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BusinessWeek: April 19, 1999 |
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Cover Story
Special Report: Executive Pay The numbers are staggering, but so is the performance of American business. So how closely are they linked? --Michael Douglas, as Gordon Gekko in the film Wall Street Money begets money. --John Ray, English Proverbs, 1670 As the American Century draws to a close, times have rarely been better. Eight years into an expansion that just won't quit, the robust U.S. economy is the envy of the world. Growth in the gross domestic product continues to hum along at a rate of 4.3%. Thanks largely to a world-beating high-tech sector, and the willingness of American companies to quickly adopt whatever new technologies and new processes give them an edge, U.S. competitiveness may never have been higher. Unemployment is at a 29-year low, wages are rising, and consumer spending is soaring--all without a whiff of inflation. And the stock market--ah, yes, the U.S. stock market. With the Dow now hovering around 10,000, up 263% this decade, the U.S. equity markets have outrun, outgunned, and hands-down outperformed every other major stock market in the world. That market has also made many people wildly wealthy, and none more so than chief executives at major U.S. companies. Thanks to a pay structure that has linked most executive compensation to the stock market through huge option grants, the head honcho at a large public company made an average $10.6 million last year. That's a 36% hike over 1997--and an astounding 442% increase over the average paycheck of $2 million pocketed in 1990. Yet even $10.6 million is chicken feed next to 1998's best paycheck. Walt Disney Co. CEO Michael D. Eisner took home $575.6 million--primarily from options--the second largest payday ever recorded by a public company CEO. Altogether, the five best-compensated execs split a stunning $1.2 billion, numbers so over the top that even those not far removed from the executive suite find their chins dropping. "I have a difficult time relating to the compensation today," says Donald E. Petersen, former chairman of Ford Motor Co., "and I've really only been out of the full-time part nine years." But if the numbers are staggering, so too has been the performance of American business over the last decade. While tradition-bound Europe struggles to boost growth and entrepreneurialism, debt-soaked Japan remains mired in recession, and much of the developing world fights to regain its economic footing, U.S. executives are energizing older companies and creating new ones daily. The obvious questions: Are the sky-high pay and the sky-high performance linked? Has pay-for-performance worked? Is CEO greed good? Supporters of today's compensation system say this performance is no coincidence. If paying top dollar is the price of ensuring that the boss makes moves that benefit all investors, fine. The CEOs who have responded to the challenge have created billions in value. And those who fail are pushed out far more quickly today--albeit with golden parachutes. "If shareholders are betting on a management team with their dollars and the team can move the share price, then I think it ought to participate in that achievement," says Richard A. Jalkut, CEO of telecom company Pathnet Inc. and former CEO of Nynex Inc. In a world of cross-border mergers and global competition, those are no longer questions that only American companies have to worry about. Suddenly, the issue of whether the best way to motivate executives is to offer options-fueled pay packets is being debated around the world. Particularly in Europe, many companies are considering adding an equity component to their compensation systems--in part, to ensure that they don't lose their best talent to the U.S. (page 89). Moreover, European companies such as DaimlerChrysler and Deutsche Bank must figure out how to keep their European execs happy when they're paying a lot more to those working in their new American subsidiaries. Even in Japan, where egalitarian pay structures have long been considered a virtue, the four-year plunge in earnings has convinced Sony and others to try out options. "The level and the makeup of pay in the U.S. is beginning to have an influence on big global companies," says Vicky M. Wright, Hay Group's worldwide managing director for reward consulting. LOOSE LINKAGE. If there's little doubt that Corporate America is doing something right by linking pay more closely to shareholder value, however, it's also clear that greed has its limits. Despite the anecdotal connection, no academic has proven that higher pay creates higher performance. While self-interest is, as Adam Smith observed centuries ago, a great motivator, the link between pay and any objective standard of performance has been all but severed in today's system. The options windfall is as likely to reward the barely passable as the truly great; moreover, it's rewarding virtually one and all in amounts that are expanding almost exponentially. "It's not that the guy steering the ship is turning the wheel the wrong way," says pay consultant Alan M. Johnson. "It's that the wheel isn't connected to the rudder." Given the growth in sheer numbers of options being handed out, critics also warn that the seeds of future problems are already being sown. The biggest risk: In using options, companies today are in effect outsourcing the oversize compensation to the stock market. Investors willing to buy shares, after all, are paying for today's hefty raises, not the corporate coffers. But the ability to do so rests on a market that's only riding the Up escalator. Critics worry that the practice is setting untenable levels of pay expectation for the future, even as it creates hefty dilution. The skeptics certainly have some influential company. Alan Greenspan, for one, favors indexed options--options that require that the stock does better than a market or peer group index--despite the fact that they have an accounting cost. He publicly criticized the level of CEO pay in front of the House Banking Committee in February. Or listen to Berkshire Hathaway's Warren E. Buffett, who devoted two pages of his annual report to the subject: "Although options...can be an appropriate, and even ideal, way to compensate and motivate top managers, they are more often wildly capricious in their distribution of rewards, inefficient as motivators, and inordinately expensive for shareholders." Whatever the outlines of the debate, though, one thing is clear: The rich are getting richer, and fast, according to BUSINESS WEEK's 49th annual Executive Pay Scoreboard. Compiled with Standard & Poor's Compustat, a division of The McGraw-Hill Companies, the survey breaks out the pay of the highest-paid executives at 365 of the largest companies in the U.S. CEO pay again outpaced the stock market in 1998, rising 36% to the Standard & Poor's 500-stock index' 26.7%, even as earnings for the companies in the index fell 1.4%. Long-term compensation--mostly from exercised options--made up 80% of the average CEO's pay package, up from 72% in 1997. The average salary and bonus fell for the second year in a row, to $2.1 million. In some cases, that was because of poor results, but more often it was because CEOs are trimming such fixed compensation or deferring it tax-free in return for more equity. Nice work if you can get it. That 36% raise compares to 2.7% for the average blue-collar worker, one-tenth of a percentage point above last year's boost. White-collar workers got 3.9%, according to the Bureau of Labor Statistics' Employment Cost Index. This year, the boss earned 419 times the average wage of a blue-collar worker. Although such constantly levitating numbers can be hard to truly grasp, consider this: