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Extravagant CEO pay is back
It appears that excessive compensation for top executives is as rampant as ever. We look at five companies that lavish an average of $55 million a year on their chiefs.
By Michael Brush
From Walt Disney to Hewlett Packard to AIG, heads are rolling in executive suites across corporate America.
But for those CEOs keeping their jobs, there is some good news: Excessive pay for the top brass is making a comeback.
That may not be such hot news for shareholders. Savvy investors flag hefty pay packages because they can be a sign of weak boards that are too cozy with management and not looking out for shareholders.
One component of CEO pay, bonuses, last year hit its highest level in five years, rising 46.4% to a median of $1.14 million at the top 100 companies excluding brokerages, according to a study by Mercer Human Resource Consulting for the Wall Street Journal.
With the help of the Corporate Library, a Portland, Maine, group that evaluates how well boards look out for investors, we've identified five companies that were extraordinarily generous to their chiefs this year. These CEOs' average pay in 2004: $55 million.
It appears to me that 2004 was another year in which investor concerns about executive pay levels are being completely ignored, says Paul Hodgson, who works with the Corporate Library.
Pay one CEO, or 3 federal branches
Topping the library's list of the highest paid execs was George David, the chairman and chief executive of United Technologies (UTX, news, msgs). The boss of this aerospace and building-systems company pulled down a cool $88.7 million in 2004.
What kind of firepower can you buy with $88.7 million these days in the market for CEOs?
Heres one way to think about it. David pocketed just a little less than the $89.1 million we pay all the top executives running the three branches of our federal government. In other words, for around the same amount United Technologies shareholders paid for their CEO last year, taxpayers got: One president, a vice president, 535 lawmakers on Capitol Hill, and nine Supreme Court justices.
Related news and commentary on MSN Money
Davids pay includes a base salary of $1.2 million, an annual bonus of $3.5 million and gains of $83.6 million from cashing in options.
Who else pulls down the big bucks?
Robert Toll, the chairman and CEO of Toll Brothers (TOL, news, msgs), a successful homebuilder, got $50.2 million. That included a base salary of $1.3 million, an annual bonus of $30 million and cashed-in options worth $12.3 million.
Bruce Karatz, the head of the homebuilder KB Home (KBH, news, msgs), earned $50.1 million. Outgoing Qualcomm (QCOM, news, msgs) chief Irwin Jacobs and Morgan Stanley (MWD, news, msgs) boss Philip Purcell round out the list. Jacobs earned $44.44, Purcell $40.5 million. A good chunk of each total came from cashing in options: $26 million for Karatz, $41.3 million for Jacobs and $18 million for Purcell.
Worth every penny?
Might these executives really be worth the money? Thats a sensitive subject. I have been in a lot of meetings with CEOs, and whenever the topic of their pay comes up, it is always very awkward. Everyone braces themselves in the room, says Christy Wood, the head of global equity for the California Public Employees' Retirement System (CalPERS).
Like many investment groups, CalPERS looks closely at CEO pay as it reviews the quality of corporate governance at potential investments -- a term used to describe how fair the legal structure of a company is towards its owners, the shareholders.
When asked, our five companies with the priciest execs were all quick to say their CEOs are worth every penny. The reason: They turned in great performances on behalf of shareholders.
United Technologies is a good example. The stock has risen 74% since I told readers to avoid it in early October of 2002 because of several ticking time bombs in the accounting that, in reality, never went off. The S&P 500 advanced only 43% in the same time frame. Since David became CEO, United Technologies stock is up 672% -- compared to 212% for the S&P 500. So why shouldnt he be rewarded handsomely?
KB Home offers a similar defense. The company has met or beaten Wall Street expectations for 38 consecutive quarters. And its earnings per share have grown at a 38% compound annual rate for the last 10 years. The stock is up fivefold in the last twelve years, and it doubled in the last year.
The price tag for performance
But there are some problems with this we deserved it defense.
First of all, there is no rule that says shareholders have to pay tens of millions of dollars a year to get a CEO who produces solid returns. The fact is, there are companies out there getting great performance from CEOs and paying a lot less, says the Corporate Librarys Hodgson.
