Executive Compensation in the Defense Industry
With Steven Pearlstein
Washington Post Financial Staff Writer
Wednesday, April 16, 2003; 3 P.M. ET
A year of corporate scandals hasn't stopped big corporations from lavishing excessive pay packages on their CEOs, Steven Pearlstein writes in his column today.
Excerpt: "The proof [that firms still don't get it] can be found in the fresh crop of proxies detailing the compensation received by chief executives last year. It's not just that many of the top guys got big raises despite a lousy year for most investors and negligible pay increases for most of their employees. More significantly, the proxies confirm that directors continue to accept the claptrap that the only way to attract and retain top executives is to lavish them with wealth way out of proportion to what other talented humans seem to require." Read the full column.
An Edited Transcript of the Discussion Follows:
Steven Pearlstein writes about business and the economy for The Washington Post. His columns on the economy appear every Wednesday and Friday.
Editor's Note: Washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.
Alexandria, Va.: Aren't CEOs a commodity that the "market" competes for? If so, aren't their pay packages a result of market competition?
Steven Pearlstein: Well, you've asked exactly the right question and one that I dealt with in the part of the column that didn't make it in the paper. I've thought about this a lot and talked to a number of execs and headhunters and directors and what emerges is this fact: the market for CEO's is highly imperfect. The reason is that, in the Fortune 500 say, there are really only two ways to get to be a CEO: be a CEO or COO of another Fortune 500 company, or move up the ranks of your own company. And often this is limited further by having to be in the same or similar industry. So at the end of the day, there really aren't many choices and directors are notoriously risk averse about taking a chance on the untested (they'll ever take the failed/experienced over the untested). And in that situation, it's a seller's market.
Here's another way to think about it that supports the point. It's an old piece of wisdom that if you don't miss a plane every once and a while, you're spending too much time in airports. The analogy in the CEO market is that if companies don't lose CEOs every once and a while because they are bid away by a similar sized company, then they are paying too much across the board in order to eliminate the risk of any pay-induced defections. And we know there are almost no pay-induced defections.
Washington, DC: Your column makes a clear case against excessive pay packages for CEOs. But what about the rest of a company's top echelon of executives -- the CXOs, VPs etc.?
Steven Pearlstein: At the very top, most of those salaries are set in part by referencing the CEO compensation. So if the CEO pay is bloated, so will the other top members of the team. Once it gets down below executive officers, I suspect the market is more efficient and open and prices are closer to being reasonable.
Falls Church, Va.: Bravo and well said. What's the answer? Seems like shareholders should be the ones to force change. But how is that possible given that institutions and insiders own the bulk of the shares in these companies?
Steven Pearlstein: The only way shareholders could force this is if there were genuine corporate democracy, which there isn't. Corporations run like Soviet Russia: there's one slate of directors and that's all you can vote for. The directors also make it a policy NOT to listen to shareholders or make themselves available to shareholders. So it's a closed system and there is really no way to break through other than to use an event to create enough of a big public hue and cry that you embarrass one set of directors to make a change in policy or management. But that's hard. The attitude of most directors and corporate executives is every bit as arrogant as it appears: if you don't like the company, sell the stock. That's why the shorts are more effective in forcing reform than actual shareholders.
Northfield, Minn.: The defense industry is one area where "industrial policy" concepts that were in vogue 20 years ago do in fact still exist -- that is, these corporations and their long-term investment decisions are basically driven by government policy decisions about which weapons to buy and how much to spend. Doesn't this give government some clout to say "wait a minute" on lavish salaries in at least this sector?
Steven Pearlstein: Precisely -- and I'm sorry that that was another point I wasn't clever enough to fit in this morning. This is an industry where the ups and downs of sales are largely determined by the government, no matter how good or bad the CEO is. Most of their products are monopoly products, and the only question is how many the Pentagon is going to buy. Their R&D is financed by the government, as are many of their big facilities like shipyards and tank plants, so they need very little equity relative to debt. This is not to say running these companies is a breeze and not to say that some times they can get caught out with some big losses and write-offs. But by and large, the competitive environment is less intense than other industries and there is a lot that happens that is outside control of the company and the CEO.
