Share price movement – while the most immediate measure of changes in shareholder value – may be an insufficiently robust measurement of changes in the intrinsic value of a firm. Using the study’s aggregate performance metric which adds operating cash
flow/equity, ROE, and revenue/expenses to quarterly shareholder returns, Exhibit 15 charts relative corporate performance versus relative CEO pay. Even given this more robust measurement of corporate performance, however, increased CEO pay relative to peers was not characterized by increased corporate performance. The distribution is somewhat tighter than using quarterly shareholder returns alone – the standard error falls from 16.7 to 13.7 – but the correlation improved only negligibly, to an R-value of 0.122. Exhibit 15
R3000 - Relative Performance vs. Relative CEO Pay
(50) (25) - 25 50 (100)% (50)% 0 % 50 % 100 % 150 %
Relative CEO Pay (Pct H/(L) Peer Median)
R e la ti v e C o rp P e rf o rm a n c e (p p ts B /( W ) P e e rs )
Increased size of the corporation, as many researchers have noted, is better correlated with increased executive pay on an absolute scale (in a regression analysis of the S&P 500 companies, the R-value was 0.308). However, when compared to relative CEO pay (Exhibit 16), the size of the corporation – a good proxy for complexity of the CEO’s role – was almost utterly uncorrelated (R-value of 0.001) with higher relative compensation. Exhibit 16
R3000 - Market Cap vs. Relative CEO Pay
0 25 50
0% 100% 200% 300% 400% 500% 600%
CEO 3-Year Pay (Pct H/(L) Peer Median)
M a rk e t C a p ( B il s )
Notes
1
In 2006 the U.S. Securities and Exchange Commission strengthened disclosure requirements around executive compensation by requiring, among other things, that companies which “engaged in any benchmarking of total compensation, or any material element of compensation, [begin] identifying the benchmark and, if applicable, its components (including component companies).” August 29, 2006, SEC final rules 33-8732a, Item 402(b)(2)(xiv).
2
Kaufman, Leslie, Cashing Out Rambo: Is Al Dunlap's Buyout Too Sweet? Newsweek, Jul 31, 1995. Available at http://www.newsweek.com/id/120888.
3
Jensen, Michael C., Murphy, Kevin J. and Wruck, Eric G., Remuneration: Where We've Been, How We Got to Here, What are the Problems, and How to Fix Them (July 12, 2004). Harvard NOM Working Paper No. 04-28; ECGI - Finance Working Paper No. 44/2004. Available at SSRN:
http://ssrn.com/abstract=561305 or doi:10.2139/ssrn.561305 4
Mishel, Lawrence, Jared Bernstein, and Heidi Shierholz, The State of Working America 2008/2009. Ithaca, NY: ILR Press, an imprint of Cornell University Press, 2009. For a longer-term view of the trend, see also Frydman, Carola, and Saks, Raven E., Executive Compensation: A New View from a Long-Term Perspective, 1936-2005. August 2008. Available at
http://www.econ.barnard.columbia.edu/~econhist/papers/trends_frydmansaks_0808.pdf
Though a standard frame for these discussions, expressing CEO pay as a multiple of “typical worker” pay inherently casts the issue not as an issue of shareholder returns, but as a public policy issue of economic fairness, as Mishel, et al, demonstrate: “The 1980s, 1990s, and 2000s have been prosperous times for top U.S. executives, especially relative to other wage earners…. In 1965, U.S. CEOs in major companies earned 24 times more than a typical worker; this ratio grew to 35 in 1978 and to 71 in 1989. The ratio surged in the 1990s and hit 298 at the end of the recovery in 2000. The fall in the stock market reduced CEO stock-related pay (e.g., options), causing CEO pay to tumble to 143 times that of the average worker in 2002. Since then, however, CEO pay has recovered and by 2007 was 275 times that of the typical worker. In other words, in 2007 a CEO earned more in one workday than the typical worker earned all year.”
The comparison to “typical worker” pay, not surprisingly, has become a particularly helpful tool for burnishing populist credentials. The AFL-CIO offers visitors to its site the opportunity to “compare your pay to the CEO’s” at nearly any U.S. public company. On the same webpage, under the heading “How to Track Down Executive Pay,” visitors are also offered helpful tips for investigating such questions as “Does the CEO Deserve that Big Pay Package?” and “Is your CEO raking in the big bucks while running the company into the ground?”
5
In May 2004 the state of New York sued to recover the $140 million in deferred compensation which had already been disbursed; Grasso was still due an additional $48 million under the terms of his contract, though that amount was never paid out. In July 2004 the Court of Appeals dismissed all claims against Grasso, allowing him to keep the $140 million he had already received.
6
He, Zhiguo, Optimal Executive Compensation when Firm Size Follows Geometric Brownian Motion. Review of Financial Studies, 2008.
7
The summary of these theories, and the direct quotations within the summary, are drawn from David Peetz’s helpful analysis of the topic. See Peetz, David, Submission to Senate Inquiry into the Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009.
https://senate.aph.gov.au/submissions/comittees/viewdocument.aspx?id=616b9d36-5267-4ada-9214- db249a580d67.
Though sections of Peetz’ presentation related directly to the Austrialian market or distinctive features of the legislative plans being considered, his analysis of these explanations for the rise in executive pay is drawn largely from third-party research on U.S. executive compensation.
