Thanks, but I don't want a golden parachute
While working stiffs suffered another real pay cut in 2005, it was another year of record-setting raises for America's CEOs. A Pearl Meyer & Partners survey of large companies found the median CEO received a 10.3 percent raise last year to $8.4 million. And those at the top got packages that were truly jaw dropping. CEO William McGuire's accumulation of $1.6 billion worth of UnitedHealth Group's stock options was so huge and fortuitously timed that the Securities and Exchange Commission has taken an interest. And drivers around the country fumed when they learned that Exxon's retiring CEO Lee R. Raymond not only took home $49 million just for last year but also is now collecting a pension worth $98 million.
It has gotten so bad that a few chagrined CEOs, worried about the effect of all this largess on investors and workers, have started to hand back some of the goodies. One of these is Edward J. "Ned" Kelly, CEO of Mercantile Bank, who earlier this year canceled a standard golden parachute contract that would have given him three times his annual salary and bonus—a total of $9 million—if he had sold the bank holding company. Kelly is a veteran of boardrooms who has served on the compensation committee of Constellation Energy Group and now heads the audit committees of CSX and the Hartford.
U.S.News & World Report visited him in his Baltimore office to ask: "Are you nuts?"
So you don't have any employment agreement at all?
I do have one, but it doesn't require the firm to pay me any severance should they choose to let me go for whatever reason.
Why did you do that?
I'm in a position where I do not need the job protection.
Why not?
Frankly, because I am pretty confident in my ability to get another job if I want one. In part, that is because of my particular background and having moved around a fair amount. In addition, I think the best way to align shareholders' interests and those of management is through equity. The other reason I did it, which is particular to us, is that I wanted to eliminate any perception that I had an incentive to sell the firm. There was speculation when I arrived in town that as an investment banker from New York, there was a risk that this firm would be sold out from under the community. I think over time what has happened is that parachutes are no longer perceived as a way to make executives indifferent; they are perceived as a way to give executives an incentive to sell. . .
I think it is perfectly reasonable for people to get paid well for having generated value over time . . . My view would be fine, pay, and pay for performance. But if you are being paid for performance, there is no need to worry quite so much about being able to find a job.
So did you get a larger stock option grant in return?
There was no quid pro quo. The board was kind enough to give me a restricted stock grant in 2003, and then this year they gave me a restricted stock grant as well.
When I talk to folks lately they use the phrase "tone deaf" to describe boards that hand out big executive pay packages. Do you see signs of tone-deafness on corporate boards?
Not on the boards that I've been a part of. I think there are certain examples out there which have unfortunately created an aura around executive compensation which isn't positive. So I think anything those of us can do to generate a perception of reasonableness is helpful. I don't want, though, to get to a position where people confuse reasonable compensation under all the circumstances irrespective of whether it may be large, with greed, when in fact that compensation is just a reward for positive performance. . .
Something like Exxon?
Exxon is a very good example.
Surveys show executive pay is rising much faster than inflation and earnings.
But the stock prices of most of those companies are going up. Because market values have gone up, because deals have gotten larger, people have gotten paid more, and it has gotten to the point that some numbers, in fact, seem to shock the conscience. But I'm not sure it would be a positive development if people allowed themselves to react purely to the nominal numbers, because that is a very slippery slope. How much is too much? What has made America great is the fact that it has regulated but generally free markets. My own view is that the other thing that has made it great is the opportunity to generate wealth.
People have been screaming about executive pay for 15 years.
More intensely lately. Some of it has been driven by certain graphic examples we've been talking about. The other piece of it has been the huge scandals in which people have been able to extract wealth before the firm collapsed, which has generated a sense of inequity.
You're talking about a WorldCom or Enron?
Precisely. The other cases are from the tech boom, which was ridiculous, in my view. There were people there who were able to extract great wealth as others were left with zero. You look at that and say to yourself, basically, how is it that this guy had all these options and was able to cash them in and walk away with a couple hundred million dollars, and we have zero because the firm wasn't really valuable? I think if you combine the scandals with the tech bust, that has generated a heightened sense of inequity with respect to pay.
One of the complaints about option grants has been that they just reward survival. If you last five years, inflation is going to make them vest. When you are on compensation committees, do you try to adjust those for outpacing the S&P 500?