Washington, DC: Do you suppose that Vice President Cheney, he of the $30 million Halliburton bonus, might take the lead in an administration task force to investigate the question of excessive corporate compensation at the expense of shareholders?
Steven Pearlstein: I want to be very clear about my opinion on this because I've already got a ton of email on the subject: I don't think it is a good idea for the government to get in the business of regulating executive compensation. The last time we tried, setting limits on deductibility of riskless pay like salary, companies responded by loading up the pay packages with stock options which were deductible because pay was at risk. I don't think the results, while unintended, were the ones we were after. I'd say the best antidote to this is full disclosure and lots of ragging by the press and the public and the academics until one day they finally get the message and do the right thing on their own. Call me an optimist -- and a skeptic about this type of government micro-regulation.
Pfafftown, N.C.: I am an individual and a 30 year veteran of following and investing in the stock market. Recent years of CEO pay and executive stock options have caused me to withdraw from any further investing in common stocks. I believe these options dilute shareholder equity and investors are losing and executives are getting rich quick. Is my thinking an exception? If not, what will be done to correct this perception and restore investor confidence in capital markets?
Steven Pearlstein: What needs to happen is that some companies break from the pack, adopt more reasonable pay schemes and show they can beat the pants off the companies that stick to the old model. Their stock prices climb, along with profits, and the market forces the others to adopt this as a "best practice." In short, there needs to be more Berkshire Hathaways. Buffett can't do it alone.
Alexandria, Va.: Indeed you would not accept the "everyone does it" argument from your eight-year-old, as you wrote today, but the problem of excessive CEO salaries is harder: as long as some firms are overpaying, others will have to do the same or have retention problems.
What is the remedy, would you guess: legislation putting tax or other disincentives on corporations who do it? More aggressive oversight by large institutional investors? A late awakening of shame by top CEOs?
Steven Pearlstein: You raise an interesting point, that this is a classic "commons problem," in which everyone knows what the right thing to do is but nobody is willing to do it unless everyone is made to. Otherwise, doing the right thing will mean that your CEO gets picked off. What I'd say on that is that your CEO won't get picked off until he or she has proven that she can deliver great results for an extended period of time. And if that means you lose your great CEO's every five or six years and have to find another, my guess is that might be a pretty good outcome, because change is a good thing. Also, even in such a competitive situation, a company can raise the pay by 20, 30, 40 percent and retain the executive and still be below today's outrageous levels if you start somewhere in the reasonable range. What is reasonable, you ask? I'd say a million in base pay, a million in potential bonus (based on business, not stock market, metrics) and a million dollars in restricted stock (not options)that can only be cashed in if you remain with the company for some defined period of time, and then only at the time of retirement as CEO.
Arlington, VA: Airline executives are some of the biggest offenders these days of raking in lavish executive compensation packages, while thousands of their employees have been laid off and their companies are suffering. What do you make of the decision of Delta Airlines execs and others who have had no qualms reaping fat paychecks? Should their bonuses be repaid if the airlines take on federal aid packages?
Steven Pearlstein: Frankly, I don't think the airlines are the big offenders here. Some CEO's took voluntary pay cuts early on. And none of them are getting big bonuses, that I can see. Stock and stock options, obviously, are virtually worthless right now for most of the majors.
Washington, DC: So, in your first answer to "Alexandria's" question about market forces, you're basically saying that the market has set the price of CEO salaries. If that's what the market will bear, why should investors get so outraged about these pay packages?
Steven Pearlstein: The market has indeed set the price for CEO pay but it is a market that is characterized by imperfect competition, which means that the price really isn't reflective of value. In a sense, it's a rigged market because of how CEO's are recruited. And it's rigged because compensation committees are still indirectly beholden to the CEO and have almost no incentive to drive a hard bargain on behalf of the corporation, even as the corporation drives a hard bargain with most of its other employees. There are lots of good and talented people out there who could be good CEOs and would be willing to do the job for much less, but they are never given the chance even to compete for these jobs because they are incorrectly labelled as not having the qualifications. That's what needs to be changed before you can say that the prices are "right" because they are set by a "market."
Gaithersburg, Md.: What do you think of the AFL-CIO's executive compensation project?
Steven Pearlstein: It's making an important contribution to this ongoing debate, but it won't succeed unless other institutional investors join in with it. Otherwise the corporate types will simply dismiss it as those union agitator types.
