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Corner Office
Heavens above, Parachutes Below!
While The Global Economy continues to Struggle with Unemployment and Depressed wages, CEOs of today seem to have Exceptional Immunity to all Cycles! B&E’s Ashutosh Harbola dives into The CEO Compensation debate, along with an Exclusive Column Shelly Karabell, INSEAD Knowledge, who provides a new Metric on This Issue
Issue Date - 12/05/2011
“It’s easy to have principles when you’re rich. The important thing is to have principles when you’re poor,” said Arthur Kroc, CEO of McDonalds. But the interesting part about the entire debate on astronomical, even galactical, CEO packages is that shareholders and the general public believe that principles are a fairly common casualty at the corner office!

CEO compensation related issues continuously hog the limelight in US, where the debate on the ‘Say on Pay’ bill, the one that would let shareholders have a non-binding vote on executive compensation has been especially fierce. Consider the recent anger over Pacific Gas & Electric Company (PG&E), whose outgoing CEO Peter Darbee gets a golden parachute of around $35 million. His departure looked imminent after one of PG&E’s natural gas pipelines exploded in a San Francisco suburb last September, resulting in eight casualties and destruction of 38 homes. State officials have been adamant that ratepayers should not pick the tab for Darbee’s retirement, and the company recently announced that the bill would be paid by shareholders instead. But shouldn’t the question have been raised on the value of the compensation package itself, rather than on who pays?

In a number of cases, companies have failed to justify compensations with respect to their financial situation and their perception on what the CEO should be worth. Even the G-20 summit in 2009 managed to sense the unnatural rise in executive compensation and an open house discussion was awarded to an issue, which has been raised by only investors so far. Even Barack Obama addressed his concern on the rising salaries while announcing the bailout package post recession. Russia initiated a move to cap CEO salaries in 2009, which was followed by China. The communist nation put an upper limit of $410,000 for state owned companies.

But capping CEO pays hasn’t gone too far in the US. Data from American Federation of Labor and Congress of Industrial Organizations showed CEOs’ median pay going up by 23% compared to 2.1% for the average worker. The median pay was reported to be $11.4 million, which came from fixed pay, stocks and different stock options of the 299 companies of S&P 500. These huge pay packets ($3.4 billion in all) would have led to the possible employment of 102,325 median workers!

A research report of American Federation of Labor and Congress of Industrial Organizations stated that between 1993 and 2008, the top 1% of Americans, captured a mammoth 52% of income growth in the US. Reports have even stated that the 2008 crisis was a result of the huge pay structure that CEOs have been getting. California-based compensation firm Equilar revealed that seven of the largest companies on Wall Street increased their compensations and benefits to $122 billion in 2007, a rise of 10% yoy. In contrast, aggregate net revenues fell by 6% yoy. These firms suffered mortgage losses of around $55 billion and destroyed some $200 billion in shareholder value.

The issue is vital enough to hold relevance in any period. Ray R. Irani, Ex-Chairman and CEO, Occidental Petroleum Corp. took home a sum of $76.1 million in 2010, almost double his 2009 compensation. Compensation expert David Hook tells B&E, “CEOs and the next layer should have a compensation ratio of 1:3, which in all senses is perfect”. In Ray R. Irani’s case the next layer was only taking home one sixth and he was making 1771 times more than the median wages of derrick operators in the industry. A huge 54% of shareholders voted against the plan and showed Irani the way out. Irani managed to make $857 million in the last decade and was reportedly the third highest paid CEO. Non-promoter CEOs have outshined promoter CEOs in issues of salary and benefits. Steve Jobs, promoter CEO, Apple, has fixed his pay at $1 per annum and is arguably one of the best CEOs of all times. In another instance, Sam Palmisano, Chairman, CEO & President, IBM reported a rise in his annual compensation of 30% from $24.3 million in 2010 (though IBM met share price targets). Not so proportionately, net income went up by 10.45% to $14.8 billion. IBM curbed other compensations of Palmisano by 3%, the 30% rise can be questioned if times change.

Lloyd Blankfein, CEO, Goldman Sachs managed a double pay rise making it to $18.8 million in 2011. Constant pressure from investors compelled the company to cut Blankfein’s salary who was drawing $68 million in 2007 and was responsible for the alleged misselling of toxic mortgage related derivatives for which Goldman Sachs had to pay a mammoth $550 million as fine. Salaries to five top directors ($69.5 million in 2010) have faced the flak even recently in 2011, as a group of nuns who are investors have asked the company to review its policies.

Another research conducted for major corporations of Wall Street found that the median pays of CEOs of top 50 companies have gone up by 30% in 2010. It does not add benefits like luxury retirement plans, platinum plated health care plans and the much talked about use of luxury jets. Total executive pay to these CEOs jumped to $126 million from $83 million in the previous year.

Even their Indian counterparts are not behind. Just like stock markets, companies seem especially optimistic about the future. Recently, V. Vaidyanathan, ex-CEO and MD, ICICI Prudential Life Insurance shifted his base to Future Capital Holdings for a mammoth Rs.500 million and 2 million warrants worth Rs.474 million, which are convertible in February 2012. It has even beaten the salary of Mukesh Ambani (Rs.250 million) and Kalanithi Maran (highest paid CEO last year, Rs.400 million).

There are packages that are well deserved too. Allan Mulally’s compensation increase of 48% to $26 million makes sense as he took Ford Motors through the tough days of recession without even taking a dollar of the bailout package from the US government unlike GM and Chrysler. And indeed, it is tough to monetarily quantify the role of leadership in inspiring an entire organisation to scale peaks or to even control slides. But it is when such ambiguity is misused to encourage excesses and create a bubble of sorts for CEO compensation that companies need to be scrutinised. Read the column by Shelly Karabell, Executive Editor, INSEAD Knowledge to understand a new metric in this area.


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