Crusading Against CEO Pay
Chief Executive Magazine, March 2006
In an interview, Nell Minow, editor and chairman of The Corporate Library, talked about overly high compensation levels for CEOs. She said that she is all for tying pay to performance but the fact is CEO pay went up 30% last year and performance certainly was not anywhere near that. The only people outside a company that can really control CEO compensation are the shareholders and they have done a very poor job. Boards of directors should control it and, if they do not control it, shareholders should respond. Shareholders have failed to understand that CEO pay is not just something to shake your head over when you get your proxy statements. Bad CEO pay is a terrible example of bad asset allocation. The return on investment for CEO pay is unacceptable. It is an indicator of a failure of oversight on the part of the board that permeates throughout the company.
GOVERNANCE
CORPORATE AMERICA has made some progress in cleaning up its governance, but overly high compensation levels for CEOs show that much remains to be done, says Nell Minow, editor and chairman of The Corporate Library, a research group based in Portland, Me. Here are excerpts from a conversation originally conducted for The New York Times:
Q: How do you assess the progress that corporations have made in improving the way they manage themselves since Enron imploded?
I have a "best of times, worst of times" perspective. Some things are much better than I ever dreamed. In other areas, things have been disappointingly slow and yet in other areas, we've gone backwards. Probably the most important change is in the boardroom. Boards of directors are universally taking the job more seriously and doing a better job. It wasn't that long ago that OJ. Simpson was on an audit committee.
Q: So boards are more independent from CEOs?
Yes, they are. But they continue to fail at their single biggest challenge, which is CEO pay. If they can't get that right, then something is still wrong.
Q: Don't CEOs who create wealth for shareholders, customers and employees deserve to be well compensated?
WATCHDOG
Minow believes CEOs contol their own pay.
Of course. I'm all for tying pay to performance. But the fact is CEO pay went up 30 percent last year and performance certainly wasn't anywhere near that.
Q: How did you arrive at that figure of 30 percent?
There are a lot of different ways of looking at pay. You have to be consistent about it. You can look at stock option grants in the years that they are made or you can amortize them over time. The most important thing is to compare apples with apples. It was long-term compensation mostly, but base pay has gone up enormously as well.
Q: Didn't last year see major gains in corporate profitability?
Yes, but CEO pay gains were vastly in excess of shareholder gains.
Q: Can anyone outside a company really control CEO compensation?
The only people are the shareholders and they've done a very poor job. Boards of directors should control it and, if they don't control it, shareholders should respond. Shareholders have failed to understand that CEO pay is not just something to shake your head over when you get your proxy statements. Bad CEO pay is a terrible example of bad asset allocation. The return on investment for CEO pay is unacceptable. It's an indicator of a failure of oversight on the part of the board that permeates throughout the company. It's a symptom of a very serious disease.
"Independent" Directors
Q: Compensation committees are increasingly independent and hire their own outside consultants. So why is it not working right?
Because at the end of the day, I don't really believe there is such a thing as "independence" on the board of directors as long as the CEO is still picking the directors. You've got the CEOs picking directors and they're writing checks on somebody else's account. When you have Warren Buffet admitting in his 2002 annual report that, while serving on boards, he agreed to approve CEO compensation because it was embarrassing to speak up, you know that something is wrong with the system.
Q: Why do people get so excited about CEO pay but not about what sports stars and movie stars make?
There are five categories of people in the stratosphere of compensation. Aside from CEOs, you mentioned two, sports and entertainment, and the other two are rock stars and investment bankers. These other four are the ultimate pay-for-performance people.
There are many actors out there waiting tables and there are many investment bankers who could be waiting tables next week. It's all on the basis of market-driven, arm's length negotiations. If Kate Moss, who is a model, is photographed using cocaine and loses all her endorsements, that's a perfect example of the market working. But CEOs are the only ones who I pick the people who set their pay.
Q: Let's say I have created a company whose market capitalization is $10 billion and I have a personal net worth of $1 billion...
Hurray for you. That's great. I love to see that. At my core, I am a capitalist. Unfortunately, what I see more often is Gary Wendt saying, "I won't even walk in the door without a $45 million cash signing bonus." Or the CEO of Global Crossing saying, "I won't walk in the door without 2 million options at $10 a share below market."
Q: Aside from what's happening at United Airlines, Delphi and some other companies in bankruptcy, wouldn't you say that, overall, boards have made progress in linking compensation to how a CEO performs?