Frederick, Md.: Isn't it the case the MBA programs include courses on business ethics? Isn't excessive CEO pay an ethical issue, one that should be discussed by the future business leaders of America?
Steven Pearlstein: I actually don't think it should be viewed as an ethical issue so much as an economic one. It's not a question of fairness. It's a question of paying more than you need to and wasting investor money and distorting the pay scale and expectations of everyone else and building up resentment among your employees. The only ethical component is that we are offering these guys such big rewards based on company "performance" that they are encouraged to cut ethical corners.
Omaha, Neb.: Is there a publication or Web site where one can go to look up current CEO compensation for each publically traded company? I would like to know before deciding to invest in a company.
Also, will the Enron executives ever be held responsible for their fraud?
Thank you for keeping this issue alive.
Steven Pearlstein: There probably is a Web site, but I don't know it. Eventually, BusinessWeek and other publications will publish a complete list once all the proxies are out (there is an early list in this week's issue of Business Week). Maybe the AFL-CIO project is doing it.
Arlington, Va. : Who's to say what is outrageous? Are you saying that the three executives you mention engaged in "the games corporate insiders routinely played to enrich themselves while hoodwinking investors" or have had their judgment and ethics warped?
Steven Pearlstein: Corporate insiders hoodwink investors by peddling the notion that these pay packages are what are needed to attract, retain and incent top talent. That is false. And the packages offend the sensibilities of a wide swath of the investing public. That is also a fact. Who's to say the pay packages are outrageous. Obviously, everyone is entitled to have an opinion in a free country, and newspaper columnists get to publish their opinions in the newspaper, along with others.
Alexandria, VA: You must know a fair number of corporate CEOs. Simple question: How do they live with themselves taking salaries so much higher than their workers, especially when often their bonuses are a reward for "restructuring," which often translates to big layoffs?
Steven Pearlstein: Restructurings are a necessary if distasteful part of the process of creative destruction which underlies American style capitalism. Well-done restructurings are, in the long run, a benefit of the remaining employees, investors and the economy as a whole by making the company and the economy more productive. It's how we get richer over time. Good companies try to take some of the savings for those who are laid off, helping them over the transition in various ways. But it won't really help those who are laid off if the CEO is paid less. The CEO should be paid less, in fact, if he or she doesn't take the painful restructuring steps that may be necessary.
Herndon, Va.: Can you name a single scandal-less Fortune 500 company where directors and CEOs were "punished" by shareholders for excessive compensation packages?
Steven Pearlstein: Tyco International. All the directors are gone, as are the top executives. But this happened only after the full extent of the looting by the top guy was uncovered by the Manhattan District Attorney. Before then, the investors seemed content to go along with the outrageous pay packages because the stock was doing so well.
Washington, D.C.: Is this a problem that politicians SHOULD be seeking to solve?
Steven Pearlstein: No.
Washington, D.C.: Mr. Pearlstein. What's your roadmap to fixing the problem that you describe so clearly in your column? In your reply to Northfield, Minn., you didn't answer the second part of his question, which is: If these companies are so beholden to Uncle Sam for their bottom lines, can't the good uncle do something about their ridiculous pay packages?
Steven Pearlstein: Again, not all problems are amenable to a government solution and this is one of them. Sorry about that. Public persuasion and shareholder activism are the way to go here, as uphill a struggle as that is.
Washington, DC: I disagree with your assertion that the government can't help here. Yes, past attempts failed. But look to the 19th century when the first real corporate reforms were enacted -- those were successful to some extent in protecting shareholders. I don't know what can be done by legislators, but I imagine that the issue of stock options could be addressed without setting strict mandates on real salary levels.
Steven Pearlstein: Stock options might be discouraged simply by adopting the accounting reforms that have been talked about, requiring companies to deduct the "value" of options at the time of issue as a business expense, thereby reducing corporate profit. I don't want to get into that debate here. But that would surely discourage excessive use of options. But don't be surprised if companies don't shift from options to some other kind of tax-advantaged compensation. I'm sure there are consultants working on that as we speak.
