How to get paid like a U.S. CEOJuly 5, 2011: 10:57 AM ET
While millions are still out of work, U.S. CEOs received a 28% pay raise this past year. A lot of factors are driving the increases. Job performance isn't one of them.
By Eleanor Bloxham, contributor
If you were a CEO of an S&P 500 company last year and your pay only went up 28%, then sorry, but half your peers did better than you.
So with millions out of work, how do U.S. CEOs keep their pay rising in good times and bad? The short answer is an army of support and a few small distinctions.
Here's how it's done.
Step One. Ignore global benchmarks in setting pay.
While outsourcing may be negatively affecting your pay as a non-CEO or your ability to find work, U.S. CEO salaries are soaring in part because of the failure of boards to compare the pay of U.S. CEOs against their global counterparts.
Exxon's (XOM) board, for example, doesn't use other global energy firms when setting their CEO's pay.
And Wal-Mart's (WMT) board compares its CEO's pay mainly to CEO pay at other U.S. firms and fails to include no. 2 world retailer Carrefour, no. 3 Metro AG, , or no. 4 Tesco among their benchmark companies.
Why does that have an impact?
Recent research by professors Nuno Fernandes, Miguel Ferreira, Pedro Matos, and Kevin Murphy finds that, on average, U.S. CEOs earned double their non-U.S. counterparts between 2003 and 2008. And, adjusting for firm size and industry, U.S. CEOs still earn around 80% more than their non U.S. based peers.
Step Two. Convince your bosses that pay need not be based on your performance. In fact, they can just ignore performance in setting pay.
While we'd all like to have a nickel every time someone said CEO pay is based on the principles of "pay for performance", research by Fernandes and his colleagues shows that U.S. CEOs aren't being paid double their global counterparts because they are doing a fantastic job. (Additional research supports the argument that U.S. CEO pay has little relationship to a CEO's job performance.)
So, if it's not to do with performance, what is driving CEO pay upward?
Step Three: Get equity.
The research shows that U.S. CEO pay is higher primarily because U.S. CEOs are awarded high levels of equity compensation, which includes pay in the form of company stock and stock options.
But you can't stop there.
Step Four: To make sure the gravy train doesn't stop, get institutional shareholders to believe your equity pay benefits them.
When companies have U.S. institutional owners, boards are more likely to offer high levels of equity compensation (and, in turn, total compensation), the research shows. U.S. institutional owners have pushed for greater equity-based pay based on the assumption that offering pay incentives like stock and stock options boost performance and align pay with performance. That has not been the case, however.
When insiders, rather than institutions, hold more of a company's stock -- for example, in family-owned firms -- "they keep pay down," says Fernandes. There's "better discipline." Insiders do a better job of controlling the CEO than outside institutional owners have, he says.
Step Five: Get an independent committee to determine your pay.
According to the research from Fernandes and Co., regardless of a company's size, higher CEO pay is associated with a board comprised of more independent directors. But isn't it counterintuitive that having more independent directors would lead to higher pay? Perhaps on the surface, yes, but independent directors are likely more attuned to institutional owners' interests.
If U.S. institutional owners want more equity-based pay, which leads to outsized U.S. (versus non U.S.) pay, independent directors are more likely to deliver what they think institutional owners want. The directors are "shielding themselves from [liability] problems" by handing out "higher equity based pay," Fernandes says.
Step Six: Make sure your company is listed in the U.S.
Fernandes says that the U.S. is exporting its pay practices abroad. When non-U.S. firms are traded on U.S. exchanges, the firm's CEO pay gets a boost.
Step Seven: Take advantage of regulation to boost your pay and make the case that your additional pay is in shareholders' best interests. (You are really doing it for them.)
How do you pull this one off? Use regulation and accounting conventions to justify pay increases.
For example, in 1993, Congress passed legislation that limited the amount of base executive pay that companies could deduct in their taxes to $1 million. This legislation is often cited as one of the drivers for the rise of CEO incentive pay.
Another driver has been past U.S. accounting conventions related to stock options. In the past, the expense of paying executives with stock options did not have to be included on the company's income statement. This accounting, which made companies' income statements look better because the stock option compensation did not show up as an expense, is often cited as a key contributor to the rise in CEO incentive pay.
Going forward, James Reda, founder and managing director of compensation firm James F. Reda and Associates, predicts that a new Dodd-Frank requirement to include a chart that compares executive pay with performance will be used as yet another "excuse to increase pay" for CEOs at U.S. companies.
"Companies will use this as a rallying cry to increase pay," he says, and they'll be "slicing and dicing the information any way they like." If one performance metric doesn't work, they'll just change the comparison, Reda says.
Reda predicts in five years we'll see a doubling of U.S. CEO pay from the current levels.
So those are your seven steps to be paid like a U.S. CEO -- although they may not be so easy to duplicate for the non-CEOs among us.
Of course, corporate boards could study other approaches to motivating and rewarding good CEO performance, which does seem to be an issue of concern. A survey released in May by the National Association of Corporate Directors (NACD) with compensation consultants Pearl Meyer & Partners showed that "a total of 33% of respondents … ranked 'the selection of performance goals that align with shareholder value creation' as their top Board issue."
Perhaps institutional owners could also rethink what they want. Has higher equity based pay been worth the money they've spent? What signals do they really want to send?
Higher CEO pay is likely not going to benefit you. It means fewer dollars in the coffers for your raises, no better performance for your company, and more unemployed workers, rather than new hires who could help you with your growing workload.
Maybe it's time for more than a collective sigh. Let's hope the U.S. contagion won't spread too far too fast.
Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a board advisory firm.