The AFL-CIO calculates that a worker making $25,000 in 1994 would now make $138,350 this year if his pay grew at the same speed as the average CEO. The breathtaking numbers don't even include the biggest executive payday ever. Last spring, Computer Associates Inc. paid CEO Charles B. Wang a restricted stock bonus then worth $670 million for getting its stock price above $53.33. That came on top of $7 million in salary and bonus and $22.8 million in long-term compensation the prior year. Because the payout took place in Computer Associates' 1999 fiscal year--for which the company has not yet filed a proxy--Wang's jackpot is not included in this year's pay survey. But ca has already felt the effect: In July, the company announced a $675 million charge to pay for the award to Wang and other executives, prompting a 30% stock plunge. FAB FIVE. Still, for those convinced of the virtues of a pay-for-performance system, the top five CEOs on BUSINESS WEEK's list this year make for a pretty good argument. The companies they run--Disney, CBS, Citigroup, America Online, and Intel--are stewards of the New Economy. Most of them longtime CEOs of their companies, they have played a role in the shift of the U.S. from an industrial economy to a service economy premised on technological advancements. All five executives have, over time, revolutionized their industries and streamlined their organizations. Along the way, they have created unprecedented shareholder wealth. None of the top five would comment on their pay. Few investors would begrudge AOL's Stephen M. Case the $159.2 million he pulled down this year. After all, he has forged one of the most successful companies in a totally new industry. And shareholders appear only too happy to ride the coattails of recently appointed CBS CEO Mel Karmazin, who earned $202 million. Most of that came from the exercise of options he had held for 10 years at Infinity Broadcasting Co., which he converted to CBS shares. Infinity was sold to CBS in 1997 and partly taken public again last year. Says a proud George H. Conrades, chairman of CBS's compensation committee: "I think his reward for the growth and the value he created is directly attributable to his leadership and probably one of the best examples of pay for performance." Certainly, the rise in the stock market does seem to correlate with a major shift from fixed to variable pay. Although stock options have been popular in the past--primarily during bull markets--never before were they used as heavily as in the last decade. Some argue that the tighter linkage to shareholders pushed executives to make the hard choices needed to become competitive. "Can we prove that stock options did this? Of course not. Can we offer some evidence that would suggest it played a role? Yes. We really made it worth people's while to drive stock prices up, and they found ways to do it," says Jude Rich, chairman of benefits consultant Sibson & Co. Perhaps nowhere has that been truer than in the exploding Internet sector, where the red-hot market in initial public offerings has served as an equalizer. Some upstarts now boast the same net worth as old-timers. One is Margaret C. Whitman, CEO of Web auction site eBay Inc. Granted 7 million options when she was hired in February, 1998, she made $43 million in eBay's September IPO--good enough for 17th place and the highest annual pay ever recorded by a female executive. Although most of it hasn't yet vested, Whitman's stake is now worth nearly $1 billion, thanks to the wild 1165% rise in eBay shares. Whitman's experience exemplifies a Silicon Valley culture in which people happily toil day and night for little cash compensation in hopes of hitting the brass ring. And the creativity burst coming out of options-laden tech companies like eBay is admirable. But the staggering, near-instant jackpot is discomfiting, to say the least, to those who have worked for years to reshape businesses. If performance is really what matters, is Whitman, CEO for less than a year at a newborn company, really worth the same as ibm's Louis V. Gerstner, who has wrestled one of the country's largest companies out of near-obsolescence? Moreover, the sheer amount of excess being created in these packages has a dark side of its own. Take two of the best-paid executives in history, Disney's Eisner and Citigroup's Sanford I. Weill. Until recently, neither has been a slouch in the performance department. In taking Disney from a moribund brand to a global multimedia entertainment outfit, Eisner has helped Disney's stock rise 450% in the past 10 years. Weill has done even more. In cobbling together financial-services businesses ranging from Travelers to Smith Barney to Citicorp in creating Citigroup, the ultimate financial supermarket, the stock has zoomed 1277% in the same period. "How many people could have done such a great job?" asks Arnold S. Ross, partner at pay consultant Hirschfeld, Stern, Moyer & Ross Inc. But lately, things haven't been sailing along quite as smoothly. Disney's stock has trailed the market in the past two years, and earnings have fallen. While Citigroup's stock is still strong, earnings there, too, have slumped. But the weak performance hasn't taken either CEO off the Pay Express. Eisner got a new grant of 24 million shares in 1997, while Weill's compensation committee awarded him 1.7 million options in "Founder's Grants" for the Citigroup deal. That's on top of a controversial system of reload options that gives him a new grant of options every time he exercises some old ones. Moreover, both CEOs have already been handsomely paid for the stellar earlier performance. Eisner has been paid a total of $901.6 million over the last decade, and Weill, $694.8 million. Their pay levels are so high that the two scored worst and second worst, respectively, on BUSINESS WEEK's screen of executives who gave shareholders the least for their pay. But Ray Watson, who chairs Disney's executive committee, defends the lavish 1997 package. "We wanted to tie him up for the rest of his working life. Heck, Sony would have given him half of Japan to run their company." Not letting the options vest until 2003, he argues, will keep the CEO focused on long-term growth. A Citigroup spokesman said Weill's pay "is tied to the extraordinary creation of shareholder wealth." BUSINESS WEEK's formula includes options as pay in the year they are exercised. OPTION MANIA. Eisner and Weill may be among the princes of pay, but they're not the only CEOs whose wallets are filling faster than ever as the size of option grants rises rapidly. According to a preliminary study of 1999 proxies by Pearl Meyer & Partners Inc., the value of new stock-option grants is already up 17% over last year, even as the soaring market makes old ones more valuable. And since some 40% of large companies grant options for a fixed number of shares, according to compensation consultant Towers Perrin, the median they use as a comparison when setting their own CEOs' pay corkscrews ever higher. Cracks Nell Minow, a principal in activist investment fund LENS: "Even an English major like me can figure out that you make more money if one of the multipliers is bigger." The increase in options is letting a lot of execs do some cashing in, even as they guard plenty of upside potential. While many have left a lot of options on the table--AOL's Case still has $286 million in options, of which about half are exercisable--many have taken a chunk home or converted some to shares, even as they ask for still larger packages. In BUSINESS WEEK's study, 53% of CEOs exercised options in 1998 worth an average $13.5 million, up from $8 million in 1997. The pay-for-performance link is further weakened by the fact that the numbers of options are so large--and the market so high--that everyone, good or bad, has