No, I don't think so. I was an English major but even I know that if you give someone 2 million options at today's price and it's not indexed to the market and it's not indexed to. the peer group, he's going to get paid on the basis of what the market does, not on what he does. I see a lot of what I call hot fudge sundae compensation plans, where you get the ice cream and the fudge and the nuts and the whipped cream and the cherries and the bananas. What is that delivering?
Boardroom Chemistry
Q: Regarding your point that CEOs pick their directors, hasn't that practice changed in recent years as boards are more involved in picking their own members?
It's very slowly beginning to change. But it's still a closed loop of friends of friends. I feel very strongly that what we really need, and is the most important corporate governance reform that's on the agenda right now, is majority vote. Companies should adopt a policy that no one can serve on the board unless he or she has received over 50 percent of the vote. I've never seen a shareholder initiative gain traction as quickly as that one.
What's great about it is that it's very embarrassing for a company to try to argue that someone who gets less than 50 percent of the vote should be allowed to serve. So I foresee a time very near in the future when companies that give their executives outrageous pay packages will find that shareholders will refuse to support the compensation committee that made the decision.
Q: CEOs say that if they're not involved in choosing directors, that alters the chemistry of the boardroom. What is your view?
It's my opinion that the chemistry of the boardroom is undermined by the current system, which is overly cozy. What I'm saying is that I don't anticipate a time when shareholders are nominating their own directors and I always expect that the CEO will be involved in having some say. But it's human nature, particularly for CEOs-who by their very chemistry are independent-minded and aggressive-to want to put cheerleaders on the board, not real partners.
Q: Recruiters say they are looking for people with specific sets of skills to put on boards. Is that just a smokescreen?
If bad corporate governance is a disease, executive compensation is running a fever. I think boards are doing a better job, but they have a long way to go.
Q: Where would you say the standards of governance are higher, in the corporate world or in Washington?
Political careers are falling apart because of the Ab ramof scandal. There may be two or three representatives or senators whose careers are over. We've also had it come out that the author of the second best-selling book of last year wildly exaggerated some of the things in his purportedly nonfiction book. No sector has a monopoly on the problems of grappling with integrity.
"It wasn't that long ago that OJ. Simpson was on an audit committee."
"It's human nature for CEOs ... to want to put cheerleaders on the board, not real partners."
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Buffett slams pay for 'fat cat' failure
Robert Lindsay, Associate City Editor, The Daily Express, March 6, 2006
WARREN BUFFETT, the world's most respected investor, has launched a tirade against fat-cat payments for chief executives and "ever-accommodating" pay consultants.
In his annual letter to shareholders of his Berkshire Hathaway investment vehicle, Buffet said: "Today in the executive suite the all-too-prevalent rule is that nothing succeeds like failure." Buffett, the world's second richest man after Bill Gates, attacked the trend for "huge severance pay", share options and "lavish perks". He said when a chief executive was sacked he could "earn more while cleaning out his desk than an American worker earns in a lifetime of cleaning toilets".
Boardroom compensation committees and pay consultants were too compliant, he said, when fed statistics that showed other bosses were getting paid more money.
He added: "A mediocre or worse chief executive - aided by his handpicked vice president of human relations and a consultant from the ever accommodating firm of Ratchet, Ratchet and Bingo - all too often receives gobs of money from an ill-designed compensation arrangement." He went on: "Outlandish goodies are showered upon chief executives simply because of a corporate version of the argument we used as children: 'But Mom, all the other kids have one.'" Buffett, said to be worth $40billion (GBP 27billion), takes a $100,000 annual salary to run Berkshire. Company's profits rose 17 per cent this year to $8.53billion on revenue up 10 per cent to $82billion, despite $3.4billion of losses from his General Re reinsurance arm caused by hurricanes Katrina, Rita and Wilma.
He argues that executive share options, widespread in UK boardrooms as well as in the US, encourage bosses to cut dividends and hike share prices by buying back shares.
He also says he has found his successor - but refuses to name him, saying only he is a "reasonably young" manager at Berkshire.
He owns up to failing to close down General Re quickly enough before it ran into trouble due to complicated derivative contracts, and warns the spread of such contracts in the insurance industry could create "financial chaos".
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Putting a Ceiling on Pay
No Whole Foods executive can earn cash pay
of more than 14 times what its average worker
makes. Will other companies follow?
Andrew Blackman, Staff Reporter of THE WALL STREET JOURNAL,
April 12, 2004; Page R11
How do you know when an executive is overpaid? For some, it's a simple question of math.
