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Delinquency Of the CEOs

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By Robert J. Samuelson
Thursday, July 13, 2006

Delinquency , n. 1. failure in or neglect of duty or obligation.

The controversy over CEO pay is not just an accounting matter. Love them or hate them, corporate chief executive officers preside over a vast segment of America's wealth. How they manage or mismanage it enriches or impoverishes their shareholders and the entire nation. CEOs are often unfairly stereotyped as heartless because they shut plants and cut jobs -- unpopular actions that are often necessary. Still, the public pounding of CEOs for their lavish pay packages is amply justified.

Any tally of CEO pay suggests jarring disproportion. The Post recently reported the 100 best-paid executives in its region. The highest received $39.6 million, and all the top 20 exceeded $10 million. Fortune magazine ran a scathing pay story in its latest issue illustrated by these examples: $405 million to retired Exxon Mobil chairman Lee Raymond (his 2005 pay, plus the value of his pension and stock grants); $90 million to Franklin Raines, the former chief executive of Fannie Mae (his compensation from 1998 to 2003); $99 million to Hank McKinnell, the CEO of Pfizer (2005 pay plus his pension's value).

The minority of CEOs who deserve massive payouts (because they contributed uniquely to a company's success) or whose pay is properly restrained are tainted by their peers. The Business Roundtable, a group of 160 CEOs, argues that a few huge pay packages create a distorted picture. Not really. Consider a Business Roundtable study, using data that Mercer Human Resource Consulting collected on 350 major companies. The idea was to examine median CEOs -- those in the middle -- as typical. Here's what the study found:

· From 1995 to 2005 median CEO compensation at these companies rose 151 percent, from $2.7 million to $6.8 million (the figure included base salary, bonuses, stock options and other "incentives" -- but not pensions).

· In the same period, the median sales of these companies increased 51 percent, to $7.6 billion, and the median profits 126 percent, to $591 million.

· By contrast, the median pay increase for full-time, year-round workers ages 25 to 64 in these years was only 32 percent, to $38,223 (that's all workers, not just those at the study's firms).

Remember, these are run-of-the-mill CEOs, not the superstars or the supergreedy. Even they seem to regard being a multimillionaire as an entitlement befitting their position. From 1995 to 2005 their pay rose five times faster than the typical worker's. In 1995, median CEO pay was 94 times median worker pay; by 2005 it was 179 times as much.

How CEOs are paid -- their incentives -- matters, for them and society.

Through the 1970s, CEOs were the ultimate Organization Men. Usually company careerists, they were compensated mainly "like bureaucrats in the sense that they were primarily paid for increasing the size of their organizations," economists Michael Jensen and Kevin Murphy argued in several studies in 1990. Because pay increased with company size, CEOs often created ever-expanding, unwieldy and inefficient conglomerates. This approach was bad for America and for shareholders.

Recognition of that led to change. Compensation for CEOs and other top executives in the 1980s and 1990s was increasingly tied to a company's stock performance. The aim was to motivate executives to improve efficiency and profitability, driving up the firm's share price. The usual instruments were stock options: the right to buy shares at a fixed price (called the "strike price"). A CEO might receive an option to buy 100,000 shares of stock at $10 a share. If the price went to $30, the executive could instantly make $2 million (shares bought at $10 can be sold at $30).

In the 1970s most CEO compensation was cash; by 2000 half or more often consisted of stock grants. Up to a point, the shift succeeded. It rewarded good management. But it also inspired abuses, because option grants were excessive and unconditional (providing huge windfalls, for example, from a general rise in stock prices). Executives manipulated reported profits to sustain stock prices. Enron and WorldCom exemplified illegal methods. Legal channels also existed. One survey of executives found that 80 percent would decrease advertising or research and development spending to hit profit targets.

CEO pay has accelerated so rapidly mainly because it lacks normal disciplines. If you and I set our pay, we'd do well, too. That's essentially the CEOs' prerogative. Some modest market pressures exist. In the 1990s about a quarter of CEOs of big firms were hired from the outside, up from 15 percent in the 1970s. But CEO pay is mostly set by sympathetic directors, often other CEOs. They want their guy to stay up with the pack.

"[N]obody has any idea what the right level should be," Pfizer's McKinnell told Fortune. True. There is no ideal way to set CEO pay. Any system can have bad, unintended consequences. That's why the current CEO pay explosion is primarily a moral failure. Would Exxon's Raymond have worked just as effectively for $100 million instead of $400 million? How about $25 million? If so, he was overpaid. By that standard, so are many CEOs.

But they have contrived a moral code that exempts them from self-control -- a moral code that justifies grabbing as much as they can. They unduly enrich themselves at shareholders' expense and set a bad leadership example. Because almost everyone else sees their code as self-serving and selfish, CEOs have undermined their moral standing and their ability to be taken seriously on other issues. They are slowly becoming a threat to the very system they claim to represent.


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