Executive Paydirt

In its 2006 report on executive pay, Forbes magazine gave Capital One CEO Richard D. Fairbank two interesting rankings. In the “performance vs. pay” category, Fairbank placed 167th in a field of 189—no surprise considering that his company had lagged behind its peer group over the previous six years. Nevertheless, the credit-card mogul was unsurpassed in another realm. His total compensation was a shade north of $249 million, more than he’d earned in the previous five years combined.

Headlines like these have stoked public debate over income inequality in the United States, but economists are divided over how to approach the problem—or whether it’s even a problem at all. At April’s Wharton Economic Summit, a panel of experts tried to assess whether the labor market for CEO pay is broken, and if so, how it might be fixed.

Common sense would seem to dictate that above-average pay should be contingent on above-average performance. But definitions of performance are notoriously malleable, said Lawrence Zicklin WG’59, a senior fellow at Wharton: “One CEO says, ‘The price of my stock is the measure.’ Another one says it’s earnings per share. The third one says it’s growth in sales. Another one says it’s a comparison with the three weakest players in the industry. Boards have to be more sophisticated than that.”

If board directors were required to be licensed or certified, he added, perhaps compensation packages would be more reflective of a CEO’s effectiveness as a leader than his or her prowess at salary negotiation.

But how much credit does a CEO really deserve for the performance of an organization made up of thousands of other managers and workers? In a buoyant economy, it’s not always easy to tell, said Adam Zoia C’91 W’91, founder of Glocap Search, a global headhunting firm that specializes in financial services. “The CEO to some extent is free-riding on what would have happened even if they weren’t doing a good job, because the market tends to go up and the economy tends to grow.”

Few cases illustrate that point more spectacularly than the pay history of a CEO named David H. Brooks, whose earnings rose from $525,000 in 2001 to $70 million in 2004. There is no disputing that his company, DHB Industries, has had a bull run, but as an outfit that sells combat-grade body armor, it’s an open question how much credit Brooks deserves for the rise in demand.

For Thomas Donaldson, the Mark O. Winkelman Professor and director of Wharton’s Ph.D. program in ethics and law, one of the most unsettling trends in executive compensation is not just what CEOs are paid, but how. Musing on why it was that Enron and a dozen other large companies were ruined by executive-suite scandals since 2000, Donaldson rejected the notion that greed was entirely to blame. After all, there was plenty of greed around in the relatively quiet early 1990s, too. What happened in the interim was a dramatic shift in the structure of executive pay packages.

“It was about 20 percent [stock] options and 80 percent cash at the beginning of that era, and the reverse at the end,” Donaldson pointed out. “For at least mildly unscrupulous managers, the temptation is raised, especially with unrestricted stock, to puff up the value of the firm, and walk away and know that they would be fine.”

In other words, current controversies in executive pay hinge not only on the difficulty of measuring performance and apportioning credit for it, but distinguishing real results from bogus ones—and engineering a system of compensation that doesn’t provide incentives for chicanery.

Yet even if a consensus emerged on those issues, setting reasonable salary benchmarks is still a tricky business. According to research by Wayne Guay, associate professor of accounting at Wharton, median CEO pay among the 7,000 publicly traded firms on the major American stock exchanges is $1.5 million. Assuming a 70-hour work week, that amounts to about $450 per hour. That’s certainly a wage most professionals would be thrilled with, but as always, there’s another way to look at it. Those company chiefs earn about $20 billion a year to run enterprises with a total market value of $20 trillion.

“Their cut of the assets under management is about one-tenth of one percent,” Guay said. Compared to hedge-fund managers, who typically earn a full two percent of the assets they manage, plus 20 percent of the fund’s profits, that begins to look like a pittance.

So the next time a pundit bemoans the absence of justice in the world of executive pay, you might just hear some poor CEO whispering, “Amen.” —T.P.


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