CEOs should be well paid. Fix the abuses - Editorial

Chief Executive, The, June, 2003

It's that time of year when CEO compensation dominates the headlines. (See "Pay Under Pressure," p 34.) The debate is highly polarized, which means it is thoroughly unproductive. Here's a stab at common sense.

Start with a basic given: The urge to make money--indeed, to get rich--is one of the core motivating factors that lead people to build businesses. It was that way for Carnegie and Rockefeller, and that way for Gates and Dell. These innovators haven't just made money for themselves. They've created products and services that boosted the entire economy and created huge wealth for employees and shareholders.

The reason our system has accepted, and at times celebrated, these entrepreneurs is that people believed CEO pay was roughly proportional to the wealth that was created for others over the long term. If the government or the financial markets were to fundamentally assault the power of CEOs to make money, that would strike at the heart of our economic system. That option should be off the table.

Yet abuses have crept into the system of compensating the CEOs of public companies. CEOs such as those at Enron and WorldCom and Tyco went for a get-rich-quick strategy and pumped up their results to cash in on stock options. Others lost all sense of proportion; the decision by American Airlines' Don Carty to protect his wealth while asking employees to give back significant earnings is perhaps the most appalling recent example. (See Darts, p. 14.)

The goal of every right-minded individual should be to squeeze out abuses and restore confidence in the decision-making process that governs CEO compensation--but to do it in a way that doesn't destroy the ability of CEOs to earn handsome incomes. If a high-potential executive can't earn what he or she sees as a fair salary at a public company, that individual could simply go to a private company, where compensation levels are often higher and are never disclosed publicly.

The fact that Sarbanes-Oxley and the stock exchanges are requiring more independent directors, some of whom will serve on compensation committees, will create a more balanced decision-making process at public companies. That's for the better.

But ultimately, it falls to each board to think about the long term and to make sure that there is some correlation between how the overall enterprise is performing and how the CEO is compensated.

One of the big problems with options the way they were used during the go-go '90s is that they tied pay to performance and shareholder value only for a brief period. It was far too easy for CEOs with shaky ethics to make out big. Some companies think they can solve the problem of greed by turning to restricted stock grants instead of stock options. But restricted stock grants are guaranteed income; they're not pegged to performance. That just ensures that executives will be rewarded even when shareholders aren't. What is the logic of that? Long-term stock options, whether expensed or not, remain a useful way of connecting compensation with performance.

"Golden handshakes" and "golden parachutes" also reflect a short-term view. New CEOs may require severance agreements. But failure should not be rewarded with tens of millions of dollars. That's not proportional.

One arrangement we applaud is Cinergy's requirement that executives hold exercised options and restricted stock until 90 days after leaving the company. That means CEO James Rogers, who is 55 and would like to retire at 65, is concentrating on making the right long-term decisions for his company--and for his own compensation.

There is no single formula that can be applied to CEO pay. If a company isn't experiencing rapid growth, then using stock options as a form of motivation is of limited value. Nor is there a single ratio that can govern CEO compensation versus that of the lowest level employee.

But if boards and CEOs emphasize the long term and proportionality, it is possible to restore public confidence and obviate the need for regulatory action. It would be in everybody's best interest if CEO pay didn't dominate the headlines. Maybe then we could get back to building businesses and reigniting true growth in the American economy.