
If you’re a sports fan: People wonder, does your favorite football player deserve a $100 million contract, or whatever it is? Part of it seems egregious. But we are a market-based society. Look at the revenues they generate. They’re paid that money for a reason, because they bring in a lot of money.
All that taken into consideration, what is the advice you give to boards on this?
One size does not fit all. I think it depends on your industry. It depends on the tenure of your CEO. Is this a new one? Is this an established one? Obviously, the health of the firm is important. So there’s a lot that goes into it. But you know, my own research kind of suggests that not all compensation’s the same. So even if you provide a CEO with incentive compensation there are different types, and not all of them provide the same incentives.
It’s like everything else, you know? It’s easy to just take the number and run, but you need to think more about what it means and what works for your company.