CEO compensation: greed or glory? - results of PricewaterhouseCoopers' Chief Executive's 12th annual survey of CEO compensation

Chief Executive, The, Sept, 1999 by Carl R. Weinberg

IT'S BEEN ANOTHER BANNER YEAR FOR CEO PAY - AND FOR PUBLIC OUTCRY OVER THE HEFTY PAY PACKAGES THE NATION'S BUSINESS LEADERS ARE TOTING HOME. THE WALL STREET JOURNAL DUBS IT "GREED GONE WILD," WHILE BUSINESS WEEK ASSERTS, "IN TODAY'S MARKET, THE ONLY TRUE CONCLUSION IS THAT IF GREED IS GOOD, IT'S BEST FOR THE CEO." BUT IN THEIR HASTE TO RANT ABOUT FLAGRANT GREED, PAY CRITICS ARE OVERLOOKING CRUCIAL POINTS. CLOSER EXAMINATION OF TODAY'S SOPHISTICATED COMPENSATION FORMULAS SHOWS THAT PAY AND PERFORMANCE ARE LINKED MORE CLOSELY THAN EVER AND SUGGESTS ANOTHER LINK - BETWEEN AMERICA'S CEO PAY STRATEGY AND THE NATION'S ECONOMIC GROWTH.

Once again this spring, thousands of companies mailed out their proxy statements, and the nation's business press unleashed a ferocious attack on CEO pay levels. Fortune, Forbes, The New York Times, Business Week all got into the act. The Wall Street Journal's opening words endorsed the "greed gone wild" theory, stating: "Pay for performance? Forget it. These days, CEOs are assured of getting rich - however the company does."

According to the business press, excesses in CEO pay undermine the strength of the U.S. economy in three ways. First, they divert value from shareholders through excessive dilution. Second, CEOs make short-term decisions that inflate the company's stock price, which then crashes after they exercise their options and sell their shares. Third, employees feel alienated from the boss, which leads to lower productivity, as well as an absence of commitment and creativity.

There's only one small problem with the theory of "greed gone wild." The U.S. economy is the envy of the world - the only major one to flourish over the last few years. The question is: Does the U.S. economy grow despite the excesses of CEO pay? Or does America's philosophy of CEO compensation provide U.S. companies with a global competitive advantage?

According to research conducted by PricewaterhouseCoopers for Chief Executives 12th annual survey of CEO compensation the high-risk high-opportunity CEO pay strategy used by most major American companies is a secret weapon contributing to the unprecedented recent growth of the U.S. economy. The survey, which covered 320 companies in 17 industries, indicates that the prevailing CEO pay strategy is a lot more sophisticated than the simplistic "greed gone wild" description it receives in the press. Rather than demonstrating rampant greed, today's CEO pay packages have helped the U.S. achieve glory as the unchallenged leader of the world's economy.

CEO PAY IN 1998

In reality, CEO pay has never been so closely aligned with performance as it was in 1998. For the 280 CEOs in our study who also held the job in 1997, the median increase in total cash compensation was only 5.4 percent - an unsurprisingly modest gain, given the lackluster growth in corporate earnings. Nearly half of these CEOs - 117, or 42 percent - experienced declines in total cash compensation in 1998, and in most cases they led companies whose 1998 performance lagged their industries.

CEO-pay critics point to other statistics when they assert that CEO compensation continues to escalate out of control. The median base salary increase in our survey was 6.5 percent, almost double the national average of between 3 percent and 4 percent. Also, the median Total Pay increase was 8.5 percent. How can CEO pay be related to company performance, the critics argue, if it increases almost 10 percent in a year of weak corporate profits?

With a more sophisticated analysis of the data, the pay-performance linkages become clear. Today's CEOs often receive salary increases every other year, resulting in bigger increases. In fact, 82 of the 280 CEOs - or 29 percent - failed to receive an increase in base salary in 1998. Similarly, many companies today make option awards every few years, resulting in large swings in total pay. This is one reason why 116 CEOs - or 41 percent - experienced declines in total pay from 1997 to 1998.

Our Leverage Index chart illustrates this pattern of larger, less-than-annual option grants. The Leverage Index measures the sensitivity of the CEO's pay package to growth in the company's stock price. A Leverage Index of 1.00 indicates no sensitivity; 2.00 means the package is worth twice as much in five years if the stock price doubles. In our judgment, compensation committees should aim for a minimum CEO Leverage Index of 2.00.

In 1998, 244, or 76 percent, of the 320 CEOs in our study had a Leverage Index of 2.00 or more - an increase from 71 percent in 1997. At the same time, the percentage of CEOs with a low Leverage Index - 1.25 or below - remained at 14 percent. Viewed together, these two trends provide strong evidence that CEOs today receive larger - but less frequent - stock incentive grants, thus encouraging them to focus on shareholder returns instead of negotiations with their compensation committees.

LEVERAGE INDEX

INDEX                   1998          1997

2.00 and above          244           226
1.75 to 2.00             15             8
1.50 to 1.75             11            20
1.25 to 1.50              4            19
1.00 to 1.25             46            47

TOTAL                   320           320
CAPITALIZATION INDEX

INDEX                    1998          1997

20.00 and above          160           130
10.00 to 20.00            92            93
5.00 to 10.00             44            63
1.00 to 5.00              24            34

TOTAL                    320           320