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Executive Pay


As a matter of basic fairness, Plato posited that no one in a community should earn more than five times the wages of the ordinary worker. Management guru Peter F. Drucker has long warned that the growing pay gap between CEOs and workers could threaten the very credibility of leadership. He argued in the mid-1980s that no leader should earn more than 20 times the company's lowest-paid employee. His reasoning: If the CEO took too large a share of the rewards, it would make a mockery of the contributions of all the other employees in a successful organization.

After massive increases in compensation, Drucker's suggested standard looks quaint. CEOs of large corporations last year made 411 times as much as the average factory worker. In the past decade, as rank-and-file wages increased 36%, CEO pay climbed 340%, to $11 million. "It's just way off the charts," says Jennifer Ladd, a shareholder who is fighting for lower executive pay at companies in her portfolio. "A certain amount of wealth is ridiculous after a while."

Oddly enough, CEOs came to command such vast wealth through the abuse of a financial instrument once viewed as a symbol of enlightened governance: the humble stock option. Throughout the 1990s, governance experts applauded the use of options, maintaining that they would give executives a big payday only when shareholders profited. And for a while, as the bull market ran its course, that's the way it worked. But as the market cratered during the past two years, a funny thing happened: Shareholders lost their shirts, but executives went right on raking in the dough.

In recent months, especially, shareholder anger has boiled over, as company proxies disclosed the many ways compensation committees subverted pay for performance. There is, of course, a fundamental difference between investors who have their own money at risk in the market and option holders, who do not. But companies have gone even further to shield top executives from losses in a falling market. Some awarded huge option grants despite poor performance, while others made performance goals easier to reach. Nearly 200 companies swapped or repriced options--all to enrich members of a corporate elite who already were among the world's wealthiest people.

When CEOs can clear $1 billion during their tenures, executive pay is clearly too high. Worse still, the system is not providing an incentive for outstanding performance. It should be a basic tenet of corporate governance never to reprice or swap a stock option that is under water. After all, no company would hand out free shares to stockholders to make them whole in a falling market.

To really fix the problem, Congress needs to require companies to expense options. If every option represented a direct hit to the bottom line, boards would be less inclined to dole them out by the millions. Determining the value of an option for accounting purposes is no slam-dunk. It may be that companies should mark-to-market all or a portion of the actual gains or losses in vested stock options every year. At the very least, Congress should provide preferential tax treatment to encourage boards to replace their plain-vanilla option grants, which reward CEOs if the stock rises, with indexed options, which provide a payday only when the stock appreciation outstrips that of peer companies.


Steve Ballmer, Power Forward
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