Deja vu All Over Again

Editor's Note:  Today's post comes to us courtesy of guest contributor Jacque Vilet.

The other day I came across an old file on executive compensation.  A lot of the material was written by or about Graef Crystal.   Crystal was the chief guru of executive  comp back in the 70’s and 80’s.  He was a consultant at Towers Perrin (now Towers Watson).  His clients were the Fortune 50.  He created most of the executive comp plans we know today. Since he left the consulting world, there have been new bells and whistles added, but the basic plans still remain.

In 1987 Crystal went through an “epiphany” of sorts and did a complete 180 in his thinking.   His book, In Search of Excess was published in 1991-- part expose, part call for reform.  Since then he has been a researcher, lecturer and writer on the abuses of corporate executive compensation.

Re-reading his material made me wonder whether executive comp has changed much in the last 20-30 years. 

When Crystal started as a consultant in 1959, companies often paid CEO’s by formula:  A multiply of the average worker’s pay --- maybe 40:1.  He did a study in 1973 of major company CEOs and they were earning about 45 times the pay of their workers. In 1991, it was 140 times. In 2002 it was just a little bit south of 500 times.

Crystal says the train began to come off the tracks in the late 70’s when compensation consultants began marketing CEO compensation surveys.  From then on, CEO pay was determined by what other CEOs were paid.  

Crystal would ask companies:  “Where would you like to position your CEO? At the average, below the average, or above the average?”  Well, one-third of the companies said, "We want to position our CEO in the top 25 percent, that way we can get better talent." Two-thirds of the companies said, "We want to be at the average." Not one company wanted to be below the average.   If one-third of the companies are chasing the top 25 percent and two thirds are chasing the average, that average becomes essentially uncatchable. Every year, what do you know? We're behind again.

Companies began trumpeting stock options as the way to link executive interest with shareholder interest. Yet some of these same companies thought nothing of letting their executives swap old option shares for new, lower-priced shares when the market took it on the chin. So much for the linkage between executives and shareholders.

Critics and supporters of CEO pay practices agree on the principle of pay for performance.  While everyone can rally round paying for performance, in a rational world that implies risk taking: The CEO's fortunes should rise and fall with his company's. But at many corporations, the board has adopted only half the principle. The CEO gets a terrific reward when the company does well -- pay for performance, see? -- but he still gets a pretty good reward when it does badly.   And if the CEO does really badly, then he is fired and takes home a phenomenal severance package usually worth millions.  

In 2009, Crystal analyzed the pay of 271 chief executive officers. His findings? "Simply put," Crystal says, "companies don't pay for performance.  Just about all the rational factors you can think of, taken together, don't play a big role in determining CEO pay, and some factors that you might expect to influence it, or that ought to in a perfect world, don't matter at all.”  The whole system is over-focused on competitive pay entitlement and under-focused on performance measurement and strong incentives.

Some of Crystal's former co-workers and clients have called him a Judas for criticizing the system he used to be a part of. He prefers to be compared to Mary Magdalene. "Maybe I was a hooker," he says. "But I'm hoping to end my life as a saint."

So back to my original question --- how much has executive comp really changed in 30 years?

What are your thoughts?

Jacque Vilet, President of Vilet International has over 20 years’ experience in International Human Resources with major multinationals such as Intel, National Semiconductor and Seagate Technology.    She has worked with both local nationals and expatriates and has been an expat twice during her career.    Jacque holds the CCP, GPHR and SWP (Human Capital Institute).  She is a member of WorldatWork,  Society of Human Resources Management and the Human Capital Institute.   She is co-chair of the Global HR professional emphasis group for the Dallas chapter of SHRM.  She is a regular contributor to HCI, HR.com and IHR Forum.

Image courtesy of compliancex.typepad.com

Comments

[Laura Schroeder]

Welcome and great post! I think you're right on about when executive compensation started getting out of control. And I don't think we'll see much change in the current setup. Maybe someone should start a company called 'Six Figure CEOs', offering qualified business professionals to run your company for 6 figures and no golden parachute.