A growing number of shareholder activists are pushing companies to establish maximum ratios between what their executives earn and what their average- or lowest-paid workers earn.
Shareholders voted on executive-pay ratios last year at the annual meetings of J.P. Morgan Chase & Co., General Electric Co., Coca-Cola Co. and Bristol-Myers Squibb Co. In each case, the board opposed the idea as unworkable, and in each case the proposal failed by a wide margin.
A smaller company, however, has imposed a ratio for years -- without the sky falling. Whole Foods Market Inc., the country's leading organic-food retailer, has a rule preventing any executive from earning an amount in salary and bonus that's more than 14 times what the average worker makes. The current cap: $409,000.
The idea, the company says, is to foster a sense of partnership among the employees, or "team members" as they are called at Whole Foods, of Austin, Texas.
"It's part of our culture," says company co-founder and Chief Executive John Mackey, who adds that Whole Foods has used such ratios since before it went public in 1992. "We have a philosophy of shared fate, that we're in this together," he says.
Ratios have been tried elsewhere, with limited success. For almost a decade, ice-cream maker Ben & Jerry's capped executive pay at seven times the salary of the lowest-paid worker, but abandoned the policy in 1994 when co-founder Ben Cohen retired as chief executive and a new CEO had to be hired from outside the ranks of the South Burlington, Vt., company (now owned by Unilever). Similarly, office-furniture maker Herman Miller Inc. for a while imposed a pay ratio of 20 to 1, but dropped it in 1996 after struggling to attract talented candidates for its top jobs.
Ira Kay, head of the executive-compensation consulting practice at Watson Wyatt Worldwide in New York, says pay caps can work well at smaller companies, but can be difficult to sustain as a company grows and needs to hire executives from outside. "The key advantage is it's very employee-friendly," he says. "The theory is that it creates a positive culture with higher levels of productivity.
"The disadvantage," says Mr. Kay, "is that if you have to go into the open labor markets to try to hire someone from outside, it can be very difficult."
Pay ratios are now getting more attention, fueled by recent corporate scandals and the popular perception that CEOs are just paid too much. The average CEO in the U.S. earned 282 times the salary of the average worker in 2002, according to an annual survey by the Institute for Policy Studies, a Washington think tank, and United for a Fair Economy, a Boston nonprofit. In 1982, the ratio was 42 to 1.
Hot Issue
"This is definitely one of the issues that's going to receive more attention this year," says Joanne Dowdell, director of corporate responsibility at Citizens Advisers Inc., a socially responsible investment firm in Portsmouth, N.H. "The recent wave of corporate scandals exacerbated an issue that was always on the table," says Ms. Dowdell. "Shareholders are saying, 'We're tired and we're not going to take it anymore.'"
With the 2004 proxy season not yet complete, 10 shareholder proposals requesting ratios already have been submitted for this year, compared with 12 in all of last year, according to the Investor Responsibility Research Center in Washington. The main proponents of these resolutions have been members of the Interfaith Center on Corporate Responsibility, an association of religious institutional investors in New York, and members of Responsible Wealth, a Boston-based organization of affluent persons concerned about economic inequality. Catholic Knights, a fraternal benefit society that supports charitable and social causes, has filed shareholder resolutions at several large companies this year requesting that shareholder approval be required for any executive pay package that's more than 100 times the average compensation of nonmanagerial staff.
"When the average employee feels devalued, when the guys at the top are on a greedfest and are not sharing the results with the rest, they lose trust," says Dan Steininger, president and CEO of the Milwaukee-based organization.
At Whole Foods, concepts of equality and employee empowerment fill the company literature for investors and play a big role as a motivational tool for workers. A mission statement titled "Declaration of Interdependence" uses phrases like "collective vision," "collective energy" and "community of self-interest" to describe the working environment.
In such a context, Mr. Mackey says, huge executive pay packages would seem like a betrayal of trust. "When [executive] pay is excessive, you're demoralizing the employees," he says. "You're causing envy and resentment."
The $409,000 pay cap at Whole Foods was arrived at by taking the average hourly pay of all employees -- from the CEO to part-time shelf-stackers -- converting it to an annual rate of pay, and multiplying by 14. Mr. Mackey says 14 isn't set in stone. The cap was raised from eight to 10 in 1997 and to 14 in 2000. It could always change again. He says he just tried to find a number that seemed fair and reasonable within the company, while also allowing him to hire good people.