Virginia: I work for a corporation where the bosses/directors make good money. They recently cut some jobs. They did it at the very bottom. People are scared. WHY didn't they act decently -- if each director cut ONE HOUR of their time they would save the same amount. This gives the worker bees a clear message: you are nothing; your job is vulnerable. These are truths, but there are ways to save a bit of money without alienating everyone who works there. But we know, it's all about the top people anyway.
Steven Pearlstein: As I said, I think these are separate issues. If the execs and directors can be got at a cheaper price, they should be. And if companies have way to do the same amount of work with fewer people, they should do so in a humane way. These are separate analyses.
Arlington, Va.: You raise a GREAT issue in reply to an questioner -- who said corporations need the same leaders year after year? Our founding fathers had a brilliant idea a long time ago to require lawmakers to stand for re-election, and we now limit presidents to two terms. But this point is never raised in MBA programs, to my knowledge. Fresh blood and new ideas work.
Steven Pearlstein: Thanks.
Gaithersburg, Md.: Thank you for your article, but some of your points don't make sense to me. First, people have hoped for decades that corporate directors might voluntarily change their attitude regarding executive compensation. But directors have not taken and will never take this initiative because they are managers themselves who have a personal, vested interest in maintaining (and even reinforcing) the status quo of inflated compensation packages. The system is monopolistic, incestuous and corrupt.
Second, you say that "bloated pay packages...warp the values of the larger society." Right on! But then you say that "these are lessons that corporate directors have yet to learn." Excuse me, but corporate directors don't give a damn about larger society, nor should they - their responsibility is to maximize the return for shareholders, period.
If executive compensation is going to be reformed, then the incestuous, corporate governance insiders have to be dealt with like a monopoly (which is what they are). Investors and regulators have to break them up.
Steven Pearlstein: That's a good column you wrote there. Want a job? My only quibble is with your last line: investors should break up the monopoly but I'd be careful about the regulation part. Sarbanes-Oxley made a stab at this by requiring more outside directors. And the NYSE took the step of requiring that outside directors meet regularly without management present to talk, among other things, about compensation. The Conference Board's Blue Ribbon Commission recommended that the job of chairman not be filled by the chief executive, to encourage the board's independence. But in the end, this will only be solved if the directors change their view and discover some backbone. I'm not sure you can regulate or legislate that, but you CAN embarrass directors into doing the right thing.
Bethesda, Md.: I often hear about 'social investment' funds that are eco-friendly, labor-friendly, etc. Do you know if an particular funds are basing their investment decisions in part on CEO compensation?
Steven Pearlstein: Some have begun to use a governance screen that may or may not contain a pay component. But usually it is only a screen to make sure pay varies with performance. It doesn't set a limit on what the baseline level of pay should be.
Baltimore: I have this feeling that you're right about the government not being able to fix this. I'm sure that the CEOs would hire lobbyists to influence any legislation or regulation to the point where it would cause more harm than good. It could give them an excuse, "I'm not overpaid according to the government"
Steven Pearlstein: Precisely.
Charlotte, NC: My big complaint is with the "golden parachute" severance packages. It encourages CEOs to take excessive risks that can destroy or weaken the company. If they're wrong the Board fires them, but they walk away with huge severance. It should be the same severance rate for all employees!
Steven Pearlstein: You've got that right.
Bethesda, Md: You made a great point about how boards do not want to take any risk by naming a CEO that doesn't have all the usual credentials. Do you feel as though they should take more risk by choosing CEOs with less experience? The Washington Post seemed to do well by picking a 28 year old to run the Kaplan division.
Steven Pearlstein: The Post did score a big one with the Kaplan guy. As for criteria used to screen CEO candidates, my sense is that they are much too rigid and inflexible and conventional. Experience is only one area where this is true.
Bethesda, Md: Where do compensation consultants stand in this? Are they being paid by the board or by the CEO (who is usually the Chairman of the board anyway)?
Steven Pearlstein: They should be hired by the compensation committee, which is made up exclusively of outside directors. In reality, I suspect the committee relies on corporate employees to solicit the consultants and engage their services. The real problem is that there are only a handful of consultants who are considered safe enough to be used by the Fortune 500 (remember, these directors are very risk averse)and they all pretty much sing the same tune when it come to pay levels. They are an integral part of the problem.