Look at Costco Wholesale (COST, news, msgs), says Hodgson. The retailers stock is up 60% in the past two years. But Costco CEO James Sinegal earns $558,000 a year -- which looks like pocket change compared to the multiple millions of dollars our top-paid CEOs get. Sinegal is sitting on $22.6 million worth of exercisable options, which he has accumulated over more than a decade as CEO.
"I feel like I have been well rewarded," says Sinegal. He thinks keeping a lid on CEO base salary and bonus sends a signal that all employees are important. "If the CEO of a company is paid 10 to 12 times the highest hourly rate, that is probably pretty fair."
Heres another reason you might think these high salaries are defensible. Companies with the gold-plated CEOs like to point out that almost all of their pay comes from bonuses linked to stock performance. Since they made the stocks go up, why shouldnt they enjoy the gains? This is true to a point.
But the logic breaks down when you compare how much more these pricey execs make to the amount of excess performance they helped bring about.
Take United Technologies, for example. On Davids watch, he helped produce stock gains three times the returns for the S&P 500. Thats commendable, no doubt. But his $88.7 million in compensation last year was 19 times the median CEO pay package of $4.43 million at S&P 500 companies in 2003. On average, from 1996 to 2003, David earned $21.1 million per year. Only in his first two years as CEO, in 1994 and 1995, did he get anywhere near the recent S&P 500 median. He earned $1.9 million and $2.3 million in those two years.
KB Homes return on invested capital is around three times that of the S&P 500, an impressive feat. But KB Home chief executive Karatz earned 11 times the pay of the average CEO of a company in the S&P 500.
Morgan Stanley chief Purcell earned way more than his peers in the brokerage sector last year. But his brokerage had the lowest average quarterly return on equity over the last eight quarters, says Douglas Sipkin, an analyst with Wachovia.
Our top five highly paid CEOs made $55 million last year on average, or 12 times the median pay package for S&P 500 execs. It does seem high, says Wood, at CalPERS. The fundamental problem here is that all other inputs seem to be geared towards low cost, except labor. If they were looking at real estate or computers, they would want to pay low price. But for some reason, we have indoctrinated ourselves that it is OK to pay high cost for labor. Particularly when the laborer sits in a corner office.
Morgan Stanley argues that Purcells pay was not out of line because he got less than the CEOs at other top brokerage firms, like Goldman Sachs (GS, news, msgs), Bear Stearns (BSC, news, msgs), or Lehman Brothers (LEH, news, msgs). This is true if you ignore options.
But include his options and Purcell earned much more than the others. The CEOs at Goldman, Bear Stearns and Lehman got $29 million, $28 million and $24 million last year, compared to Purcells $40.5 million. Besides, Morgan Stanleys were no worse than everyone else defense falls flat since all these brokerages get low grades for executive pay, according to the Corporate Library.
What it all means for investors
Excessive pay -- anything more than 20% above the mean at similar-sized companies, according to the Corporate Library -- pulls down the library's corporate-governance ratings for companies. So do things like takeover defenses, because they may entrench boards, or too many business ties between board members and the managers, or the company, they are supposed to oversee.
But can these corporate-governance ratings really help you make money as an investor? Theory holds that companies with good corporate governance may be better investments because their boards are more likely to be working for shareholders since they are not too cozy with management. Indeed, companies with Corporate Library grades of A or B for governance do better than those with a grade of D or F, says the Corporate Library.
But I wouldnt rush to sell a stock because it had a grade of D or F -- like these five companies whose marks were torpedoed by their huge executive pay packages. Instead, it makes more sense to look at a rating like this as one factor among many.
An 'A' for effort: Giving $19 million back
And even though these five companies get low marks for corporate governance now, you have to give them props for taking steps to improve their ratings.
Robert Toll, the CEO of Toll Brothers, recently took the unusual step of voluntarily cutting his 2004 pay by $19 million, as his stock-incentive plan would have paid him even more than he got last year. His scaled-back incentive plan also covers the next three years.
And Morgan Stanley recently decided its CEO would get no incentive pay if return on equity is less than 10%.
Qualcomm, which says its outgoing CEO cashed in so many options last year in part because many were set to expire, recently asked shareholders to eliminate a takeover defense. Surprisingly, shareholders rejected the proposal. The bottom line: As with any stock grading system, you have to look at whats behind the grades, and look at the big picture, before making the call.
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