been able to take money out of the market. If you've got 10 million options of a stock granted at $80 a share, you're set to make $20 million a year if your stock goes up just $2 annually, no matter how far below the market that rise is. Certainly, many people with underperforming shares are making such gains today. While indexes are breaking records, most money is flying either into Internet IPOs or into a small group of blue chips. The 100 largest companies in the S&P 500 have created 90% of the rise in the market so far in 1999 while many other stocks are in the tank. Yet the pay rises aren't limited to those overperformers. Case in point: Cyprus Amax Minerals CEO Milton Ward, who took home $2.1 million in salary and bonus last year, along with 425,000 options, up from 100,000 the previous year, as the stock plummeted 36%. Another way to rescue a fortune from a swooning stock has been repricing. Rationalized as a strategy to retain executives when a company stumbles, repricings, especially when the top execs are involved, break the link between shareholders and management. Take Cendant's Henry R. Silverman, whose rapid-fire merger tactics hit a roadblock after his company, hfs Inc., merged with cuc International Inc. in 1997. Massive accounting irregularities were uncovered at cuc in the spring of 1998. Rather than let him suffer along with investors, Cendant's compensation committee signed off on the repricing of a big chunk of his 25.8 million options at $9.81, well below their original range of $17 to $31. With the stock now trading at 15, those options are worth some $54.3 million. Shareholders got no such relief. Silverman also exercised options worth $61 million to take the No. 9 slot on bw's best-paid list. He wouldn't comment, but a spokesman says he exercised most of them before the troubles surfaced. Such options-based games only work if the market rebounds. But what if it doesn't? A look back at history (see insert) would suggest that even in a slow or bear market, executives always manage to get theirs. When the market doesn't cooperate, the rules simply change. In the 1970s, for example, a prolonged bear market made options worthless. So companies switched over to bonus plans based on the achievement of cash-based internal goals and restricted stock; although those shares can't immediately be sold, unlike options they retain their value even if they fall below their grant price. Already, such shifts are occurring. According to Executive Compensation Advisory Services, 38% of 1999 proxies reviewed so far have restricted stock grants, up from 29% just three years earlier. Moreover, other nonoptions costs of executive pay are also going up sharply, such as pensions that must be paid until death, life insurance policies, and long-term incentive plans tied to other performance measures, such as sales and earnings growth. Assorted perquisites such as the $144,415 payment to Charles M. Cawley, CEO of mbna Bank, for "personal assistants," are also on the rise. The effect of piling on all these goodies, warns Harvard Business School professor Samuel L. Hayes: "It's not a level playing field on the downside." Another growing liability is the cost of both bringing in a new CEO--and booting the old one. Even if a company moves against an underperforming CEO, it must pay him as much to go as it would have had he been a success. Electronic Data Systems Corp. took a $35 million hit to earnings to fund departing CEO Lester M. Alberthal Jr.'s severance package, even as it brought in new CEO Richard H. Brown with such features as a $4.5 million signing bonus, 1 million options, and 275,000 shares of restricted stock. He too received an ironclad agreement to take home a good chunk of that should it not work out. Often, not even taxes count: 52% of companies have agreed to pay any taxes coming from "excessive" parachute payments last year, according to Executive Compensation Advisory Services. Add a bear market to these goodies, and many companies may be in big trouble. While the nonoptions costs of pay are already rising, there is no way companies will be able to match today's windfall option gains for CEOs. Yet it's unlikely that CEOs will tolerate a 95% pay cut because the market finally stalls. "When someone that made $50 million is making $5 million to $10 million, they're going to think they're just as good a manager as they were a year ago," says Alfred Rappaport, management professor at Northwestern's Kellogg School. Dilution is another lien on the future that the love affair with options has ignored. While many companies have pushed options down the ranks while simultaneously showering the boss, the potential dilution has increased rapidly. According to pay consultant Watson Wyatt Worldwide, the average overhang--which is options already granted plus options available for grant, divided by the number of outstanding shares--hit 13% in 1997, up from 5% in 1988. Many institutional investors now vote against any plan where the potential dilution is over 10%. According to Strategic Compensation Research Associates, the votes against new stock plans is inching up, reaching an average 14.8% for the second half of 1998. Although companies argue that they need the shares to motivate employees, a new study suggests there's a limit. Watson Wyatt's Ira T. Kay found that the one-third of companies with the highest overhang had lower shareholder return than companies with medium and low overhang. He found a sweet spot at around 10%--a level that many companies are now surpassing. A few have decided options aren't worth it. When Warren Buffett bought General Re Corp. last year, he replaced the option plan with a cash-based incentive program and took a $36 million charge. In doing acquisitions, Buffett always gets rid of options and takes a hit to earnings. Sometimes the cost is so high it kills the deal. Stock buybacks have become a common way for companies to counter dilution, but that's hardly trouble-free. Despite the soaring market, stock buybacks are at an all-time high; net share issuance was -$391.4 billion in the second half of 1998, down from -$134.2 billion for the first half of 1998. While many companies don't say why they do buybacks, some, such as Microsoft Corp., have specifically said they are doing so to reduce dilution. Usually, buybacks are done to boost the stock price in a down market, but this time, companies are buying back their stock at record prices. John M. Youngdahl, senior money market economist at Goldman, Sachs & Co., notes that debt levels are increasing at the same time. The combination may soon put pressure on capital spending. "In past episodes of lofty share valuations, you would see the more traditional financial response when profit growth slowed--the issuing of shares," he says. "This time we've seen high valuations and a slowdown in profit growth and yet share issuance has gone sharply negative." Something, he says, may have to give. A final bit of rain on the pay parade is the prospect of shareholder and employee outrage if the music stops. Complaints have been fairly muted this year, because many people have shared in some of the market-linked prosperity. But should the market backslide--especially in a year when many labor unions are scheduled for wage negotiations--the CEO-worker ratios may get a lot more scrutiny. "You will see a lot more screaming as soon as the market turns down a little bit," warns Richard L. Trumka, secretary-treasurer of the AFL-CIO. For now, that day remains a ways off. In today's market, the only true conclusion is that if greed is good, it's best for the CEO. Return to top | |
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  Return to top  Return to top TABLE The Top-Paid Chief Executives...And 10 Who Aren't CEOs The Top-Paid Chief Executives...
