Executive Compensation

Executive Compensation

Introduction

Executive compensation is presently a topic of concern. President Bush recently mentioned it during the most recent State of the Union address. The media frequently speaks of executives that are paid vast sums of money, showered with perks such as corporate jets, vacation homes, gifts, and staff positions for friends and family. Almost as frequent, we read of executives that fail to meet stockholders expectations but somehow manage to step down and depart with lucrative “exit packages”. In addition, it has been noted by analysts of “The Corporate Library,” CEO’s of Standard & Poor's 500 companies receive an average of $13.51 million in compensation per year. Based on our observations, the average CEO of our sample of the S&P 500 receives a comfortable $67 million in compensation per year.

Although a reasonable compensation system for executives and workers is fundamental, the past has seen record growth in compensation for top executives. More frequently than one would expect, boards of directors vote on setting CEO pay. Too often, directors have awarded compensation packages that go above and beyond what is required to attract and retain executives, even rewarding poor performing CEOs. Further, some CEOs may have far greater control over their pay than anybody previously suspected. According to a statement in the Wall Street Journal, “Year after year, some companies’ top executives received options on unusually propitious dates,” certain CEOs may be backdating their own stock option grants to capitalize on their value.

One such executive is Martin C. McGuinn of Mellon Financial. Mr. McGuinn currently averaged 5.5 million dollars a year in compensation while his company realized a -2% annualized return during his tenure (Forbes Magazine, 2005). Another executive, Richard Grasso, the former CEO of the New York Stock exchange, separated after a meager eight years with $187.5 million in compensation (www.oag.state.ny.us/press, 2004). Other exit packages that have gained investor attention are Bob Nardelli of Home Depot ($210 million), Ex-Pfizer Inc. (PFE) chief Henry McKinnell ($200 million), and ExxonMobil (XOM) leader Lee Raymond ($357 million). These are just a few of the CEO’s that have helped to attract the attention of Washington and concerned investors over excessive executive pay.

While excessive CEO pay is a “corporate governance” problem, it stems from the loss of board ownership and control. Ironically, one of the jobs of the board of directors is to protect shareholder interests and minimize agency costs; however, approximately two-thirds of companies have CEO’s as the board’s chair. When one single person serves as both chair and CEO, it is virtually impossible for others to police, monitor, or evaluate their performance. One would ask,