Public Company CEO Pay, Is the Day of Reckoning Here?

Say-on-Pay
Many point to “Say-on-Pay” as a mechanism whereby shareholders can express their view on executive compensation and can prevent excessive CEO pay. However, this say-on-pay is just an excellent way of appearing to provide some form of checks and balance while not changing the flaws in the system. The major of people assume that a say-on-pay vote is a vote to approve the executives’ compensation for the current year. To quote an old friend, “Let me disabuse you of this notion.” 

Say-on-pay votes ask shareholders to opine retrospectively on the compensation of named executives, rather than on the company’s compensation program going forward. Say-on-pay does not dictate actual executives’ pay.

Furthermore, in the U.S., say-on-pay votes are non-binding advisory votes by shareholders. Since it is an advisory vote, even if a say-on-pay proposal failed to receive majority support, this would not prevent a company from implementing its pay practices. 

While say-on-pay allows shareholders to engage with companies to encourage good governance practices and alignment with company performance, the most significant influence on executive compensation is the compensation consultants and proxy advisors. Ultimately the decision on executive compensation is that of the Board.

Pay for Performance
Lastly, we get to the main reason for the high level of pay, Pay for Performance. For years, CEOs and their supporters, e.g., compensation committees, compensation advisors, have staunchly defended the level of compensation to CEOs because of “Pay for Performance,” the idea to align CEO compensation to the company success, and the CEO’s performance provides value to the organization.

So, do these compensation plans drive performance? 

For about 25 years, I have said the job I want is “F##k up CEO,” or to put it politely, “Pre turn around CEO.” You get paid a lot of money to join the company, while as the CEO, you get paid an excellent salary to destroy the company, and then you get paid a whole bunch more money to leave. These jobs are out there, and I have seen many people get them, and here is a list just to name a few:

There are so many others, including Dick Fuld at Lehman Brothers, Angelo Mozilo at Countrywide Financial, Ken Lay at Enron, but time is limited.

Therefore we there many stories of CEO enriching themselves while the organization fails to perform. However, while stories may be anecdotal, academic research has shown that incentive-based CEO compensation appears to have only a small or negligible impact on firm-level performance, and particularly when firms have weak corporate governance.

A study in the Journal of Management Research in 2018 analyzed the earnings of more than 4,000 CEOs throughout their tenures against several performance metrics. They found virtually no overlap between the top 1% of CEOs in terms of performance and the top 1% of highest earners. Among the top 10% of performers, only a fifth were in the top 10% in terms of pay.

In 2017, only two out of the 20 highest-paid CEOs, who didn’t leave their jobs before the end of the year, landed in the top 20 for shareholder return. According to many compensation consultants, many firms condition a significant share of pay on three-year performance metrics that are only partially affected by a single bad year.

As a result of COVID, many companies are filing for bankruptcy protection. However, according to Reuters, nearly a third of more than 40 large companies seeking U.S. bankruptcy protection have awarded bonuses to executives within a month of filing their case. Also, many of these companies are simultaneously furloughing or terminating employees. Some examples:

Firms paying pre-bankruptcy bonuses know they will face scrutiny in court on compensation proposed after their filings. Still, the trustees have no power to halt bonuses paid even days before a company’s bankruptcy filing, said Clifford J. White III, director of the U.S. Trustee Program, at the Justice Department. Thus, the firms “escape the transparency and court review.” Also, unsecured creditors and employee pension funds bear the pain in such activities. Concerning employee pension plans, the Pension Benefit Guaranty Corporation usually takes them over, meaning we all pay for the hubris through our taxes.

The spotlight on CEO “Pay-regardless-of-Performance” may lead to a day of reckoning and boards doing their job. There is increased pressure from some large asset managers like BlackRock, but not the majority as I write this.

Thus, while I hope CEOs may truly be paid for performance as this behavior reinforces the inequality of the system, reinforcing the view, “Accountability means lower-level people get financially penalized if they make a mistake, but the CEO never does.” I wouldn’t hold my breath.

Further, if CEOs were paid for performance, the concept might then migrate to Private Equity and Hedge Funds requiring not only pay for positive performance. Given the traditional 2 and 20, forget the 2% of AUM, but tied the 20% to exceeding some external metric, i.e. the S&P 500 for a Private Equity Group. That would really put the cat among the pigeons.