“It is a notorious fact…that the typical American stockholder is the most docile and apathetic animal in captivity” – Ben Graham1
All attempts to reform executive compensation have been completely useless in the 21st century. The march higher continues unabated at a compounding rate that would make Bernie Madoff proud.
The problem is that all battles to curb it, have been reactionary (not to mention tepid), say by voting “no” on a specific corporation’s CEO’s pay package for a given year. Here’s a perfect recent example:
“Chorus” that’s a perfect description of this toothless fight. And what was the result of this chorus?
“In a largely symbolic vote, 38% of GM shareholders rejected a compensation plan at the automaker.”
Also, all twelve of the company’s candidates to the board were elected by shareholders with each receiving 96% of the vote.
The measures currently being used are the equivalent of using a thimble to put out a major forest fire – completely inconsequential. The ability of corporate boards and executives to consistently end run these efforts, say by reducing a bonus by a million or two in a contested year, only to see it spring back in spades going forward, has given rise to Matt Levine’s first meta-rule of executive pay: “All executive-pay rules have the effect of increasing executive pay.”
Instead, it is time for shareholders to first put forth a systematic process to determine executive compensation. Furthermore, it’s imperative that they set the narrative by putting forth a plan that by any other standards is overly generous. With that in mind, here’s what I propose.
First of all, a hard cap on total CEO compensation of $10 million a year2
‘Gee willikers, that’s a lot of money!’ Yes, by any measure but the current warped one it is. Yet there’s more to this proposal, and it gives the CEO a way for him or her to possibly increase the value of this bounty multiple-fold over the years. In fact, over the last twenty years, this twist is so generous, it would have allowed even an ‘average’ CEO the chance to double his compensation. Best of all, there is probably no other employee at the company who will have a greater influence on effecting the outcome of this opportunity than the CEO.
Second, all compensation over $1 million a year must come in the form of company stock, which the CEO cannot sell a single share of until two years after she’s fully given up the reins. Anyone unwilling to accept this will have to explain to all how they are unable to live off of a million dollars a year.
Hypothetically then, taking the midpoint of the $10 million hard cap, a CEO would receive $1 million in cash and $4 million in stock. Over five years then, he/she would have received $20 million in stock. Do I hear any complaints so far? How about worries about being able to find excellent candidates?
If not, then let’s move on to another possible whine: “With a whopping $20 million in stock being retained, the CEO would be too heavily concentrated in his personal portfolio,” a rationale cited by many current CEO’s, or more likely their corporate flacks, when they sell company stock. This might be one of the most laughable claims in the history of capitalism. Does your local dry cleaner or most other private businessmen get to regularly sell some of their business and de-risk?
Absolutely not, and that’s exactly the reason for this clause: because with so much at stake, the CEO will think and make decisions like the owner of a business. Silly acquisitions, huge leverage or excessive cash on the balance sheet, share buybacks at market highs and lack of them at market lows, all of this would be decided by someone with considerable skin in the game and in it for the long run.
As for that ‘twist’ and the ability of a CEO to double his compensation. The market has averaged a 7% annual return over the last twenty years. At that rate the average stock doubled every ten years – as good a number as any for the tenure of a CEO. More importantly, if he’s a good CEO, his returns and effectively his compensation should be higher, and if he’s a great CEO then her compensation could be through the roof.
The key is that it’s all determined by the effects of stock appreciation over the long term. Unlike the current charade of a system, there are no outs. Best of all, the CEO is the employee in the strongest position to create her own destiny.3
Finally, in case you were feeling sorry for the extreme slashing to a CEO’s comp, there is one supplemental bonus for her in addition to their $1 million in cash comp and ~$4 mil in stock. That average stock return of 7% was net of dividends. Were a CEO to be in office for ten years, the average annual cash dividend he’d receive would be $400,000 a year4. Not too shabby?5
IN order to justify the plan above, there is only one question that must be asked “Can we not find excellent, fully qualified people to run these companies for $2, $5, $10 million dollars a year?” It’s time to find out.
Ok, we’ve given you the ‘Why’ for compensation reform and a very rough outline of what it should be. Next up is ‘How’ we finally break through and put it in place throughout corporate America…
- He does what the board of directors tell him to do and rarely thinks of asserting his individual rights as owner of the business and employer of its paid officers. The result is that the effective control of many, perhaps most, large American corporations is exercised not by those who, together, own a majority of the stock but by a small group known as “the management.” [↩]
- $10 million would be for CEO’s of the very largest corporations, and it would scale down from there using various metrics. No reason to get bogged down now in exactly which ones to determine who gets what. Using market cap for example, the 15 largest companies by that measure comprise almost a quarter of the value of all U.S. equities, so let’s say those 15 get the $10 mil, and it scales down from there, the universe of CEO compensation for say the top 1000 publicly traded companies would show that the median very well may be lower than $5 million. [↩]
- Sure, a CEO’s ability to influence both the success of the business and his chosen industry are not omnipotent. Yet just like a private business owner, the CEO can choose to join up with a given business and go into a given industry [↩]
- Using the average dividend of the S&P 500 of 2%, times $4 mil a year in stock, over ten years; or, starting w/ $0 in year one and $800k in year ten, yields an average of $400k per year [↩]
- Except once again by today’s standards. Where have we come to where $400k a year for an individual is piffling? [↩]