It’s proxy season, and several companies have released chief executive pay data in their annual filings. CEO salaries in S&P 500 companies are up 8 percent, on average, to $9.3 million, and as usual, critics are claiming that CEO pay is out of control. Their biggest targets are Disney’s (DIS) Bob Iger ($40.2 million), DirecTV’s (DTV) Michael White ($18.0 million), and Hewlett Packard’s (HPQ) Meg Whitman ($15.4 million).
The truth is companies that pay for high-priced executive talent usually get better results—and the money they pay these executives is a good investment.
The quality of a company’s CEO is the single biggest driver of its results. Since Iger took over Disney in 2000, he almost doubled the company’s value, creating $50 billion in shareholder wealth. DirecTV’s White generated more than $10 billion in shareholder value in just three years. Whitman is in the second year of a major turnaround at HP and has one of the best CEO track records, having expanded eBay (EBAY) from a startup to a Fortune 500 company in 10 years, generating roughly $40 billion in shareholder value.
CEO salaries are rising because more companies are realizing the value of good CEOs, and their pay—much like contracts for top-tier professional athletes—is getting bid up.
Critics of high CEO pay claim it is out of line vs. lower-level salaries and wages. But this is like comparing the Yankee Stadium peanut vendor’s pay with that of the players.
Of course, everyone in a corporation is important and should be compensated fairly. But good companies with poor CEOs are rudderless and fail. Good CEOs like Iger and White create thousands of new jobs because their companies are successful. It is a virtuous cycle. Employees prefer to work for winning companies like Disney instead of for struggling companies with weak CEOs.
Elected officials don’t understand this, and in the past decade they passed laws designed to generate more criticism of high CEO pay, such as mandatory shareholder votes on compensation.
Many public company boards are on the defensive, fearful of pursuing talented executives with pay packages that activists might attack.
Private equity investors are taking advantage of this and are luring away talented executives. There are now more than 3,000 private equity-owned companies, and the number is growing. As a whole, these companies outperform publicly traded counterparts, and executives who work for them have more upside potential.
In 2009, the Blackstone Group (BX) lured Mars’s North American president, Robert Gamgort, away to run Pinnacle Foods, a company just 30 percent the size of Mars North America. When Pinnacle (PF) went public last month at a value of $2.3 billion, Gamgort received stock and options worth about 1 percent of the company’s value.
The SEC’s disclosure rules are also leading to unnecessary CEO criticism. Its reporting treats incentive-based options the same as ordinary pay, making it look as if CEOs are being paid more than they really are. HP’s SEC filings, for example, show that Meg Whitman was paid $15.4 million last year. In reality, she received only 12 percent of that amount, making her one of the lowest-paid CEOs of a big company. The other 88 percent was unvested stock options and grants that she cannot earn unless she increases HP’s stock price by 40 percent or more—which is a tall task.
The “golden parachute” is another misunderstood, highly-criticized concept.
Most CEOs are under multiyear contracts—much like ballplayers—so that the company can retain them at a set price without losing them to a competitor. As anyone who follows baseball knows, it is impossible to be right about star players all the time. Every team has contracts they wished they hadn’t signed.
Good executives, like good ballplayers, are in high demand and often need guaranteed pay to jump ship. Current Yahoo (YHOO) CEO Marissa Mayer had a cushy vice president job at Google (GOOG), a seven-figure pay package, and unvested stock options worth $14 million. Yahoo was a company in trouble that desperately needed someone like Mayer. It took Yahoo a $117 million, five-year (partially guaranteed) contract to lure Mayer away.
So far Mayer is off to a great start. She has already increased the value of the company by more than $10 billion, so initially it looks like a great deal for Yahoo shareholders. But if she stumbles and gets fired, her contract includes a large “golden parachute” she is already entitled to, which Yahoo had to offer to get her to leave Google.
Yahoo’s board had a choice. They could spend big bucks to get Mayer, giving the company a chance to be a winner again. Or they could put their shareholders and employees through several more years of failure with lesser-qualified, but lower-paid CEOs, such as Jerry Yang, Carol Bartz, and Scott Thompson, who collectively ran the company into the ground.
If only they had anted up to get a star player three CEOs sooner, they might not be in the mess they’re in today.