Reading a CEO's Paycheck


By Amy Tsao Spring is in the air, and that means reporters are sifting through Corporate America's annual reports. They're finding -- you guessed it -- fat pay packages for chief executives in 2002, despite dismal earnings and massive layoffs at many companies. CEO pay declined 33% in 2002, to $7.4 million on average. However, execs in the middle of the pack actually enjoyed a rise of 5.9%, to $3.7 million, according to an annual BusinessWeek study of executive pay, conducted with Standard & Poor's ExecuComp (see BW, 4/2/03, "Executive Pay").

Some pretty egregious examples of high pay for poor performance are coming from hard-hit sectors. Take airlines. AMR (AMR), which runs American Airlines, convinced union members to take substantial pay cuts to keep it from a Chapter 11 bankruptcy filing. At the same time, the board had voted to award multimillion-dollar retention bonuses and safeguarded pension plans to management. Then there's Delta Airlines (DAL), whose CEO took a pay cut and gave up his 2003 bonus. But the board also set him up with a sweet pension deal that would be protected from creditors in the event of a bankruptcy filing.

ON THE RECORD. American's pension plan would work the same way. Both companies have said that the moves were made to prevent top execs from quitting. However, at American, the board canceled the retention bonuses, and after apologizing to employees, CEO Donald Carty resigned on Apr. 24 (see BW Online, 4/24/03, "What Was Don Carty Thinking?"). Still, angered unions may rescind their support for the cost-cutting plan, which involves pay cuts and layoffs for the rank and file.

Investors could be excused for hoping that a new era of more independent research on Wall Street will see analysts joining in the growing criticism of companies whose executives are paid huge sums, regardless of how their outfits perform. But that hasn't been the case. Indeed, most Wall Street analysts have said zilch about outsize pay.

Some analysts point out that executive compensation is a relatively small expense for companies reporting revenues in the billions of dollars and profits in the hundreds of millions of dollars. So, while vast compensation packages might merit moral outrage, analysts say the subject doesn't deserve their microscopic examination. Also, such information isn't hidden: All annual statements include the pay of the five most highly compensated executives.

"ABILITY TO PUNISH." On a more practical note, analysts say they can't afford to cut ties to the leaders of the companies they cover when research is becoming more of a commodity. Having access to management is considered critical to competitive research since access gives analysts information -- new product design, strategy decisions, and the like -- that can't be parsed from publicly filed financial statements.

Analysts who speak out against pay packages run the risk of being cut out of the information loop. "CEOs have the ability to punish people who [criticize] them," says compensation expert Graef "Bud" Crystal, who adds: "An analyst can have big trouble on his hands."

Oversize CEO pay should raise red flags for investors

Some sector strategists and ratings agencies are beginning to look more closely at executive pay, however. But it will take time "before these issues are incorporated into analysis of an investment," says Nell Minow, corporate-governance expert at the Corporate Library, a shareholder research consultancy. The investing community is just starting to realize that executive compensation is the "greatest single indicator...of governance risk," she says. She and other shareholder activists say oversize CEO pay should raise red flags because a board that will award outrageous pay to top execs may lack independence on other issues, they reason.

ANOTHER BLOW TO TECH. Actually, analysts are starting to scrutinize compensation more closely, albeit indirectly, through a debate over upcoming new accounting rules on expensing stock options. The Financial Accounting Standards Board (FASB), a quasigovernmental accounting agency, is leaning toward what's called the fair-value accounting treatment of options. Such a move could significantly affect the bottom line at companies that love using options to pay employees -- particularly the top brass.

The new FASB rule is expected to require companies to report stock options as an immediate expense to earnings, rather than footnoting them as a future expense for when the options are actually exercised. Says Crystal: "It may take some froth out of the size of these option grants. That's a way to try to reform whole system."

Tech companies are expected to take the biggest hit from the new rules, which analysts expect to take effect as early as 2004. Awarding options offered the best of both worlds during the tech boom of the 1990s: Companies with little in profits could pay employees with stock options when share prices were soaring. In his March update, tech strategist Steve Milunovich at Merrill Lynch figured that companies' profits would have been reduced by an average of 67% had they expensed options in 2002.

"PAY IS A COST." Traditional credit-rating agencies such as Standard & Poor's, Moody's Investors Service, and Fitch Ratings also have announced plans to rate corporate-governance quality at companies, with executive-pay scales being one of several measures. These ranking systems are just getting off the ground, but "it shows that there is market demand for this kind of perspective," Minow says.

Plenty of academic studies show that lots of highly paid CEOs turn in solid performances and keep shareholders happy. Bill McGuire, CEO of health insurer UnitedHealth Group (UNH), made $58 million in salary, bonus, and stock-option grants in 2002. Even Crystal admits that while the figure may sound high, McGuire appears to be earning his keep by delivering a 48% rise in earnings, to $1.3 billion, on $25 billion in sales last year. The stock trades at about $91.

Still, Crystal argues that companies with excessively paid CEOs are often poor performers. "Executive pay is a cost. If you go crazy, you end up hurting the profits of the company and hence the stock price," he says. And while analysts may not be game to take CEOs to task for earning thousands of dollars an hour, investors might want to look at executive pay as one more tool in assessing whether a stock is a good investment. Tsao covers financial markets for BusinessWeek Online in New York


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