1998 SALARY LONG-TERM TOTAL
AND BONUS COMPENSATION PAY
THOUSANDS OF DOLLARS
1 Michael Eisner $5,764 $569,828 $575,592
WALT DISNEY
2 Mel Karmazin** 4,000 197,934 201,934
CBS
3 Sanford Weill 7,430 159,663 167,093
CITIGROUP
4 Stephen Case 1,177 158,057 159,233
AMERICA ONLINE
5 Craig Barrett 2,280 114,232 116,511
INTEL
6 John Welch 10,105 73,559 83,664
GENERAL ELECTRIC
7 Henry Schacht* 2,020 65,016 67,037
LUCENT TECHNOLOGIES
8 L. Dennis Kozlowski 3,750 61,514 65,264
TYCO INTERNATIONAL
9 Henry Silverman 2,818 61,063 63,882
CENDANT
10 M. Douglas Ivester 2,750 54,572 57,322
COCA-COLA
11 Charles Heimbold $3,194 $53,085 $56,279
BRISTOL-MYERS SQUIBB
12 Philip Purcell 8,888 44,487 53,374
MORGAN STANLEY DEAN WITTER
13 Reuben Mark 3,456 49,247 52,703
COLGATE-PALMOLIVE
14 Scott McNealy 1,698 46,317 48,014
SUN MICROSYSTEMS
15 Louis Gerstner 9,387 36,947 46,335
IBM
16 Duane Burnham 3,232 42,762 45,995
ABBOTT LABORATORIES
17 Margaret Whitman 247 42,755 43,002
EBAY
18 Randall Tobias* 6,008 35,680 41,687
ELI LILLY
19 John Gifford 264 39,833 40,097
MAXIM INTEGRATED PRODUCTS
20 Gordon Binder 1,766 37,420 39,186
AMGEN
... And 10 Who Aren't CEOs
1998 SALARY LONG-TERM TOTAL
AND BONUS COMPENSATION PAY
THOUSANDS OF DOLLARS
1 John McCartney $826 $77,623 $78,450
3COM
2 Leslie Vadasz 1,135 54,759 55,894
INTEL
3 Robert Luciano* 2,196 51,780 53,976
SCHERING-PLOUGH
4 Charles Cawley 4,844 48,837 53,681
MBNA
5 Richard Vague 1,640 41,635 43,275
BANK ONE
6 James Dimon $4,950 $32,214 $37,164
CITIGROUP
7 Charles Rice 9,960 22,276 32,236
BANKAMERICA
8 Terrence Larsen 2,504 26,870 29,374
FIRST UNION
9 Mark Swartz 1,810 27,223 29,032
TYCO INTERNATIONAL
10 William Shanahan 2,254 25,470 27,724
COLGATE-PALMOLIVE
11A
* Retired
** Became CEO 1/99
DATA: EXECUCOMP BY STANDARD & POOR'S COMPUSTAT, A DIVISION OF THE McGRAW-HILL
COMPANIES
Return to top TABLE Pay for Performance: Who Measures Up...And Who Doesn't To see how pay matches up to performance, BUSINESS WEEK uses two
measurement systems. One relates to how good a job the boss did for
shareholders. The other compares what the boss made with how well the company
did.
EXECUTIVES WHO GAVE SHAREHOLDERS THE MOST FOR THEIR PAY...
TOTAL PAY* SHAREHOLDER RELATIVE
THOUSANDS RETURN** INDEX
OF DOLLARS
1 RICHARD FAIRBANK Capital One Financial $1,312 393% 376
2 WILLIAM GATES Microsoft 1,696 532 373
3 JAMES SINEGAL Costco 1,483 373 319
4 EDWARD FRITZKY Immunex 2,437 663 313
5 WARREN BUFFETT Berkshire Hathaway 842 118 259
...AND THOSE WHO GAVE SHAREHOLDERS THE LEAST
1 MICHAEL EISNER Walt Disney $594,892 56% 0.3
2 SANFORD WEILL Citigroup 491,976 146 0.5
3 RAY IRANI Occidental Petroleum 110,670 -11 0.8
4 ANTHONY O'REILLY H.J. Heinz 104,678 86 1.8
5 JOHN WELCH General Electric 151,179 199 2.0
EXECUTIVES WHOSE COMPANIES DID THE BEST RELATIVE TO THEIR PAY...
