The skyrocketing salaries of corporate tycoons have sparked a heated debate over how to compensate executives at America's largest companies. But the real concern, according to Intel Corp. Chairman Andrew S. Grove, should not be how executives are paid, but how much.
Much of the recent discussion is a distraction, Grove explained in a letter of dissent to the Conference Board, a nonprofit advisory body that recently urged companies to treat stock options paid to executives as an expense.
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"The broader issues the commission should be addressing" include the "inequitable distribution of wealth" and "excessive compensation," wrote Grove, who earned about $1.5 million from Intel in salary and bonuses last year and received options on 384,696 shares that the company estimated were worth about $6 million.
Grove's call for refocusing attention on the size of compensation packages is gaining momentum. The average compensation package of a major corporation's CEO topped $20 million in 2001, according to one recent study. William J. McDonough, who earns $297,500 a year as president of the Federal Reserve Bank of New York, told an audience on Sept. 11 that the staggering growth in executive pay is "terribly bad social policy and perhaps even bad morals."
Robert S. Miller, chief executive of Bethlehem Steel Corp. and an outspoken critic of exorbitant executive pay, said in an interview, "There's been plenty of focus on the form that compensation takes; we should be looking more closely at how much some of these people make." Miller's annual salary: $900,000.
The belief that only the right CEO can lead a company to prosperity drove salaries through the roof during the past decade as boards bidded up the price of top talent.
"There is a limited supply of high-performing chief executives who can truly change a company," said Steve Fisher, president of A.T. Kearney Executive Search. "Boards want a CEO with a proven track record. Who's to say someone who has been successful for a number of years shouldn't be paid a lot of money?"
But as more companies led by former corporate icons collapse, several new studies are challenging the assumptions on which executive searches and pay policies are based. Their argument goes roughly as follows: The criteria used to narrow the pool of CEO candidates are arbitrary and create the false impression that talent is scarce. Meanwhile, boards of directors, terrified of being second-guessed, pay top dollar to the candidate whom the market and media will accept.
"Now when you ask the question 'What exactly is a CEO worth?,' the answer has become 'Whatever he has the audacity to demand,' " said Rakesh Khurana, an assistant professor at Harvard Business School and the author of the book "Searching for a Corporate Savior."
And audacity, it seems, is not in short supply. In 1960, the average head of a top company made twice as much money as President Dwight D. Eisenhower, according to one study. Today's top chief executives earn more than 60 times as much as President Bush.
In 1980, on average, the CEOs of the biggest U.S. companies were paid 40 times as much as hourly wage earners at their companies. Now that number is approaching 500 times as much.
"What's disturbing is that so many companies paying astronomical rates have performed poorly," said Jeff Sonnenfeld, associate dean of the Yale School of Management.
For example, Global Crossing Ltd., which filed for bankruptcy earlier this year, dangled a $10 million signing bonus to lure AT&T Corp. hotshot Robert Annunziata as chief executive in 1999. A year later, he was replaced at the top of the struggling telecom company by Leo J. Hindery, who lasted just seven months before negotiating a $1 million-a-year severance package on his way out the door.
The Financial Times recently calculated that the executives at the 25 largest American companies to go bankrupt in the past few years walked away with $3.3 billion collectively in "share sales, payoffs, and other rewards." Never before, critics charge, have so many people been paid so much money for achieving so little.
"It's an abuse of the democratic system," said Felix Rohatyn, former head of the New York City arm of investment bank Lazard Freres & Co. "I can't believe it's gone on as long as it has."
Executive salaries exploded with the birth of the superstar CEO in the late 1980s. Few company leaders were household names when the decade began. But as a growing number of Americans invested in stock, Harvard's Khurana said, they started paying attention to the names at the front of annual reports. A burgeoning business press helped elevate executives to celebrity status, and charisma came to be valued in hiring as much as competence, Khurana said. Media-savvy moguls such as Chrysler Corp. head Lee Iacocca appeared in television advertisements and wrote best-selling books.
Meanwhile, the faceless managers of a bygone era fell out of vogue. Company boards that couldn't spot a future Iacocca within their ranks began recruiting from outside the firm and sometimes even outside their industry. The most famous example was Louis V. Gerstner, whom IBM hired away from RJR Nabisco in 1993 even though he had never worked in the technology field.
