http://www.businessweek.com/stories/1997-04-20/call-it-executive-overcompensation

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Call It Executive Overcompensation


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CALL IT EXECUTIVE OVERCOMPENSATION

Few Americans consider themselves overpaid--not plumbers, baseball players, building contractors, or movie stars. CEOs are no exception. After all, they led Corporate America in 1996 to double-digit gains in company profits and in share prices. They helped create 21/2 million jobs and raise real wages. They boosted U.S. competitiveness in global markets. So what if many CEOs took home upwards of $30 million, while others took in $60 million--and one garnered more than $100 million? It's all pay for performance, isn't it?

Well.... For many, it may be pay for stock market performance, not business performance. No one begrudges the top CEOs, who deliver fantastic returns on equity (ROE) to their shareholders, their due. Manpower Inc.'s Mitchell S. Fromstein, for example, took in $10 million for delivering an ROE of 32%. But last year, average--repeat average--total CEO compensation rose an astonishing 53%, nearly five times the 11% average gain in corporate profits, according to

BUSINESS WEEK's annual Executive Pay Survey (page 58). Most of that compensation came in the form of stock options, which rose along with the rest of the market. In the classic error of confusing a bull market for genius, dozens of CEOs were rewarded not for their own achievements but for those of Federal Reserve Chairman Alan Greenspan and congressional budget cutters, who set the equities market on fire with policies that promoted low inflation and moderate economic growth. These chief executives simply hitched a ride on the performance of others, including other CEOs who churned out the earnings that set the market moving at warp speed.

Even so, who got hurt? Since most of the compensation was in options, which are not charged against earnings, who loses? Answer: the shareholders, who are beginning to whisper the word "dilution." Thanks to option mania, earnings per share are increasingly watered down. What's more, the cost of options has been easy to hide, because they don't have to be listed on the income statement. But as of yearend 1996, companies must quantify, in a footnote in the annual report, what the options' cost would have been. Guess what? Shareholders can now read, for example, that option grants last year, if accounted for, would have cost PepsiCo Inc. 6% of earnings, or $68 million.

The law of unforeseen consequences is clearly at work with option mania. Pressure from institutional investors in the late 1980s to reform CEO pay and shift it away from automatic cash increases to options was viewed as a way to tie pay to performance. But few foresaw the granting of enormous option packages--many in the hundreds of thousands, annually--or the skyrocketing market that would carry the compensation of many very average executives to such heights.

What's to be done? First, the true cost of options must be made clear. Footnotes are not visible enough. Income statements must delineate the size and cost of stock options, and their value probably should be deducted in calculating earnings. CEOs should also curb their own hubris. They are team leaders, not celebrities or one-man bands. There are many turnaround situations where a new CEO dramatically improves earnings and the stock price. Here, outsize compensation makes sense. But usually, a chief executive works with a team of people who manage thousands of employees, each contributing to the success or failure of the company. A team leader requires respect to function. Making 200 times the average paycheck, simply because the market has a good year, doesn't generate respect. Factory wages rose 3% last year. White-collar workers received 3.2%. Enough said.

Boards of directors' compensation committees are responsible for seeing to it that CEO pay is truly linked to performance, and many have been derelict in their duty. One board has handed out so many options to a chief exec that he took home his $60 million despite a company stock rise of just 11%--as the Standard & Poor's 500-index jumped 23%. Others committed the financial sin of repricing options downward when earnings couldn't generate enough equity growth to put the CEO's options "in the money."

It is time for shareholders to insist that CEOs get paid according to their output. Exceptional performance--and only exceptional performance--demands exceptional pay. Tossing out $50 million packages just for hitching a ride doesn't cut it. Compensation inflation is running riot in many corner offices of Corporate America. This has simply got to stop.


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