Public CEO Compensation Plans: Complicated, And Often Creative2:10 PM EST Tue. Dec. 11, 2012
Earlier this year, Apple revealed that its new CEO, Tim Cook, earned $378 million in total compensation in 2011. He has an enormous job in steering the company his predecessor, Steve Jobs, founded and nurtured from its birth. The amount of money Apple, Cupertino, Calif., will fork over this year stands in stark contrast to Jobs' famous $1 a year total compensation.
More recently, Marissa Mayer took the top job at Yahoo, Sunnyvale, Calif. Yahoo will pay Mayer a base salary of $1 million, with a $2 million target bonus. Mayer's equity awards come in at $12 million and her so-called make-whole payment -- to compensate for stock left behind at her former employer, Google -- is a hefty $14 million.
As the blogosphere lit up with opinions over Mayer's value, the promised payout brings to mind the question: How much is any CEO really worth?
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Determining exactly how to pay a top executive is challenging. Public companies devote pages in their proxy statements to explaining how their executive compensation packages were derived, which experts were consulted, and what competitors pony up for their own top executives. The criteria used by boards of directors to pay CEOs reflect the talents each individual company values, as well as the corporate culture. The compensation packages also reflect the board's view of the roles of incentives and rewards.
"When you are talking about the IT industry, executive pay is mainly incentive pay," said PricewaterhouseCoopers Managing Director Rick Ericson. "It's complicated. A typical executive, in a typical year, receives a collection of complex financial claims."
Part of those packages, typically, is stock options. More than 10 years ago -- prior to the dot-com bubble bursting -- it was common for high-tech startups to pay executives with stock options for two main reasons. First, it allowed companies that were cash-poor to attract talent on a hope and a promise. Second, stock options were considered, more or less, "free," since they were not accounted for in a company's profit and loss statement.
"To be perfectly clear, though, those options were never free," said Ericson. "They did not allow companies to escape the valuation effects of dilution."
However, the promise of getting rich by working for a new dot-com superstar was infectious. Companies would sign a senior executive, sometimes wooing him or her from a venerable brick-and-mortar company. The largest part of the package was options. "There was a huge bias toward paying executives this way," Ericson said. "When the accounting rules changed [in 2005], they started using a lot fewer stock options. Corporate practices have changed a great deal, and so companies started to look at other forms of long-term incentive compensation."
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Those "other forms" can be quite creative. Hollis Gonerka Bart, a partner at Withers Worldwide, where she leads the Litigation and Employment practice group, regularly represents senior executives and CEOs in the structuring and negotiation of compensation packages and incentive plans. Increasingly, companies are personalizing their compensation packages to attract the best and brightest and, rather than offering huge perks, the trend is toward more long-term incentives.
"I hear, 'This is what we're paying, and we'd love to have you, but that's about it,'" said Bart. "In general, we're not seeing big packages. Instead, there are long-term incentives, driven by deferred compensation. If a company is doing it right, it should be building incentives into the company's five-year plan, tying portions of compensation to tenure and achieving targets set by the board of directors."
Today's CEO is very involved in negotiating the terms of his or her contract, particularly the target he or she is required to meet. At the same time, today's boards of directors, said Bart, are not hesitant to fire "for cause." That no longer suggests inappropriate or egregious behavior on the part of the executive, she explained, but can simply mean not hitting performance goals. It's imperative, therefore, for the CEO to be personally involved in creating the compensation package.
"Working out the goals together ensures the goals are meaningful, and it creates a dialogue between the executive and the board from the very beginning. It gives the executive a seat at the table," Bart said.
Sometimes that seat at the table makes some additional requests. Bart related a case in which a CEO was relocated from the East Coast to the West Coast in the middle of the school year. The company agreed to pay $20,000 in travel costs so that the CEO's family could regularly visit, plus it agreed to shoulder any tuition monies the family might lose due to the move. But the CEO asked that, in addition to typical relocation costs, the firm also pay to move his substantial art and wine collections. The board agreed.
A good compensation plan also includes retention incentives that inspire executives to stay with the company and not look for a "resume-building" opportunity elsewhere. They are motivated to continue working because the goals are attainable, lucrative -- nobody wants to leave money on the table, after all -- and are aligned with the interests of the shareholders.