TOTAL PAY* AVG. RETURN RELATIVE
THOUSANDS OF ON EQUITY INDEX
DOLLARS
1 DANE MILLER Biomet $992 19% 30
2 WARREN BUFFETT Berkshire Hathaway 842 9 29
3 STEPHEN SANGER General Mills 8,488 190 29
4 WILLIAM GATES Microsoft 1,696 32 27
5 RICHARD FAIRBANK Capital One Financial 1,312 21 27
EXECUTIVES WHOSE COMPANIES DID THE WORST RELATIVE TO THEIR PAY
1 JEFFREY BEZOS Amazon.com $225.4 -119% -0.5
2 NOLAN ARCHIBALD Black & Decker 50,638 -37 -0.4
3 STEPHEN CASE America Online 213,785 -122 -0.2
4 MICHAEL EISNER Walt Disney 504,892 9 0.1
5 SANFORD WEILL Citigroup 491,976 16 0.1
*Salary, bonus, and long-term compensation paid for the entire
**Stock price at the end of 1998, plus dividends reinvested for three
years, divided by stock three-year period price at the end of 1995
DATA: STANDARD & POOR'S COMPUSTAT
Return to top TABLE Fortunes in the Future These chief executives still have huge rewards to reap from stock options
that have yet to be exercised. The top 20 treasure chests:
VALUE OF NONEXERCISED
EXECUTIVE/ STOCK OPTIONS*
COMPANY THOUSANDS OF DOLLARS
MILLARD DREXLER $659,493
GAP
TIMOTHY KOOGLE 544,314
YAHOO!
BARRY DILLER 496,349
USA NETWORKS
CHARLES WANG 481,764
COMPUTER ASSOCIATES
LOUIS GERSTNER 435,333
IBM
ECKHARD PFEIFFER 410,403
COMPAQ COMPUTER
HENRY SILVERMAN 399,517
CENDANT
GERALD LEVIN 304,104
TIME WARNER
STEPHEN CASE 286,260
AMERICA ONLINE
STEVEN BURD 276,360
SAFEWAY
JOHN CHAMBERS $266,793
CISCO SYSTEMS
JOHN WELCH 261,538
GENERAL ELECTRIC
RICHARD FAIRBANK 258,638
CAPITAL ONE FINANCIAL
MELVIN GOODES 250,681
WARNER-LAMBERT
DAVID POTTRUCK 240,766
CHARLES SCHWAB
JOSEPH NACCHIO 211,944
QWEST COMMUNICATIONS
CHARLES HEIMBOLD 205,349
BRISTOL-MYERS SQUIBB
THOMAS SIEBEL 199,929
SIEBEL SYSTEMS
REUBEN MARK 193,398
COLGATE-PALMOLIVE
WILLIAM ESREY 181,152
SPRINT
*Based on stock price at end of company's fiscal year
DATA: STANDARD & POOR'S COMPUSTAT
Return to top Who Earned the Pay--and Who Didn't America's spending spree with plastic continues, but credit-card issuer Capital One Financial Corp. is downright tightfisted with its own chief executive's pay. In the past three years, Richard D. Fairbank has pulled in a total of $1.3 million--mere pocket change among Corporate America's potentates. And last year he took no pay, period. That's not all: Since 1996, he has exercised none of his 3.2 million options. Those skinflint ways made Fairbank one of the two top finishers in the pay-for-performance derby, according to a BUSINESS WEEK analysis. Compare Fairbank's piddling pay with the stock's 393% total return--price appreciation plus dividends--and he did the best. WRESTLING. No wonder Capital One pleases Wall Street. Fairbank, who couldn't be reached for comment, has almost doubled its earnings in three years, to $275 million in 1998. It has been successful at identifying customer niches, offering 6,000 different kinds of cards--for groups from horseback riders to wrestling fans. The key to making this work is Capital One's ability to cull prospects likely to default on payments. By another measure, matching a CEO's pay to return on equity--a key profitability indicator--the leader is Dane A. Miller of Biomet Inc. This orthopedic-equipment maker has become a powerhouse in artificial replacements for hips, knees, and shoulder joints, expanding through acquisitions. ROE since 1996 has averaged a healthy 18.7% per year. Factor in Miller's tiny 1996-98 pay of $992,000, and it's clear why he heads our roster. "I don't feel underpaid," he says. Ah, but then there's the bottom of the list. Comparing shareholder returns with pay, stockholders fared the worst with Walt Disney Co.'s Michael D. Eisner. For 1996-98, he hauled down a mind-blowing $595 million, some $570 million from exercising stock options. True, the 56% stock run-up during the period isn't shabby: It beats the Standard & Poor's 500-stock index, which rose 43%. Yet was it enough to justify more than a half-billion dollars? The company contends he's well worth it. Disney board member Ray Watson says the fat options are warranted since Eisner has been the catalyst of Disney's long-term growth. IN A SWOON. But the storied Disney growth engine has sputtered lately because of its sagging ABC network and high movie-production costs. Earnings dipped 13% in calendar 1998, as did the shares, dropping 12 from their May high to end at 30. The other underperformer--at least by ROE--is Amazon.com Inc.'s Jeffrey P. Bezos, who delivered the worst ROE relative to his pay. Although Bezos, who owns 36% of the company, earned just a measly $225,000 from 1996 to '98, negative ROE did him in. But don't expect him--or his investors--to care. The hotshot on-line bookseller epitomizes the red-hot Internet economy, in which earnings don't seem to matter. Indeed, Amazon has never been profitable and is in no hurry to be so, arguing that it's sacrificing earnings for growth. Faith in its E-commerce future is enough, as Amazon's gravity-defying stock shows. Investors who hold the remaining 64% of Amazon clearly agree. From the mid-1997 stock offering through 1998, their holdings gained $10.7 billion in value. So unlike some of his underperforming brethren, Bezos is a hero. Return to top TABLE The Overachievers RICHARD FAIRBANK In 1998, he took no pay. But in the past three years, Capital One's total return has soared 393% DANE MILLER He got under $1 million for three years, while annual ROE was 18.7 Return to top TABLE The Underperformers MICHAEL EISNER Is a $595 million payout a tad much for a 56% stock rise? JEFF BEZOS Profitless Amazon.com: lousy ROE, but investors don't care Return to top What Keeps the Pay Merry-Go-Round Whirling Where are all the superstars? One reason for skyrocketing CEO pay is the perceived talent shortage. Top talent has gotten harder to find in a global environment. Says George H. Conrades, head of the compensation committee at CBS Corp.: "One of the biggest challenges in business...is the [lack of] top-flight management talent." No one knows this more than executives, who use that leverage--and the threat to seek greener pastures--to push the pay envelope. As a result, the fear of losing a good executive weighs more heavily in setting CEO pay than performance standards: For every performance clause in a contract today, there's a special "retention bonus" to offset it. Says Robin A. Ferricone of pay advisors SCA Consulting: "There's a real tug-of-war between retention and pay for performance." LOW RISK. But is the cupboard really so bare? A closer look suggests not. Most