Mr. Mackey, who holds the additional titles of chairman and president, earned $326,000 in salary and a bonus of $41,000 last year. He also holds a 1% stake in the company recently valued at about $45 million -- wealth that stems not from his company's compensation practices but from his being a co-founder in 1980, he says.
In addition to salary and bonus, however, Mr. Mackey and his senior executives receive stock-option grants whose values aren't capped by the ratio. With a few exceptions, options grants from 1994 to 2003 averaged between 5,000 and 10,000 shares a year per executive. Mr. Mackey and his team received grants of 8,000 stock options each in 2003. Each grant will be worth $175,000 if the shares appreciate 5% annually over the option term of seven years, or $410,000 at a 10% growth rate, according to the company's proxy statement. Whole Foods shares have more than tripled over the past three years, and total shareholder return over the past decade has averaged 23% a year.
Options Gains
Cashing in their options grants has added significantly to the compensation of Whole Foods executives in recent years. Mr. Mackey exercised almost $2 million of options last year and had exercisable options with a market value of $2.9 million when fiscal 2003 ended last Sept. 28. Chief Financial Officer Glenda Flanagan has exercised almost $3 million of options over the past three years and had $2.7 million more in exercisable options when fiscal 2003 ended. Chief operating officers Walter Robb and A.C. Gallo each exercised almost $2 million of options over the same period and had exercisable options valued at $1.2 million and $819,000, respectively, at the close of fiscal 2003.
Some critics of pay ratios say formulas that exclude options are useless. A pay cap is meaningful only if it applies to total compensation -- not just cash, says Alan Johnson, managing director of Johnson & Associates, pay consultants in New York.
"Usually it's a charade," Mr. Johnson says. "Employees see through it. They know the CEOs are making millions on stock. So to limit salary, what does that prove? It's a PR gimmick."
At least one former Whole Foods worker agrees. "Our store managers told us we should be in awe" of the salary ratio, says Brendan O'Sullivan, who used to work behind the deli counter at a Whole Foods in Madison, Wis. "But everyone knew Whole Foods was making a fortune and we weren't."
Mr. O'Sullivan became so disillusioned with what he saw as a lack of respect for the workers that he got involved in a failed attempt to organize a union at the Madison store in 2002. "It's hard for me to believe in the original goals," he says of Whole Foods. "I think it's now just marketing to fill a certain consumer niche." Mr. O'Sullivan left Whole Foods in October and is now working as a union organizer for health-care workers in Oakland, Calif.
The value of the executive stock options, Mr. Mackey maintains, is largely due to the huge growth in Whole Foods stock, from a split-adjusted $4.25 when the company went public in 1992 to around $75 today. But all Whole Foods employees get options once they've been with the company for three years, he says, and 94% of options are held by nonexecutives, so that "the wealth gains from the shareholder value increase flows throughout the entire organization." Whole Foods doesn't advertise or try to publicize its salary cap in any way, Mr. Mackey adds.
At Herman Miller, based in Zeeland, Mich., the ratio covered only cash compensation, which led to the gradual development of other generous perks such as life insurance, pensions, stock awards and a special executive health plan, says Mark Schurman, director of external communications. But after having trouble attracting and retaining talent, the board in 1996 eliminated the ratio and the perks and switched instead to an incentive-based package using the economic-value-added, or EVA, method. EVA, considered by many to be a more accurate measure of management performance than just profit, subtracts the costs of the capital that management used to generate that profit. Herman Miller also decided to more closely tie executives' interests to the long-term performance of the company by requiring them to acquire and hold a certain amount of company stock -- six times base compensation for the CEO, and three to five times for other top managers.
Little Reaction
Mr. Schurman says he doesn't recall employees being particularly upset when the pay ratio was dropped. One reason: The company has long attempted to make its workers feel like stakeholders by awarding universal cash bonuses and regular stock awards, as well as allowing employees to buy stock at a 15% discount. (Employees at Herman Miller own 13.5% of the company's shares outstanding.) It also helped that the company was performing well at the time of the transition and was able to pay out record bonuses.
Mr. Mackey acknowledges that limiting his pay is no panacea. He sees his job as finding the right balance between the competing claims of the company's various stakeholders: customers demanding lower prices, employees wanting higher wages and shareholders expecting better returns. If a salary cap helps make the workers feel they are part of a partnership, he reasons, they will keep on creating value.
Moreover, Mr. Mackey maintains he can still get and keep very good people for $400,000 a year.
"In the history of Whole Foods," he says, "I've never lost an executive I didn't want to lose."
Write to Andrew Blackman at |