Not generally. When we look at options, we want the stock to go up. We're not smart enough to figure out why or why not. To the extent it does go up, shareholders have done well, too. As you know, there has been a big shift away from options. A lot of people have applauded that. Trust me when I tell you that the reason for that is that you now have to expense options. We have always expensed options here. So when certain tech-firm executives say they can expense options and pay for them or they can take restricted stock, which has an assured value, they are going to take restricted stock all day because they've got guaranteed value. With an option, you've got zero value on Day 1. With restricted stock, you've got the value of the stock. Trust me, it wasn't moral. It was economic.
With options, you have zero value unless the stock price goes up, but with restricted stock, you still have something even if the price goes down. So how do restricted shares align your interests with shareholders'?
Well, there was the theoretical moral hazard issue with options. If all you have is leveraged upside and no downside, you are going to do everything you can to drive the stock price up. It was an inducement to take risks.
So do members of a compensation committee say, "Well, the CEO brought this much value so they ought to get 20 percent or 40 percent of that?"
Absolutely. But it never approaches those levels.
Would it shock you if it did approach those levels?
No. It does approach those levels on Wall Street, which is a perfect example of the tension between capital and labor. You need talented people. They want to get paid for their efforts. And the firm is heavily dependent on those people. So generally they have higher compensation. What people have more of a problem with is circumstances where they believe that the talent isn't as crucial to the enterprise, where there is a windfall aspect to it.
Should we be worried about the fact that executive pay is rising so much faster than wages?
As a broader social matter, what we should be worried about is our ability to create opportunity. If people lose hope of advancement, that generates very serious problems. I think that part of what's created the disparity is that in general it seems to me that the quality of jobs has gone down. In other words, the opportunity to advance is less than it once was. Part of that is because of the transition from manufacturing jobs to more of a service economy. To the extent that you create an even more serious class divergence in America than has existed historically, that tends to generate problems. I think we have to be sure everybody's got opportunity so people don't lose hope that they too can one day generate wealth.
Do you ever get upset that nobody is screaming about Kobe Bryant's pay? Do you think there is a double standard against business people?
People don't think about it analytically as much as they might or should. I think there is a common understanding that if you've got a particular talent you ought to be able to command from the market whatever it is that the market is willing to pay. It is apparent with an athlete because it is so visible and commonly understood that a guy can run a 4.3-second 40-yard dash.
But for executives it is much more subjective. How much is luck?
It is, but ultimately, the proof is in the numbers. If the stock goes up, shareholders do well and executives do well. And if it doesn't, shareholders don't do well and executives don't do especially well, either. One thing that hurts perception is the tax-free payments. Some CEOs have paid no income taxes because the company has paid them. That is egregious. I think grossing people up for excise taxes is fine. But grossing people up for all taxes is a problem. I can understand why people get upset at that.
So when you made your decision, did you get calls from other CEOs saying, "Hey, stop making it bad for the rest of us?"
(Laughing) No. But I think it is going to be an increasing trend . . . Trust me when I tell you that the CEOs I talk to do read the newspapers. We are sensitive to the criticism. Most CEOs are very sensitive to what their institutional shareholders think. I go out and try to see mine as frequently as I can. In general, they are pretty free about telling you what they like and don't like.
Next year, for the first time, companies will probably have to reveal the true value of supplemental executive retirement plans, or SERPs. Given what's happened to rank-and-file pensions, when you meet with other board members, what is the conversation about executive pensions?
I have a SERP here. When I came here from Wall Street, the firm wasn't in a position, no surprise, to approximate what I used to make. They gave me credit as if I had been here for a while as a "perk" of joining. So I have one. It is limited and is reduced by other benefits I get–401(k), the cash balance plan, and things like that. I have asked, and the compensation committee has concurred, that we ought to ask what the value of that is, in order to figure out whether it makes sense.
Some people say that compensation consultants have been driving up executive pay because they want to curry favor with executives who might hire them for other jobs.
I have never known a compensation consultant to depress compensation.
What about concerns that boards are too deferential to executives?
Boards generally don't want to annoy management, they don't want to antagonize management, but they take their responsibilities very seriously, in my experience . . . I am very leery of anybody who tries to establish upper limits on compensation . . . The fact is the market is aware of what executives are being paid, and as we go to better disclosure, the market will be even more aware of it. . . . Ultimately, that will be reflected in the stock price of the firm.