baby boomers are currently in their 40s--the typical time to gun for the CEO chair. Women, minorities, and foreign execs are now legitimate contenders for the corner office. Meanwhile, mergers are shrinking the number of CEO slots. And after hitting a peak in 1996, the number of CEO searches fell 14% in 1997 and rose just 2% in 1998, according to the Association of Executive Search Consultants. "There isn't really that large a shortage of qualified professionals," says consultant James A. Reda of Arthur Andersen & Co. So where does the problem lie? Often, with the board. In a volatile market, companies can see their stock plummet if they pick an unknown name. That can lead a risk-averse board to go after a candidate that won't ruffle feathers. Well-known, proven candidates tend to bring with them gigantic pay demands, however, leaving committees feeling they must pay up. "We tend to drive toward the conclusion that the entire industry has nine talented people," says Meyer Feldberg, dean of Columbia Business School and director of the compensation committee at Federated Department Stores. "It becomes a self-fulfilling prophecy." One example: When George M.C. Fisher got the nod at Eastman Kodak Co., the stock moved up nearly five points in a day, creating $1 billion in shareholder value. But his inability to spark a comeback has left the stock anemic. Yet Fisher still has an outsize pay packet that includes millions of stock options and restricted stock grants. Like almost all execs, his deal contains a zinger: a guarantee that should things not work out, he'll collect big-time anyway. Says John R. Walter, the former AT&T president who took home a $31 million severance package after nine turbulent months: "Any executive that has a proven track record, when he goes into a new situation, he probably wants a great deal of security. It's just a normal reaction." Just because boards feel unable to stop the pay merry-go-round does not mean they don't bear some responsibility for it--especially if they don't help a company develop internal talent. "What influences pay more than anything," says Donald S. Perkins, former CEO of Jewel Cos. and head of the comp committee at Aon Corp., are "companies that do not develop their successors." Moreover, consultant Reda argues, companies have more leverage than they think they do (table). It's up to them to showcase the opportunities they offer--without giving away the store, too. Return to top TABLE A Negotiator's View Arthur Andersen consultant James Reda on how to hire a CEO: -- Money is important, but it's not everything. The ideal candidate must have another reason to switch jobs. Be patient. -- When bringing in a new hire, link the pay that mirrors what the exec is leaving behind--the "make-whole"--to the achievement of specific goals. It's not a giveaway. Return to top The Stock-Option Option Comes to Japan (int'l edition) A decade ago, Japan's relatively flat executive pay regime was viewed as a crucial competitive advantage. Japanese bosses decried the high-octane pay deals, flush with stock options, of their U.S. counterparts as emblematic of the short-term mentality that put quarterly earnings and share prices ahead of long-term strategic planning. By contrast, they argued, their more egalitarian pay structure, in exchange for lifetime job security, was positively enlightened. Well, no more. Suddenly, a dash of pay inequality is an idea who's time has come. With corporate profits plunging for the fourth year running, by 20% in the latest year, Japanese compensation strategies are getting a rethink. Some 160 listed companies, including Sony, nec, and Sega Enterprises, now offer executives stock options, says a study by Towers Perrin Foster & Crosby Inc. MODEST BEGINNINGS. Electronics giant Sony is a leader. As of August it had issued about $21 million worth of stock options with exercise rights extending to around 2004. And on Mar. 8, Softbank, a high-tech outfit with growing Internet interests, offered executives about $20 million in warrants maturing in 2003. It may be a modest beginning, but, says Naohiko Abe, a consultant with Towers in Tokyo, "we now are very busy helping companies overhaul their compensation programs." More fundamentally, companies are dumping on rigid pay scales based on seniority that treat corporate stars and slackers the same. Now the deal is that if you don't perform, you're out. "But if you do [perform], we will double your salary over your peers," says Takeshi Inoue, a consultant at Boston Consulting Group Inc. in Tokyo. For years the pay packages of Japanese chief executives, whose base salaries range from $330,000 to $800,000 at the top companies, have lagged badly behind those in the U.S. Just how badly was obscure because of the secrecy surrounding the compensation of Japanese execs such as Sony Chairman Norio Ohga. Japan's commercial code doesn't require the data to be published, so companies don't. Headhunters and compensation experts make informed guesses by delving into government lists of the country's wealthiest taxpayers, and making their own informal surveys. Until 1997, stock options weren't an issue because they were banned, except at small venture companies. While some Japanese bosses might have envied the huge packages of U.S. rivals, they had different sorts of rewards. For one thing, Japanese executives led calmer lives because they escaped the incessant scrutiny of earnings and share prices. However with low credit ratings and their banks in a dire state, Japanese companies increasingly need to compete for capital in global markets. That means a higher stock price is essential. Companies also feel compelled to compete with Western rivals such as Microsoft Corp. and Dell Computer Corp. that do offer stock-option plans to lure the best young talent graduating from the universities. Payment by results fits into the restructuring needs of big companies, too. Lower pay scales imposed on less productive and expensive older employees could encourage them to leave, easing the way toward making big workforce reductions by attrition. If Japan, as expected, adopts U.S.