Declare War On CEO Pay

By Will Ashworth | October 21, 2008 AAA

The $700 billion bailout's been covered ad nausea in the last couple of weeks, especially the part about the excessive compensation of Lehman Brothers (OTC:LEHMQ) CEO Dick Fuld, who's managed to earn $480 million in just seven years.

Lawmakers on Capitol Hill grilled Fuld about how he could live with himself after running the once proud investment bank into the ground. How he's still CEO is beyond me. I guess somebody has to lock up and turn out the lights.

The Divide Is Growing
The CEOs of S&P 500 companies earned an average pay packet of $10.5 million in 2007, according to a research study by Faireconomy.org. That's 344 times the average American salary. Thirty years ago, executives earned only 30-40 times the average employee. It's gotten so bad that Americans now provide $20 billion annually in tax subsidies toward executive compensation, the study found. Companies deduct options-related expenses to the IRS that are higher than reported in their financial statements, lowering taxes paid while also increasing earnings.

How insane is this? Some will argue they are just taking advantage of the laws currently in place. Well, if these are the rules, we should probably change them. Taxes, the last time I checked, pay for many of our programs including Medicare. This writer doesn't want CEOs and corporations to benefit at the expense of medical care for the poor and elderly, and I doubt I'm alone in this.

Bonuses Should Be For A Job Well Done
If you read the average proxy statement and, more specifically, the summary of compensation, you'll notice that the top executives of public corporations often receive stock options, restricted stock and even performance shares as additional compensation for a job well done. That's great in theory, but the reality is that although performance-based bonuses were down in 2007, presumably due to poor performance, discretionary bonuses were up - ensuring that CEO pay didn't lose ground. So, the question is, do these bonuses reflect the job done? (For related reading, see Lifting The Lid On CEO Compensation.)

To illustrate how stock-based compensation has gone awry, I've taken a poor performer, Arctic Cat (I've followed it for many years and even owned the stock at one point) and compared it with four other companies it considers part of its peer group, as detailed in its latest proxy. The table below examines three things: 1) the amount of stock-based compensation each company expensed in its most recent 10K; 2) the amount of stock awards given to their CEO in the latest fiscal year; and 3) the latest annual earnings growth for each company.

Company Stock-Based
Compensation Expense
CEO Stock/Option Awards Earnings Growth/(Loss) Latest Fiscal Year
Arctic Cat
(Nasdaq:ACAT)
$2,063,000 $720,000 (115%)
Esco Technologies
(NYSE:ESE)
$5,299,000 $622,000 7.8%
Tennant (NYSE:TNC) $2,886,000 $369,000 33.7%
Thor Industries (NYSE:THO) $356,000 $0 (31.2%)
Toro
(NYSE:TTC)
$7,293,000 $1,778,000 10.3%

Not surprisingly, the numbers are all over the map. Arctic Cat and Thor Industries both saw earnings drop significantly in the latest fiscal year. Yet Arctic Cat still saw fit to award its CEO $720,057 in stock or option awards, expensing a total of $2 million to keep executives and directors sufficiently motivated. Call me old fashioned, but isn't a salary and cash bonus motivation enough? Why do investors continue to allow excessive CEO compensation when it is clear that this does little to alter the success or failure of most companies? I believe systemic change is necessary to put companies back in the hands of everyday investors.

One Possible Solution
Frankly, I have no problem with a compensation system that provides a generous base salary and bonuses tied to performance. Private-sector companies don't seem to have trouble "incentivising" their executives. Why should public companies be any different? But when my grandfather was an executive in the 1960s, if he wanted a piece of the action, he had to pay for it. No free ride at the shareholders' expense; he had to buy stock just like everyone else, plunking down his hard-earned cash. It's a simple concept where you must pay to play - no exceptions allowed.

That's why I think we need a public/private facility association for the sole purpose of dealing with employee compensation at public companies. The association would make loans to executives (and any other employees for that matter) up to a certain percentage of their salary and cash bonus.

The company would then work out a performance target to determine what percentage of the monthly loan payment it would cover as additional compensation. For example, in the case of Arctic Cat, CEO Christopher Twomey made $533,250 in salary in fiscal 2007 and $304,587 as a cash bonus for a total of $837,837. On top of that, Twomey received $684,632 in option awards. His total compensation including all other income was $1,608,698. In this example, the CEO would receive the same salary and bonus and then be eligible to borrow up to 100% of this amount to buy stock on the open market.

The company might decide to cover 50% of the annual loan cost (interest only) with the executive covering the remainder. Until the loan is repaid, the facility association would hold the stock as collateral. Should the executive leave the company, he or she would be responsible for 100% of the carrying cost and ultimate repayment of the loan.

Bottom Line
Any new system of compensation should balance the needs of shareholders, employees and all other stakeholders. In recent cases of excess, it's obvious that some people received more favorable treatment than others. In my example, every employee would get equal treatment. It may not be a perfect system, but it would be a lot more transparent than the current one. Let's take back our companies from greedy CEOs.

For related reading, see Evaluating Executive Compensation.

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