Some Things Never Change

By James Kwak

That picture is average total annual compensation for top-five named executive officers at U.S. public companies from 2008 to 2010. (It’s from a blog post by Carol Bowie of MSCI, which used to be called Morgan Stanley Capital International.) Over those two years, total annual compensation increased by 37% for all companies and by 54% for companies in the S&P 500. Basically, while bonuses and severance packages have fallen or grown slowly, that effect has been swamped by much bigger stock and option packages. Which is evidence that if you try to rein in some of the more egregious aspects of executive compensation, the executives, their friends on the compensation committee, and their hired guns at the compensation consulting firms will figure out ways to keep the party going.

It’s possible that 2008 was a low year for executive compensation because of the financial crisis and recession, so this is just rapid growth from a low base. But check this out:

A December 2011 survey by pay consultant Towers Watson of 265 mid-size and large organizations found 61 percent expect their annual bonus pools for 2011 “to be as large or larger than those for 2010,” while 58 percent of respondents expect to fund their annual incentive plans “at or above target levels based on their companies’ year-to-date performance.” Moreover, 48 percent of those surveyed expect long-term incentive plans that are tied to explicit performance conditions “to be funded at or above target levels based on year-to-date performance.”

Critically, 61 percent of respondent in the Towers survey said they believe their total shareholder return will decline or remain flat.


17 thoughts on “Some Things Never Change

  1. So you are tellin me i’m a day late and a dollar short when invites to the party are offered. I’ll rise above it, thanks for the info though.

  2. I don’t understand what’s puzzling about this. I think perhaps you’re not considering signaling explanations. It’s another issue all together to question the practices by which executives set up these elaborate Rube Goldberg type corporate machines and then just pull on this-or-that level to attempt quarterly improvements. I’m not trying to say that, in any absolute sense, executives add ‘value’ in proportion to their pay. In fact, there are some interesting results on the lack of correlation between CEO performance and pay, owing largely due to regulatory and political factors (much more so than lack of regulation). I think signaling explanations explain this fairly well.

  3. Another thought that comes to mind: can you locate data like this for other types of highly-compensated individuals? Actors? Professional athletes? I don’t understand why there is this greed-centric view of CEOs that somehow doesn’t apply to other high earners.

    Do you really believe that Alex Rodriguez, for example, adds value to his baseball team in proportion to his record setting contracts (not even counting advertising dollars)? If this is true for his organization, it can only be so by virtue of effects on fans. Surely regression to the mean tells us that it cannot be because his baseball talent is actually that many orders of magnitude above peer players. So if fans enjoy the hype of record-setting contract players, and essentially regard them with a sort of mythos and lore, and this is why they add value, then I don’t see why the same cannot be true for a CEO. Steve Jobs was a real innovator and did a lot of things right, but even if he hadn’t and instead he was just good at being a buzz-generating public figure and projected to consumers and investors the kind of appeal and lore that Apple wanted, that alone could be reason to have paid him astronomical amounts.

    I don’t know that the athlete/CEO analogy hols perfectly, but it is interesting to me how we draw a greed division between people who are good at convincing others to pay them a lot based on whether that convincing is done with perceived talent at a game vs. perceived talent at generating company lore / image.

  4. Stock options. So there is no money to go around but you are offering me stock in the company that has no money? Sounds legit. There can always be a bounce back and the stock you have may be the stock that saves your life. True Story.

  5. @bob: Baseball players aren’t lobbying the government to relax drug-testing requirements. Baseball players don’t take risks using other people’s money that blow up the economy. The performance of a baseball player is measured in statistics that are readily available, so it’s obvious if they are not pulling their weight or making an impact.

  6. @ Bolt, almost all CEOs do none of those things either. If you’re complaining about the rare few who do, then I’m right there with you. But statistically speaking, almost none do.

