Pressure from institutional investors to rein in executive compensation and pay-related reforms—such as expanded disclosure requirements related to compensation, deferred compensation legislation, and new rules regarding the expensing of stock options—apparently have yet to translate into lower CEO pay at most public companies, according to a new report.
On the contrary, the study—by governance watchdog The Corporate Library—claims that many CEOs unjustifiably pocketed outsized salaries. “Far from demonstrating any restraint or reining in, CEO pay growth doubled in 2004,” states The Corporate Library’s CEO Pay Survey. The analysis reported the median increase in total CEO compensation between 2003 and 2004 was 30.2 percent, significantly higher than the prior year’s 15.0 percent jump.
Hodgson
“While I expected it to go up, I was surprised by the level of increase,” the study’s author, TCL senior research associate Paul Hodgson, told Compliance Week. “I wasn’t expecting the median increase to be double the level it was last year.”
For the average increase in total CEO compensation, that number climbs to 91.2 percent, driven in part by 27 CEOs who received increases of more than 1,000 percent. The data is based on a matched set of 1,522 CEOs who were in the job for all of 2003 and 2004.
Total annual compensation rose by a much smaller median of 11.8 percent. That’s evidence, according to the report, that growth in the incidence and value of long-term incentive pay outs—such as restricted stock awards, profits from the exercise of stock options, and other long-term payments—are primarily responsible for CEOs’ soaring pay. “While some of that increase was influenced by the CEOs who received increases over 1,000 percent, the median increase still came in at 30 percent, which is pretty substantial,” said Hodgson. “That says that there are a lot more CEOs who got significant increases than that received decreases.”
“My impression of the trend is that none of the potential changes in the pipeline that could affect CEO pay levels—such as an increased level of independence among directors and moves away from stock options—are taking effect yet,” Hodgson said. “There may be changes in the pipeline, but they take a long time to filter through at companies.”
Adding Substantial Value?
Although total compensation increases among S&P 500 CEOs continued to outpace those of their small-cap and mid-cap company peers, pay growth among smaller companies has begun to catch up, the survey noted. The median total compensation increase for S&P CEOs was 33.9 percent, compared with 28.4 percent for those outside of the index. But the gap has narrowed considerably from last year’s median increases of 22.2 percent for S&P CEOs and 13.1 percent for those outside of the index.
And while many companies purport to have pay for performance systems, Hodgson said companies “have a long way to go in order to tie very large increases in pay to obvious value delivered to stockholders.” The report includes an analysis of the pay of the 10 S&P 500 CEOs who received the largest increases in total compensation.
As part of that analysis, the study looked at “a return on invested capital measure over the five year period from 2000 to 2004 to see if, at the same time as taking substantial reward out of the company, CEOs have ensured that they have added substantial value.”
The report noted that only two of those ten companies, Micron Technology and National Semiconductor, “has any kind of real long-term performance data. For the rest of the companies, there is no attempt to explain or justify what are very, very substantial stock option profits and other long-term incentives awards.”
Six of the 10 companies underperformed their peers in the area of stock price growth over the five year period, and another marginally underperformed its peers, according to the report. “Had these CEOs received indexed stock options—stock options whose exercise price rises up or down in line with the price performance of a chosen peer group—then they would have made nothing from these stock options,” the report said, adding, “A better case for the adoption of indexed stock options could hardly be made.”
The report concluded that only five of the 10 CEOs who received the highest increases received them “with any kind of justification.” Extrapolating the findings to the full sample “would indicate a very poor correlation between long-term performance and long-term incentives.”
“There still isn’t enough being done in terms of a proper linkage between long-term pay and long-term performance,” said Hodgson. “There continue to be movements afoot, but they all take a long time to spread through the majority of companies. It’s a long, slow process.”
“The study of the top 10 companies suggests that there isn’t really any correlation between value and pay,” Hodgson told Compliance Week.
In addition to changes in long-term incentives, Hodgson said, “Given the number and level of severance payments made to some CEOs who’ve lost their jobs, severance payments need to be addressed and brought down too.”
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