Washington, DC: You say on the one hand that market forces -- imperfect market forces -- set CEO salaries so high, then you say later that corporate boards have basically lied to shareholders about the "need" for high CEO pay. Which is it? The latter argument to me seems more diabolical than the former, which I happen to agree with.
Steven Pearlstein: I mean them to be the same point. The corporate insiders know the pay is higher than it needs to be, but they put our reports from compensation committees that assume the efficiency of the market and then go on to demonstrate with mathematical precision how the pay package is at the 54.89 percentile of the relevant peer group.
Let me raise another point which I should have in the column. What set of board of directors would ever tell shareholders that they want their CEO to be paid in the bottom half of the company's peer group. None. So what that means is that every corporation insists on having a CEO whose pay is above average. This is the Lake Wobegon effect. And what it means is that CEO pay is always being ratcheted up by companies seeking to avoid the bottom half, even though we know as a matter of mathematically certainty that only half the CEOs can actually be in the top half.
Herndon, Va.: So your answer to my question is actually 'No.' There are no above-board Fortune 500 companies that you know of that are taking the lead on this issue, trying to set an example for the rest of the pack. It's just the ones that got caught, like Tyco, that are cleaning themselves up.
Steven Pearlstein: Berkshire Hathaway is trying to set an example. So is the Washington Post, although I'm not sure that is the best example, since the CEO and his family own so much of the voting stock.
Arlington, Va.: Thanks for answering half of my question. But you didn't say if you think Chabraja, Coffman and Kresa have warped judgment and ethics.
Steven Pearlstein: I have no reason to doubt their ethics or judgment at all. I do doubt the wisdom of their directors in paying them so much. It seems to me you have taken a sentence from one part of the column and juxtaposed it with some examples that were chosen randomly. It's not a juxtaposition I would have done. Having said that, I don't think anyone can disagree that one of the lessons of the corporate scandals is that excessive corporate pay can warp judgment and ethics. Just because it doesn't happen in every case doesn't mean that it's not a problem.
Young Company Exec: Mr. Pearlstein, Do you think that, ironically, it is public shareholding, as opposed to private, small, family, or employee-owned businesses, that invite this type of massive pay discrepancy? I pay myself less than market wages, I do that so I can pay my people truly good wages, and hang onto them in bad times. Our focus is our people and our product, not an analyst on Wall Street or share-price.
Steven Pearlstein: An good point eloquently made.
Washington, DC: What are top salaries like in the news industry? Do senior news executives earn way more than the working reporters? Is the gap growing? Is this an issue in the newsroom?
Steven Pearlstein: The gap between the average pay and the pay of top performers is growing in almost every industry, including the news business. The gap between the executive pay and average pay is probably also growing, although not that fast. It is an issue in the newsroom with those who are at or below average, for obvious reasons. This reflects the general weakening of unions and a change in the societal values. As a country, we are simply more comfortable with a greater amount of income inequality as long as it reflects genuine differences in performance or market demand. This comfort zone, however, is not infinite. At some point, the differences will get too great and the pendulum will swing the other way.
washington, DC: There is a great site for people who want to do research on executive compensation:
It is the AFL-CIO's project on executive compensation.
Steven Pearlstein: So there you go.
Langhorne, Pa.: Hi Steve,
I enjoy your column. This is an issue that disturbs me tremendously! I don't understand why people aren't out in the streets over this! Disgusting, dishonorable practices and people are seemingly entrenched in most of our corporations. Mr. Buffet has written of his unhappiness with CEO pay practices, as well as Mr.McDonough. What can we as both citizens and shareowners in these corporations do? What is the best, most viable course of action? I find these corporate "pigs at their troughs" totally repugnant and reprehensible. The inequality in income as well as educational opportunities for the "non-pig class" (because of high, unjustifiable costs) have almost completely undermined our democratic way of life, in my view.
On a personal level, can you give me any advice on possible careers, working on issues such as this. I am in mid-life, but single and energetic, fairly unencumbered, and still idealistic. I have a B.S. degree in the social sciences, but have not yet been employed in that field.
Thanks for doing such a good job, especially for your work on this subject.
Steven Pearlstein: Thanks for your comments. Well put. I meant to get the word piggy in the column somewhere, but it slipped my mind. Alas, however, I don't give career, love or investment advice.
Steven Pearlstein: Thanks folks. It's been fun.
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