  7. Before anyone disagrees fiercely, consider that it is shareholders who hire lobbyists, not CEOs.

  8. The pro sports/CEO comparison doesn’t hold for one important reason:

    Professional sports teams are privately held with few exceptions, while it’s very likely that the respondents in the Towers survey are publicly held. So there are no public or institutional shareholders to satisfy, only the team owners. Not to mention the pro sports teams derive large portions of their incomes from pools of income generated by television and other licensing rights that are shared among all league members. Paying a few flagship players superstar salaries can positively affect the income of rival teams because the “buzz” is shared to some extent by the entire league. It’s not as clear that “superstar” CEO’s do the same or that any of these guys add more value than another to any given company.

    It’s telling that the 61% figure for static or increased bonus pools matches with the 61% static or reduced shareholder return. It would appear that somewhere along the way the focus of increasing shareholder return has been replaced with a focus on increasing managements’ return. Which might be somewhat justifiable if management had to invest their way into the executive suite. Getting stock options after the fact isn’t the same as investing up front.

  9. @ Garret — I’m not sure how seriously you meant your comment. If you’re a “shareholder” in the sense that you own small amount of stock, then fine. Obviously hiring lobbyists doesn’t apply to you; but by not dumping all stock owned in companies that do hire lobbyists, you implicitly agree (and fund) their choice to do so. Statistically speaking, you’ll make more money if you participate (at least indirectly) in lobbying. When you say “I don’t hire lobbyists”, what do you mean by that? Do you prevent the board of trustees/directors in the firms in which you do hold stock from hiring lobbyists? Or do you just demand that they pay dividends / generate returns and not bother you with the details? If it’s the latter, then you certainly do hire lobbyists, just not directly. Maybe that helps you feel better about vocally opposing lobbyists while indirectly funding them, which is fine, but I’m just not sure what your claim is meant to suggest. Shareholders who don’t want lobbyists’ help are shareholders who are willingly giving up money they could be getting otherwise (legally, to boot).

  10. I don’t think that the average shareholder has enough voting power to keep the compensation at a reasonable level. The executives and employees are receiving stock options and own a lot of stock and will vote for their increases in salary and bonuses. I’ve read that most mutual funds that hold shares also vote in the manner recommended by the Board of Directors. I think many shareholders don’t really care to read up on things and also just vote as the Board recommends. As a retired accountant, I have seen over the years how employee wages eat up much of the profit of companies. Often the executives are getting a huge portion of the earnings, especially for somewhat smaller companies than some of the very large corporations. Still, the average shareholder with an interest in the company has no voice.

  11. ” Still, the average shareholder with an interest in the company has no voice.” — But to the extent that they have a voice, e.g. by getting rid of the stock and no longer being a shareholder, they don’t exercise it. In the end, they want the earnings too, and if majority shareholders can leverage show-offy CEOs with big compensation to bring in earnings, then they’ll go along with it.

  12. @Bob – Most importantly, baseball players dont appoint their managers, and GMs who negotiate regarding salaries with them.

    CEOs appoint the people who are supposed to have oversight over them, and who also set their salaries.

  13. Grateful if @Bobthebayesian could explain for a layman what is the “signalling explanation” for these trends.

  14. James: Great job. I’m with you on this issue and appreciate you singling out the compensation committee and the hired guns at the consulting firm. My other gripe is with the exec summary compensation tables published in the proxy statements. I can’t easily see how much compensation they actually acquired during the year because of the vesting requirements on the stock awards and what happened with the old and the new options.
    The new compensation packages are just another instance of unintended consequences.

  15. At least three issues are at play here: First, executive comensation should be a function of fundamental performance measures such as net profit, profit and/or revenue growth, return on assets or equity and similar metrics. An executive’s performance should not be evaluated for compensation purposes on how well or poorly the stock price moves but on how wel or poorly the corporation performs operationally. Second, the major reason that executive compensation rises relatively fast during a time of rapid stock index appreciation is that a large protion of the executives’ compensation is in the form of this appreciating equity and therfore well-alligned with the interests of other shareholders. Finally, for most corporations, the vast majority of their shares are in the hands of institutional investors who vote their shares according to the advice and counsel of ISS or Glass Lewis and therefore reflect the intersts of those organizations, not of the interests of the rare private individual retail investor.

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