-style 401(k) portable pension plans in 2001, the move will likely speed up the trend toward incentive pay. It would certainly make Japan's labor market far more flexible and make higher share prices a real priority for Japanese managers. There won't be an avalanche of multimillion dollar stock-option deals, but Japan's paternal reward system is probably a thing of the past. Return to top Eager Europeans Press Their Noses to the Glass (int'l edition) France's Alcatel learned a hard lesson last month in how costly it can be to keep up with U.S. pay levels. It laid out $350 million for Assured Access Technology Inc. in Milpitas, Calif., which provides plumbing for the Internet. Included in the price: $60 million to keep the 55 engineers at Assured Access from bolting at the prospect of working for a low-paying French employer. The Alcatel experience shows how pressure is mounting on European companies to boost pay. Globalizing companies such as DaimlerChrysler and Deutsche Bank are unable to compete in the U.S. or to hire top international executives without offering U.S.-style pay. But it's not just about grabbing talent abroad: Once companies do so, they find their homegrown employees clamoring for more as well. Meanwhile, a new focus on shareholder interests is starting to break down barriers to stock options and incentive pay packages. Companies ranging from Daimler to Dutch insurer Aegon are pioneering the use of incentives tied to the company share price. To be sure, salaries in Europe remain below those in the U.S. In fact, European CEOs still earn on average less than half as much as their U.S. counterparts, according to consultant Towers Perrin, which studied companies with annual sales of $250 million to $500 million. But just being an American allows a manager to command much more than the locals. In Britain, companies pay chief executives who have come from the U.S. salaries that are 30% more than their British counterparts, according to consultants Monks Partnership. Bonuses for U.S. executives working in Britain are also more generous--twice as much as those offered Britons. Companies recognize that if they want a top U.S. manager, they must pay a premium. Marjorie Scardino, the U.S.-born chief executive of British publisher Pearson Group, earned $1.6 million last year, including a bonus of $872,000. Barclays guaranteed Michael O'Neill, its American CEO, $24 million over three years. And the CEO of SmithKline Beecham PLC, Jan Leschly--a Dane who spent most of his career in the U.S.--just won a $140 million package, the highest ever in Britain. Shareholders remained conspicuously silent, which shows how perceptions are changing. OUTCRY. Elsewhere in egalitarian Europe, though, big pay remains controversial. When Finnish papers reported last spring that Chairman Jorma Ollila of Nokia Corp. had accumulated some $15 million in stock under his company's incentive pay program, it caused an outcry. His response: Nokia needed a stock-option program to attract top talent. "It's no easy job recruiting people to live in Helsinki," he says. Now, Ollila's options are worth $50 million, and Nokia is extending its options plan to 3,500 employees. If the pressures are most acute in high tech, however, the old arguments against superhigh pay are everywhere giving way. It used to be enough to give European executives a predictable paycheck, plenty of vacation time, and a car. Now, headhunters say, they want options. "Managers are demanding it," says Franz-Josef Nuss, an executive search specialist at Munich's Roland Berger & Partner. The main reason is globalization. When Daimler Benz took over Chrysler Corp. last year, CEO Jurgen E. Schrempp had to confront the fact that Chrysler CEO Robert Eaton, who earned over $11 million in 1997, including exercised options, appears to have made more than the rest of Daimler's management board members put together. Worse, Daimler had to pay out $395 million, primarily in stock, to Chrysler's top 30 executives to cash out their options. Since cutting the pay of Chrysler managers wasn't possible, Daimler was forced to boost pay for its own execs. Deutsche Bank faces similar pressures. Burned by defections from its U.S. operations last year, it agreed to pay $187 million to retain five of the top execs at Bankers Trust Co. after its takeover of the U.S. bank is done. Not bad, considering that Deutsche CEO Rolf Breuer is estimated to make no more than about $1.5 million a year. Meanwhile, restructuring by tradition-bound industrial giants is also driving pay upward. Siemens, for example, plans to spin off its $3.7 billion semiconductor unit into a separate company early next year. Ulrich Schumacher, the Siemens board member who will be the new unit's CEO, says one great advantage of the spin-off is that he'll be able to compete for top talent by offering stock options. "We plan to offer performance-based compensation as soon as we can," he says. But corporate titans are not the only ones leading the way. Small companies are also making up for mediocre base salaries with generous stock options. Some of the best-paid executives in Germany aren't at giant companies on the benchmark dax 30 index but are at startups listed on Frankfurt's high-flying Neuer Markt. Headhunters say that soaring stock prices have made executives of some Neuer Markt companies richer than their counterparts at behemoths such as Siemens. The Neuer Markt Index has doubled in the past year. One example is 1&1, a Net-access and -marketing company in Montabaur, west of Frankfurt. Every employee owns stock and can check the share price at any time with a click of the mouse on company computers. Since an initial public offering on Mar. 23, 1998, 1&1 shares have risen 180%, to $126. ANGRY REDS. Still, it will be years--if ever--before Europeans make as much as Americans. That's because a combination of government restrictions, prohibitive taxes, and political opposition continues to hamper the use of options. In France, for example, a government attempt at quiet liberalization of the rules for stock options last year ran afoul of angry communists and other members of Premier Lionel Jospin's coalition. The Netherlands imposed capital-gains taxes on stock options last year after Prime Minister Wim Kok, a former labor leader, blasted "exhibitionist" stock bonuses paid to executives such as Kees Storm, CEO of insurer Aegon. Even in Britain, the value of stock options may not amount to more than four times an executive's base pay. "Every country has different rules on stock options," says Malcolm Hurlston of the European Center for Employee Ownership, which is about to publish a report on stock options. "There are tons of complications." In Germany, at least, legal barriers are slowly coming down. The government last year clarified its rules on stock option plans to make it