Worth Every Last Million

Tell me if I'm wrong: You think America's top corporate executives are obscenely overpaid. You think recently ousted Home Depot chairman Robert Nardelli was just the latest in a long line of high-flying CEOs to negotiate himself an overinflated severance package and to waft out the door thumbing his nose at us all. You think it's about time that the Senate started considering, as it did last week, closing some of the tax loopholes that have made it possible for these corporate scalpers to get away with highway robbery for so long.

I say, think again.

Executive compensation today isn't the sinful overindulgence of greedy executives that it's made out to be. There may be some abuse among the 7,500 publicly traded corporations in the country, but most of the CEOs who receive those huge pay packages not only earn them but also, yes, deserve them.

Most have increased their companies' value and improved their performance far more quickly than was common in the 1970s and '80s. Yes, corporate compensation has gone sky high, but the result is better-run, better-performing companies than the United States has ever had. And most of us -- from shareholders and investors to average consumers -- are reaping the benefits.

If you want to blame anything for today's inflated compensation packages, blame the hostile takeovers and the leveraged buyouts of the 1980s. Remember the days of the corporate raiders? Twenty years ago, those guys were everywhere, cruising the market for likely takeover targets and offering hostile bids, at premium prices, on well-known but poorly performing companies. The raiders would claim that management had failed to perform its basic duty to the companies' shareholders, which was to increase the value of their investment. These bids put management on the defensive, forcing it to justify both past performance and future plans.

The takeover effort led to a prolonged legal struggle to determine what managers could and could not do to defend themselves against hostile offers. But in the end, investors supported the bidders. And in doing so, they revolutionized corporate boardrooms, establishing the principle that if boards and managers did not create shareholder value, then shareholders would seek others who would.

By the mid-1980s, leveraged buyout (LBO) firms joined the pursuit of large underperforming companies using borrowed money. The LBO operators, however, believed that if certain management principles were followed, the risk of carrying all that debt could be greatly reduced. One of these principles required all-out managerial attention to increasing the company's operating cash flow so that debt could be repaid as quickly as possible. This in turn would improve profitability and increase the value of shareholders' equity.

Another principle was that the firm should retain the most effective managers it could find. That meant providing powerful compensation incentives. Managers who succeeded in meeting the LBO firms' performance benchmarks would be paid handsomely in company stock or options.

On the whole, the LBO management principles worked. The average LBO returns in the later 1980s were well into the double digits -- so the principle of exceptional pay for exceptional performance soon migrated to the public company arena.

From 1985 to 1990, there was more than $1 trillion worth of mergers in the United States, 25 percent of them hostile and 18 percent done through LBOs. In the 1990s, mergers continued at a record pace, but both hostile deals and LBOs decreased. One reason? There were fewer underperforming companies remaining.

The most famous takeover of the era was the landmark $25 billion buyout of RJR Nabisco in 1988. This began with a $75-per-share bid by the company's own CEO, F. Ross Johnson, supported by an investment bank. Johnson was frustrated that the stock market didn't value the tobacco and consumer goods company as highly as he thought it should. He also, admittedly, thought that if he could upgrade or break up the business, he could make much more money than if he remained CEO of an unleveraged RJR Nabisco.

"Greed in America," Time magazine blared on its cover in response to news that Johnson's management group would receive 8 percent of the stock in the LBO. But then the bid was exceeded by a higher one from the investment firm of Kohlberg Kravis Roberts. The two bidders slugged it out until RJR Nabisco's independent directors finally selected KKR's $109-per-share bid as the winner.