8
See, for example, Gabaix, Xavier and Landier, Augustin, Why Has CEO Pay Increased So Much? Quarterly Journal of Economics, February 2008, Vol. 123, No. 1, Pages 49-100.
9
To control for outliers such as Apple Inc., whose founder/CEO receives annual compensation of $1, the data behind this graphic and its associated regression was filtered to exclude those companies more than one standard deviation beyond the Russell 3000 mean for CEO pay versus peers. Scaling on the X and Y axes was also reduced to improve readability of the chart.
10
See, for example, Bebchuk, Lucian A. and Fried, Jesse M., Pay Without Performance: Overview of the Issues. Journal of Corporation Law, Vol. 30, No. 4, pp. 647-673, 2005; Journal of Applied Corporate Finance, Vol. 17, No. 4, pp. 8-22, 2005; Academy of Management Perspectives, pp. 5-24, February 2006; Harvard Law and Economics Discussion Paper No. 528. Available at SSRN:
http://ssrn.com/abstract=761970
11
Named for Garrison Keillor's fictional town Lake Wobegon, “where all the women are strong, all the men are good-looking, and all the children are above average.”
With respect to executive compensation, this has been defined as the dynamic in which “…no firm wants to admit to having a CEO who is below average, and so no firm allows its CEO's pay package to lag market expectations.” See Schaefer, Scott and Hayes, Rachel M., CEO Pay and the Lake Wobegon Effect (December 11, 2008). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN:
http://ssrn.com/abstract=966332
12
Lucien Bebchuk has been one of the most prominent researchers investigating these issues under a theory of “rent extraction.” See, in particular, Bebchuk, Lucian A., Fried, Jesse M. and Walker, David I.,
Managerial Power and Rent Extraction in the Design of Executive Compensation (June 2002). University of Chicago Law Review, Vol. 69, pp. 751-846, 2002; Harvard Law and Economics Discussion Paper No. 366, June 2002. Available at SSRN: http://ssrn.com/abstract=316590 or doi:10.2139/ssrn.316590 13
Faulkender, Michael W. and Yang, Jun, Inside the Black Box: The Role and Composition of Compensation Peer Groups (March 15, 2007). AFA 2008 New Orleans Meetings Paper. Available at SSRN: http://ssrn.com/abstract=972197
14
Cadman, Brian D. and Carter, Mary Ellen, Compensation Peer Groups and Their Relation with CEO Pay (December 2009). AAA 2010 Management Accounting Section (MAS) Meeting Paper. Available at SSRN: http://ssrn.com/abstract=1349997
15
Albuquerque, Ana M., De Franco, Gus and Verdi, Rodrigo S., Peer Choice in CEO Compensation (July 21, 2009). AFA 2010 Atlanta Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1362047 16
Albuquerque, et al.
17
DiPrete, Thomas A., Eirich, Greg, and Pittinsky, Matthew, Compensation Benchmarking, Leapfrogs, and The Surge in Executive Pay. Working Paper. Stanford Centre for the Study of Poverty and Inequality.
Stanford CA: Stanford University, 2008,
http://www.stanford.edu/group/scspi/pdfs/rc28/conference_2008/p109.pdf. 18
Albuquerque, et al. 19
Cadman, Brian D., Carter, Mary Ellen and Hillegeist, Stephen A., The Incentives of Compensation Consultants and CEO Pay (February 1, 2009). Journal of Accounting and Economics, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1103682
20
Murphy, Kevin J. and Sandino, Tatiana, Executive Pay and 'Independent' Compensation Consultants (November 22, 2009). Marshall School of Business Working Paper No. FBE 10-09. Available at SSRN:
http://ssrn.com/abstract=1148991
21
For the purposes of this section of the study a “reasonableness” threshold – based on the distribution of peer group sizes – was established at 35 named peers. Within the S&P 500 index, this threshold allowed consideration of 93% of companies which disclosed their self-selected peers, but excluded 27 companies which identified a compensation peer group so large – frequently more than 90 peers, but in some cases exceeding 200 – that they became in effect broad market indices. Frequently these companies had several smaller compensation peer groups representing fundamentally different industry sectors within which the company had operating divisions, the results of which were later combined. An additional 99 companies – one in five members of the S&P 500 index – either used only a broad industry or market index of
companies, or did not disclose the specific companies in their compensation peer group.
Of the 374 S&P 500 companies with a reasonable peer group of 35 or fewer, and which disclosed the names of their compensation peers, 30 named a significant number of peers which could not be evaluated. Frequently this was because the peer’s primary listing was on a foreign exchange and therefore the peer was not subject to the same compensation disclosure requirements as US companies. Less frequently, the named peer either was sold or had entered bankruptcy and therefore did not hold an annual meeting or file a proxy statement disclosing the necessary compensation data.
22
The eight-digit GICS taxonomy, developed by Standard & Poor's and Morgan Stanley Capital
International, categorizes each firm according to 10 sectors, 24 industry groups, 67 industries and 147 sub- industries. A match on the first two GICS digits indicates two firms are in the same broad sector; a match on all eight digits means they are in the same sector, industry group, industry and sub-industry. See
http://www2.standardandpoors.com/spf/pdf/index/GICS_methodology.pdf for further detail. 23
Because examination of compensation committee structure did not require disclosure of a company’s peer group, the subsample referenced in this section included all S&P 500 companies which held an annual meeting during the study period, and disclosed their compensation committee structure in the proxy statement for that meeting.