easier for companies to offer them. Now, all the companies on the dax 30 have either linked the pay of top managers to share performance or are planning to do so soon, according to a study by Egon Zehnder International, Europe's biggest executive-search firm. "You want managers to look in the newspaper every morning and calculate their benefit easily," says Magnus Graf Lambsdorff, a Zehnder consultant. In short, nothing focuses a manager's mind quite like a stock option. That's a lesson European companies are starting to learn. Return to top  Return to top ONLINE ORIGINAL A CEO Who Takes Pay for Performance to the Extreme It would be ridiculous to buy a stock just because the chief executive has an innovative pay package that builds in an unusually large incentive to drive the stock price higher. But if there was ever a company you might buy on that basis, tiny Cleveland-based Oglebay Norton (OGLE) is it. When John N. Lauer assumed leadership of the industrial minerals processing and shipping company at the end of 1997, he agreed to work for no salary, and his annual bonus was capped at a maximum of $200,000. He spent more than $1 million of his own money to buy shares on the open market. And the board bought him more than $1 million worth of restricted shares, which won't completely vest until 2003. But his real payoff will come -- if it does -- via a one-time stock option grant he received for up to 8% of the company. It is exercisable at $38 a share -- about a 70% gain from where the stock is now. "Essentially, he is going to work for free if he can't get the share price up over $38 in the next three to five years," says Harry Millis, who covered the company for more than 30 years as a stock analyst. Millis recently became a managing director at S.M. Berger & Co., Oglebay's investor relations firm. "I'M NOT UNIQUE." A critic of excessive CEO compensation who has done doctoral studies on the topic, Lauer says his pay package basically replicates the private-company model, where top execs are expected to buy their way in to small, nonpublic companies. "I'm not as unique as people think," he says. "When I put my own money, my own financial risk, on the line, what I'm really doing is investing in the employees of this company." So far, Lauer's investment -- as well as the investments of other shareholders who bought Oglebay's stock on excitement over Lauer's ascension -- is far from paying off. Oglebay got some positive press when Lauer, who was president and chief operating officer at B.F. Goodrich and was considered perhaps overqualified for the Oglebay job, came in and promised to transform the stodgy, slow-growth outfit into a fast-growth company. The stock hit a high of 50 1/2 on April 16, 1998, about when the small-cap segment of the market began to take it on the chin, and when natural-resources stocks also weakened. The stock has mostly been falling ever since. The shares closed this Apr. 8 at 21 5/8. Natural resources continue to be in a slump, and Oglebay has exposure to the steel industry, through its shipping and limestone businesses as well as the oil and gas industry, which uses Oglebay's industrial sands for processing. Lauer has begun to transform the company, mainly by taking on debt and expanding through acquisition into the faster-growing lime and limestone production business. Now the largest of Oglebay's three segments, lime and limestone accounted for 47% of sales in 1998, with marine transportation (bulk shipping on the Great Lakes) providing 34%, and industrial sands adding 19%. But the acquisitions haven't helped earnings yet. In 1998, Oglebay's net income fell to $12 million, or $2.52 a share, from $16 million, or $3.37 a share in 1997. Still, the company's revenues grew 65% from $145 million in 1997 to $239 in 1998. Earnings before interest, taxes, depreciation, and amortization (or EBITDA, a common measure of cash flow) rose 55% for the year, to $58 million from $37 million. Debt increased to more than $300 million, but the company still has more than enough cash flow to cover the costs, says Rochelle Walk, Oglebay's director of corporate affairs who oversees investor relations. WINTER CHILL. On Apr. 26, the company will report first-quarter earnings -- normally its weakest of the year, since the Great Lakes and one of Oglebay's limestone quarries shut down in the winter months. The increase in financial leverage creates opportunity but also more risk if there's an economic slowdown. Why? If there's a "hiccup," the company can't just tighten its belt, says Robert Robotti of New York investment boutique Robotti & Co. Some value investors are starting to see Oglebay's cheap price relative to its assets and cash flow as an opportunity. "It has some debt, it's a small cap, and it has economic exposure -- those are three death words to this market," says Paul Orlin, a general partner at value-oriented investment firm Porter Felleman, which has accumulated about 5% of the stock. "People don't want to own these kinds of stocks in this market." Given its free cash flow, Orlin says it's as if for every $100 you invested in the company, you got back $20 each year in cash. And he expects that cash stream to grow. Orlin says he was also attracted to the stock by the strength of the management team, which has much more experience than managements in most companies this size. "Obviously, the stock is extremely cheap," says Millis. It is trading at about a 15% discount to its book value of $27 a share, and its current p-e is only 8.5. Unlike other companies selling at such a low multiple, Oglebay could achieve double-digit earnings growth in 1999, he believes. Because of the way Oglebay accounts for its acquisitions, Orlin thinks investors won't see better earnings until the second half of 1999, when quarterly comparisons start to look better. And "it's not going to take much to move this stock," he says. Oglebay has only a $100 million market capitalization, no Wall Street coverage, and trades just an average of about 10,000 shares a day. With only about 2.4 million shares available to change hands, even trades of just a few hundred shares can move the stock, making volatility more likely. Lauer is clearly taking more risk with Oglebay than the 145-year-old company is used to. But it should comfort those investors bent on finding small-cap bargains that at the same time he's betting the company's future, he's betting his own. Return to top |
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