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All of the consultants CRN spoke with agreed that CEO compensation must be aligned with shareholder goals, and that does not simply mean a rising stock price. Looking at stock price alone can give a skewed perception.
"There's no one-size-fits-all in how to structure it," said Bart. "You have to determine, 'What is the company hoping to achieve through the CEO's efforts?' "
However, stock price is, perhaps, the most visible indicator of the health of a company. It's also one of the most deceptive, said Dora Vell, managing partner at Vell Executive Search, Boston.
"It's too simplistic to judge a CEO's performance only on stock price. It may be in the better interest of the CEO and shareholders to take a hit in the short term because they are building long-term value. It's critical to align the interest of the CEO with the board's objectives and shareholder value," Vell said. "A high stock price doesn't mean you're doing a great job. And the CEO is intrinsically interested in the stock price anyway because of his or her stock options that are part of the comp plan."
The most common way to measure pay-for-performance is to look at stock prices, agreed Dr. Hermann Stern, CEO of Obermatt Inc., a Switzerland-based international financial research firm. Stern, who developed the Obermatt/CRN Pay-For-Performance Index used in our study, said there are problems with looking at stock prices as a measurement.
"This gives a distorted view of performance because of market sentiment and business cycles, which is why pay is often also distorted," he said.
Stern's formula calculates pay-for-performance by measuring both performance and pay as percentile ranks. So, for pay to be based on performance, the CEO's performance percentile rank should match his or her pay percentile rank. "If a CEO achieves a performance percentile rank of 60 percent -- better than 60 percent of peers -- the pay should be in the 60th percentile as well -- that is, higher than 60 percent of the peers, but not more. If there is a difference, we call it excess pay."
It can be misleading, therefore, to use stock price to judge CEO performance. Jeff Leopold, managing director at the Boston office of executive search firm Cook Associates, said additional factors to weigh include: Has the CEO changed the value of the company? Has the employee base changed over time? What is the reputation of the company with its customers? More focus should be on the durability of the stock price, rather than the number itself, he said.
"If there is good shareholder value but a lot of employee turnover, then the CEO is mortgaging the future," said Leopold. "If shareholders, employees and customers are happy, then the CEO is doing a good job. Those are three key dimensions you need to evaluate."
Obermatt's Stern recommends companies pay more in fixed salary and use relative measures rather than absolute figures. "Only by comparing a company against its peers can we identify true performance," he said. "This also eliminates much of the massive swings in compensation and will help end the spiraling executive pay."
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Compared with five years ago, the profile of the CEO has been transformed, and so has his or her perks. Stock option packages have changed, there is more transparency with stockholders, and there is more accountability, experts say. In addition, there is a sharpened focus on what companies are looking for and less of a willingness to let an executive "grow into the position."
"The best CEOs have multiple tools in their toolkits," said Leopold. "They must know how to be strategic, and they must be hounds for execution." Without those traits, the results can be disappointing. Leopold pointed to Research In Motion as an example of a company with leadership focused solely on execution. "Without that so-called strategy gene, they don't see the world around them. In RIM's case, [the company] didn't recognize the direction the mobile world was headed and the velocity with which it was going, so it couldn't respond accordingly, and that's what has put the company in a compromised position."
Conversely, IBM's former CEO, Sam Palmisano, could keep one eye on strategy and the other on execution, Leopold said. "IBM has done a phenomenal job of building a deep bench. There's no easy way to build into compensation how to measure what the CEO has done to reduce risk of a company. And that's what a CEO does: mitigate risk."
Forward-thinking companies are constantly evaluating their plans, with input from their top executives and shareholders. Some now offer equity stakes that last longer than the CEO's tenure. That's a controversial move, with some CEOs arguing it's an unfair plan because they have no control over the future. But proponents say that while it might be imperfect, it's a step in right direction.
Most importantly, compensation must be in keeping with the company's goals, financial or otherwise. The CEO's direction must result in a solid foundation for the future. As Leopold noted, "If you are a super CEO, you'll change the durability of a company not just superficially, but for the long haul."