Mar 20, 2007

Are CEOs Overpaid?

Not if they create great value for their shareholders. Here´s why:

The controversy over CEO pay will continue to heat up as corporations announce their CEO´s pay according to the new transparency tables mandated by the SEC. That´s a good thing. But we need to distinguish between CEOs who create value for their shareholders over the long-term and those who destroy it.

What really upsets me is the number of CEOs who destroy shareholder value and walk away with tens or even hundreds of millions of dollars for failing. Remember Bob Nardelli´s $210 million payout for his failures at Home Depot? Today´s poster child for an overpaid CEO is John Antioco, who presided over Blockbuster Videos´ loss of market share to Net Flix and led his company into the red during his ten-year tenure. Why did the board sit idly by as Antioco´s failure to lead destroyed 75% of the company´s shareholder value over the past five years?

It took the election of a dissident shareholder by the name of Carl Icahn to get the board to act. And now they have acted responsibly in using “negative discretion” to reduce Antioco´s contractual termination pay from $21 million to $8 million. My question is this, why did the board fail to act until pressured by Icahn? Why did Antioco have a contract that guaranteed him termination payments in the first place? I have served on the boards of some of America´s leading companies, and none of their CEOs, myself included, have contracts. They serve at the pleasure of the board, which in turn is elected by the shareholders to protect their interests, not those of the management.

Contracts for CEOs are the root cause for the inequities in executive compensation, precisely because they are designed to protect the CEO in case of failure. Of all people in the organization, the CEO should be the most at risk when the company fails to perform and the best rewarded when it succeeds, not the reverse that we have seen in recent months. First-line employees at Blockbuster and other companies have no contracts guaranteeing their jobs or their pay, so why should the CEO?

Some will argue that boards recruiting CEOs from outside the company have to guarantee their pay with a contract. That problem just highlights the real cause of the problem: when the board has to look outside its ranks for a new leader, it has failed in its responsibility to provide adequate succession for management. In other words, the board has failed to do its most important job in ensuring the company´s continuity of leadership.

In sharp contrast to Blockbuster´s failed CEO, look at these two examples from today´s news:

  • Delta Airlines CEO Gerry Grinstein, who shepherded the company through its reorganization to come out of bankruptcy, will not receive any severance, incentive payments or stock when he retires and a new CEO is chosen.
  • Ken Lewis, chair and CEO of Bank of America, one of America´s largest banks, received $23 million in compensation last year, only $1.5 million of it in salary. Too much? I would argue not, because he and his organization have performed so well for their shareholders. During the last five years B of A´s shareholders have been handsomely rewarded as its returns have been 2.5 times greater than the Dow Jones Industrial Average. Lewis exercises his stock option gains not to maximize his gains, but on a pre-programmed earnings basis.

The time is long overdue for corporate boards to “pay for performance,” not for failure. For increasing long-term shareholder value, not destroying. And for building succession into the ranks of management to ensure leadership continuity.

I welcome your comments and feedback to these ideas.