"Looking at outsiders is the right thing to do," said Charles H. King, head of global board services for search firm Korn/Ferry International. "It doesn't mean you have to hire from outside, but there are a lot of great COOs [chief operating officers] who are not CEO material. For some, that's where they peak. When you want to lure someone away, you have to pay them more."
But the pool of CEO candidates has long been kept artificially small, Khurana said. "Ninety positions open up each year, and the only people considered for most of them are heads of other big companies," he said. "There are clearly other great candidates, but this created the perception of a leadership shortage that does not exist."
Those making the list of desirable candidates have been able to name their price. "Hiring outsiders led to bidding wars for talent, just like with free agents in baseball," said Robert H. Frank, an economics professor at Cornell University's Johnson Graduate School of Management. Frank and colleague Philip Cook calculated that by 1990 there were 50 percent more outside hires leading Fortune 500 companies than in 1970.
But many of the high-priced corporate free agents never fulfilled their promise. "We looked at 75 years of company data and never found the slightest correlation between executive compensation and company performance," said Jim Collins, author of the 2001 bestseller "Good to Great," which emerged from a five-year study of 1,435 major corporations.
More than 90 percent of the successful companies Collins analyzed were led by executives promoted from within. Yet of those he identified as attempting to make the leap "from good to great," two-thirds had hired outsider chief executives. "We found that the best CEOs tend to come from inside a company," Collins said.
Fortune 500 companies typically use executive search firms to find the right candidates and help determine the salary package to offer. The search firms use a formula for determining compensation based on several factors, including the salaries of chief executives at comparably sized companies in the same industry. Each new deal sets a new benchmark.
"Everybody wants to be near the top of the salary list," said Graef Crystal, the former head of the worldwide practice at search firm Towers Perrin. "It's like Lake Wobegon: No one can be below average."
Crystal partially blames search firms for the rising pay scales. "They get a percentage of the CEO's first-year salary, so it's in their interest to push these things higher and higher," he said. "And the time they spend on these searches is valuable, which creates the perverse incentive to bring in one guy and say he's the best candidate out there."
But overpaying for a "savior" can cause resentment among other managers and employees and distract a company from underlying problems, Khurana found in his study. Too many companies ignore the reality, he said, that success is determined by more than just the contribution of one person.
"AT&T brought in Michael Armstrong rather than focus on the fact that they were a regulated monopoly with a declining core market," Khurana said. "After five years, they still had all the same problems."
Ignoring such warnings, risk-averse corporate boards have so far stuck to the standard practice of paying a premium to poach another company's big-name CEO. "They're terrified of looking like they made a mistake," Yale's Sonnenfeld said.
Many compensation experts also say that corporate boards of directors are too weak. A recent working paper produced by the National Bureau of Economic Research argues that chief executives have seized control over the process of determining compensation. Many CEOs are also board chairmen. This makes boards see themselves as servants of management rather than working on behalf of shareholders, said Lazard's Rohatyn, who has served on about 10 boards in his career. As a result, he said, boards often rubber-stamp even the most outrageous salary demands.
New rules, such as the New York Stock Exchange's corporate accountability and listing standards announced this summer, may help strengthen boards' backbones by requiring that compensation committees comprise independent directors.
But change may be slow in coming. "Any developments will likely be evolutionary, not revolutionary," said Peter Crist, vice chairman of Korn/Ferry, who added that the events of the past year have had little impact on the three CEO searches he is conducting.
While average cash compensation for chief executives fell by almost 3 percent in 2001, according to a survey by Mercer Human Resource Consulting LLC, the average value of total compensation packages, including stock and stock options, increased by almost 7 percent.
Rohatyn noted that the public disgust that built up over the corporate excesses of the 1980s was largely swept aside in the 1990s by a tidal wave of new wealth, as soaring stock markets made many investors rich. Today, many people are angry again, but some experts wonder how long the fury will last.
"The American public has a short memory about these things," Towers Perrin's Crystal said. "Every time we try to kindle outrage, the kindling gets wet."
