The CEO makes what? Return of a fair-pay debate

It's proxy time for corporate America. That means companies must reveal the earnings of their top executives. Those numbers can be startling.

The new issue of Forbes magazine has an article headlined: "The Age of the $100 million CEO." It profiles a dozen chief executives recruited with salaries, bonuses, plus stock options worth from $130 million to $1.8 billion over a few years.

It lists 50 bosses with total 1999 incomes that range from $3.3 million to $650 million.

Are they worth it?

Pro-capitalist Forbes argues that it is the free market which sets the pay of executives, especially those newly recruited, and that the handsome pay packages do not represent manipulation of semi-helpless corporate boards.

In other words, compensation committees of corporate boards choose optimal pay contracts to give CEOs incentives to maximize shareholder wealth - make firms thrive.

But to Scott Klinger, the astounding rise in executive pay in the 1990s is "a problem of corporate governance."

A boss appoints the members of the boards that set his or her own pay, says Mr. Klinger, co-director of Responsible Wealth, in Boston. This is a network of 450 highly affluent people concerned about "economic inequality" in the United States.

Company directors, Klinger continues, are often CEO friends from other companies. Some are subordinates. Those found to be tough on executive salaries, aren't likely to get appointed to other boards.

This executive-pay debate revives each spring as the financial press fills with reports from proxies on fancy executive pay.

One new element is a just-published academic study for the National Bureau of Economic Research by economists Marianne Bertrand of Princeton University in New Jersey, and Sendhil Mullainathan of the Massachusetts Institute of Technology in Cambridge, Mass.

The two find that executive-pay gains are often as much due to "luck" as they are to performance, that is, a reward for making companies prosper.

A bit of background:

In recent years, companies have to a much-larger extent compensated executives by giving them options on company stock on top of a salary, bonuses, and other benefits.

One advantage is that options duck a law passed by Congress in 1994 which says that straight salaries beyond $1 million will not be tax deductible as an expense by the company paying them. There is a loophole in the law for compensation based on performance, and that includes options. If the stock of a company rises in price, it is assumed that the company CEO and other top execs are responsible. So it is justified that their options are now worth millions.

Another advantage, notes Professor Bertrand, is that many people don't understand options. So if a CEO wants "to steal or skim [corporate assets], it is a much better, clever way to do it with options."

That advantage is fading as the public's grasp of options grows. The AFL-CIO maintains a Web site ( which notes that in 1998 the average CEO made a "staggering" 419 times the pay (including options) of a typical American factory worker. This compares with a multiple of 42 in 1980. Options and soaring stocks largely explain that escalation.

The trade federation Web site gets some 3.3 million visitors a year, allowing corporate employees to compare their own wages with that of their CEOs.

Back to the Bertrand-Mullainathan paper. It uses three different measures of "luck" that a CEO cannot influence.

One is the price of oil. This is set by the market, as influenced by OPEC production constraints. If the price of oil goes up, the price of oil companies' stocks go up and its executives with their options get more "lucky dollars." Another is the foreign-exchange rate of the US dollar, relevant to firms heavily into trade. The third looks at yearly average performance in specific industries.

In all three cases, CEO pay (salary and bonuses as well as options) goes up from luck as much as from performance.

And Bertrand and Mullainathan find that the representation of large shareholders (say in a pension fund) on a company board reduces the extent of CEO pay arising from luck by as much as a third. Presumably the big shareholders insist on pay packages that help shareholders.

Klinger is pushing shareholder resolutions at several firms to make CEO pay more reasonable. One at Allied Signal, for instance, would limit CEO pay to an unspecified multiple of the average worker. It won't pass.

(c) Copyright 2000. The Christian Science Publishing Society

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