[Jacque Vilet]

Hey right on! Would be great for people that are already billionaires and want to "give back".

[Dan Walter]

Thanks for the post Jacque.

It should be noted that the crazy increase in exec comp levels coincided with equity compensation's "Golden Decade" (1988-1999). Rules changes and a seemingly never ending bull market drove values to unsustainable levels. Unfortunately, even after the market corrected (in a couple of fits and starts) executive compensation did not correct accordingly.

The new paradigm was set and we have spent the past 10-12 years working in this new playbook. It will take a lot to get us back to the good old days of 30 years, where everything was already decried as out of whack.

Great post. Thanks

[E. James (Jim) Brennan]

Right on target. No change seen. Not for nothing did Bud title his first "independent" book as "In Search of Excess," when he began doing penance for his years misspent "making top executives permanantly wealthy." That last, by the way, was the mandate I received when joining the corporate comp HQ of a Fortune 50 way back in the Day when Graef (Bud) Crystal gave his same "the speech" each year at the AMA conference.

For perspective, a young (then) PhD and I researched the AMA ECS original exec pay data for 1965, I think it was, which generated a disturbing article entitled "What Are Average and Above Average Salaries?". Even in the early 1970s, when AMA's ECS multiplied and divided logs instead of adding and subtracting them (that's statitistics talk) and thus overstated the actual market rates in their logarithmic formulae, they refused to correct their revealed errors: they responded that their customers preferred seeing their top executive pay LOOKing low against "the market," thus justifying ever-escalating executive enrichment schemes. SSDD. It's the Golden Rule.

[Jacque Vilet]

Wait til you see my article on Compensation Committees and BODs.

[Jacque Vilet]

Dan ---- you are more optimistic than I am.

Jim --- Bud taught my Exec Comp course in the certification program for ACA. I was in awe of him. Now . . . I would kiss his ring.

[Emily Chardac]

Great read! In 2006, the CEO to employee ratio was about 250 to 1. (http://www.epi.org/economic_snapshots/entry/webfeatures_snapshots_20060621/).

That doesn't suggest that the CEO is 250 times more intelligent, or 250 times more productive, or even talented than another person in the company. You're right: companies don't reward on performance, because if they did, exec comp would be different than we know today.

Companies have never been so profitable in history. The recession has hit the employees, but not companies. (I'm sure this can be debated. Ok, fine.) The the bottom line is that companies laid off thousands of employees, found a way to maintain efficiency, and not rehiring/replacing those salary lines because they figured out how to do without. As a result, CEOs are really getting paid the big bucks.

Makes me wonder if CEOs really have the shareholders' best interest in mind. Because the last time I checked, it's their own wallet that they are folding.

[Chris]

One important element - at least as I see it - that's completely missing in the broader conversation about executive compensation is ethics.

When executives are paid as they are, where is the ethical consideration for the fair treatment of employees? The environment? Shareholders? The public?

If a company improves its bottom line by laying-off thousands of people, exactly how did the CEO's "leadership" make the spreadsheets look better? Shouldn't the CEO and shareholders alike bear some basic, human resposibility for wrecking the lives of the people that got fired?

I think the answer should be a resounding, "yes." But then again, when the only measure of "performance" is bottom line thinking, we get exactly what we ask for.

[Jacque Vilet]

Chris --- the reality is that CEO's are not rewarded based on performance. The whole system is rotten. CEO's are paid based on market comparisons to other CEO's. If every CEO's pay is compared to everyone else's and no one is being paid based on performance ---- then what do you have? Pay that is not based on true performance of the company. All you have is a bunch of people trying to stay up with the pack.

The fact is CEO's do not have control over the market price of their company's stock. Things have changed drastically in the last 10 years. With globalization stock is impacted by many things outside the CEO's control. Also, the market is manipulated by fewer and fewer people ---- not like the good ole days when everyone participated and had an impact.

Bottom line --- there needs to be another way to measure CEO performance. But I doubt that will happen. Too much at stake.