CEOs' pay packets need closer & realistic scrutiny

DEEP POCKETS



Lately it seems that regardless of whether the company’s net worth is up or down, the compensation packages of chief executives are consistently increasing. Especially in the US where when the sub-prime crisis hit, several firms sought bailouts while their chief executives still received huge bonuses.

A 2008 analysis of the top 100 Fortune companies found that 56 per cent of the US companies gave their CEOs compensation increases regardless of how the company performed. At the same time, nearly half of Indian companies reviewed paid compensation proportionate to the company’s net worth or paid less to their CEOs in proportion to the increase in company net worth. In the US, President Obama reacted by limiting executive compensation for bailed-out firms. He said, “This is America… we don’t disparage wealth. We don’t begrudge anybody for achieving success… But what get’s people upset — and rightfully so — are executives being rewarded for failure, especially when those rewarded are subsidised by US taxpayers.” In 1985, the ratio of US chief executives’ average salaries to those of the workers’ was 40-to-1. By 2005, it had metastasised to 450-to-1. 

Such increasing income inequality was tolerated as long as the rising tide was lifting all ships. Not anymore. According to the 2007 survey by the United for a Fair Economy, an average of $10.8 million was paid to the CEO’s of top US firms in 2006.  A 2008 study by the Economic Research Institute (ERI) and The Wall Street Journal shows that the growth in the executive compensation was incongruent to the corporate earnings in the past year. The study — based on 45 randomly selected public companies — showed that while revenues increased by a mere 2.8 percent from the last year, the total compensations of the highest-paid executive increased by 20.5 percent.

Among the examples causing Obama and the American people to be upset: While Charles O Prince was Chairman and CEO of Citigroup (October 2003 to November 2007) Citigroup’s total return was -2.5 per cent.  The bank’s third-quarter profits in 2007 dropped 57 per cent, leading to a $5.9 billion write-down due to its exposure to risky mortgages. Prince’s poor performance was overlooked and he received a discretionary bonus of $10.4 million along with more than $28 million in unvested stock and options.

The CEO of Merrill Lynch, Stanley O’ Neal, walked away with more than $160 million in overall executive compensation despite the fact that the company suffered a $2.24 billion third-quarter loss due to an astounding $8.4 billion write-down on junk mortgages and risky debt security and shares dropped in value by more than 40 per cent.

The compensation package of James E Carney, the former chairman and CEO of Bear Stearns, was tens of millions of dollars while Bear Stearns barely escaped bankruptcy by joining hands with JP Morgan and Chase.

Some logic

Despite these and before one concludes that executive compensation is out of control or that compensation packages are seldom performance-based, it’s important to look at significant factors that indicate top executive compensation is not as bad as it is perceived to be.

This analysis considered the top US 100 Fortune companies in 2005 and 2008 based on their net worth and their respective CEO’s total compensation packages during the same period.  While 56 per cent had a CEO compensation either disproportionate or increasing despite a net worth decrease, 44 per cent paid compensation generally based on a proportionate increase or decrease in company’s net worth or paid less to CEOs despite an increase in company net worth.

An Equilar (the executive compensation research firm) study, as reported in the Financial Week, points out that the median value of performance-based bonuses for CEO’s of large public firms declined by 18.6 per cent in 2007 — from $949,249 to $772,717.

Discretionary bonuses and multi-year awards, which were not tied to a specific financial target, increased only marginally from an average $1.39 million in 2006 to $1.41 million in 2007-a mere 1.4 per cent increase. Proponents of high executive compensation have argued that the proposed controls will induce talented executives to leave companies that can’t offer them compensation commensurate to their expertise.

Indian perspective

In India, the perception that CEO’s are also earning huge salaries during these gloomy economic times has caused Prime Minister Manmohan Singh to comment on the situation.
In a speech at the Confederation of Indian Industries (CII), he urged capping the salaries of chief executives. He said he was concerned with the level of disparity between executive compensations and the average wages of workers. 

Raising concern might be examples such as these — P K Munjal’s, Hero Honda CEO, salary increased even while the company reported a decline in profits in 2006-2007.

Jindal Steel and Power Managing Director Naveen Jindal’s salary increased by 248 per cent to Rs 135 million in 2005-2006, when the company hardly showed any increase in its net worth.

Like his US counterpart, Singh is looking at a significant percentage of CEO compensations that are out of sync with company net worth. In an analysis of the 52 highest paid Indian executives for 2008, 29 (56 per cent) had a compensation that was either disproportionate (net worth to CEO compensation) or increasing despite a net worth decrease. This means that a little over half the highest paid executives in India received compensation increments regardless of how the company performed.

Specifically, 28 companies (54 per cent), had CEO compensation increases disproportionately to their net worth and one company (2 per cent) had CEO compensation increase despite a decrease in the company net worth. Still, in this worldwide economic slump, 23 (44 per cent) of the remaining companies paid compensation proportionate to the company’s net worth or paid less to their CEOs in proportion to the increase in company net worth. This might give Singh more comfort than Obama can enjoy. Specifically, only four companies (8 per cent) paid their CEOs compensation in proportionate increase to their company net worth whereas 19 companies (37 per cent) had CEO compensation increases that were much lesser than the increase in the company net worth.

Indian CEOs paid less

Studies generally indicate that the Indian CEO’s are paid far less compared to the global levels. Mercer’s study on the chief executive compensation packages states that the median compensation of approximately $0.5 million is paid to the chief executives in India. The median compensation of the top 100 highest paid CEOs in India jumped from $ 0.5 million in 2005 to $ 1.1 million in 2008-an increase of over 100 per cent, whereas the median compensation of the top 100 highest paid CEOs  in the US increased from $ 23.8 million to $ 32.2 million during the same period-an increase of about 36 per cent.

However, it is important to recognize that in 2005, the ratio of US chief executives’  median salary to those of Indian chief executives’ median salary was 46-to-1. This ratio was reduced to 31-to-1 in 2008-a reduction in the ratio gap of nearly 33 per cent. Some equitable examples include Mukesh Ambani, the CEO and Managing Director of Reliance Industries, who has a compensation package of Rs 440.2 million. Not far behind is Anil Ambani, the chairman of the Reliance ADA Group, who draws Rs 300.3 million. The net worth of Reliance Group has increased tenfold and the stakeholders are comfortable and confident in the company’s leadership.

Sunil Bharti Mittal, CII President and Bharti Airtel Chief Executive Officer, debates high executive salaries saying CEO’s are paid in proportion to their contribution to the organizations.  It’s worth noting that Sunil Mittal’s compensation went up by 78 per cent from the previous year. Well earned given that company profits rose by over 100 per cent.

It is the prime duty of the board of directors to protect the shareholders’ interests and ensure that the compensation awarded to chief executives is in congruence to their performance. Disproportionate executive compensation seems to be a corporate governance problem since CEO’s are often the chairman of the board of directors and hold considerable stock options. Complacent boards generally well paid and often closely aligned with top executives have been condoning liberal compensations. To scrutinise one’s own performance objectively is humanly impossible. The shareholders, the company and the workers bear the brunt of the lavish executive compensations.  More often than not, this results in mistrust in the shareholders’ minds towards the board of directors.

It is important to recognise that excessive executive compensation is not the cause of economic turmoil. It is only a symptom. The lofty pay packages of the CEO’s can be controlled and trust restored only if the boards become accountable for judicious use of resources.

Given that nearly one half of the top 52 companies paid less compensation to their CEOs despite an increase in the companies’ net worth suggests that the threatening economy has kick-started Corporate Governance and other self-regulatory systems in a significant number of Indian companies. If this trend continues, the world will see more companies tying CEO compensation to corporate performance. The end results might be more sustainable businesses and renewed public trust.

The writer is a Distinguished Professor of Marketing at the Flint campus of the University of Michigan, USA, & is the Hon Dean of Alliance Business School, Bangalore.

 

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