CEO Bonuses: Who Pays the Price?

Robert Rubin.jpg

Because so many chief executives of failed or mediocre companies have walked away with millions in bonuses and swag bags, both Switzerland and the European Union recently voted to put a cap on corporate bonuses, limiting them to a small multiple of base salary. What prompted the acceptance of the “Minder Initiative”—named after the independent parliamentarian who sponsored the referendum — is a string of stunning business losses that had no affect on the bonuses paid to the sitting executives.

Swissair went bankrupt in 2001, although not before it could pay out a $10 million bonus to its grounded chairman. The chief executive of the Swiss pharmaceutical giant, Novartis, was recently offered a $78 million sendoff. The Swiss bank, UBS AG, appears regularly in the headlines as the poster-child of bad loans ($40 billion absorbed by the government), LIBOR rate rigging ($1.5 billion in fines), and other dim practices (a so-called rogue trader lost $2.3 billion in London), although the losses are never enough to drain the bonus pool.

The architect that turned the once-staid UBS into an off-track betting parlor, chairman Marcel Ospel, regularly paid himself CHF (Swiss Francs) 24 million in annual salary, something that Swiss voters had in mind, along with the Novartis proposal, when casting their votes with Minder. After the vote, UBS quietly offered an incoming executive a $28 million sign-on bonus — something the law, when enacted, will prohibit.

In the US, corporate activists and some regulators want shareholders to have a “say on pay” of the top CEOs, or for Congress to tax away paycheck windfalls. So far, most reforms have been non-binding.

Members of the business community, nevertheless, resent the intrusion of state or federal bureaucracies into their corner offices. In their minds, salaries are best left to compensation committees and captive boards of directors, which are free to rain money on a handful of senior executives, some of whom are chairmen of the same boards that dole out their pay.

According to the latest estimate, Fortune 500 CEOs have to scrape by with compensation that averages $12 million a year and that is 380 times the pay of the average worker. In 1965, this ratio stood at 24 times and in 1990 it was 71 times.

Meanwhile, real American wages have been declining since 1974, and per capita average income in the country is about $27,000, just above the poverty line of $21,000. The median income for American households is about $50,000 a year. The reason most American corporations reward senior management and stiff the rest of the work force is because many public companies are little different from banana republics.

In theory, the shareholders elect the board, and the board watches their interests, a mandate that includes signing off on the top salaries. In practice, shareholders, even big ones, have little say in who is put on the board, especially if the CEO is also chairman. In those cases, board members serve at the whim of the same CEO. Often such an approval rating depends on voting the prince a big salary, along with big bonuses and stock options.

Under the new Swiss law and other corporate reform proposals, shareholders are given the right to approve the top pay packages in a company. This sounds democratic enough, except that most corporate proxy votes turn out results that would be familiar to commissars in the Soviet Union.

One reason is that many mutual and pension funds, which own the large positions in many public companies, are required by charter to vote with management or, if they disagree, to sell the positions. It's unusual for a large institutional shareholder to both hold on to a position and vote against management. So letting shareholders approve top compensation will not keep managers from pocketing $50 million pay envelopes.

The usual justification for multimillion-dollar rewards is that the company has performed well “in the market” or “exceeded the budget forecasts.” Of course, meeting such a benchmark explains a bonus of $250,000, not necessarily one of $20 million. Yes, the CEO has responsibilities and “duties of care,” but if the board were to auction off the position of CEO in most companies, it's likely that they would find many qualified takers for $1 million a year.

The truism about salaries—“You don’t get what you deserve; you get what you negotiate”—does not apply to the C-suite, which gets what the board is dumb enough to give away almost blindly. They go along with the lavish payouts based on similar compensation paid by competitors.

Because of this mutual-remuneration self-congratulatory circle, salaries have skyrocketed, even if stock prices have remained flat or plummeted. General Electric’s CEO has earned $54 million in the past five years, while the company’s stock went from $37 to $7 and back up to $23 a share. As the Death of Salesman line goes, “No man only needs a little salary.”

Ex-Treasury Secretary Robert Rubin pulled down $126 million from 1999 to 2009 as a top Citigroup senior executive, but when it went bust said that he had no responsibility for the bank’s creditworthiness. He confessed, “My great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today.” But he didn’t give back any of the money. Rubin’s boss, Charles Prince, left the chairmanship of Citi with about $80 million in his pockets, even though the company went to the wall the moment he was out the door.

The goal should not be just to limit CEO pay, but to increase average wages and salaries, and think of increasing the dividend, especially in companies eager to throw millions at the boss. Stock options and profit sharing could be allocated equally to all employees, and not simply reserved as corner-suite perks.

Likewise, cumulative voting of board directors allows smaller blocks of shareholders to elect a representative (you put all of your votes on one candidate).

Many top CEOs live in a bubble of private jets and pillowed suites, and are accountable to only a handful of cronies—certainly not the vote of the employees or the shareholders. They thrive in the cozy confines of oligopoly — think of a golf club lounge — in which a corporation’s success is due only to the top managers, not to the shareholders’ capital or to the workers.

Why not have a companywide plebiscite on the chief executive every two years? The Greeks knew that war was too important to be left to the generals, and had their soldiers elect them.

Employees, pensioners and shareholders all ought to have seats at the table. The Chinese garment workers in sweat shops who stitch together all those sailor suits that are sold at vast markups might be less inclined to pay Ralph Lauren $66 million a year than the board in New York would.

Minder’s law and its clones in the EU or, were legislation to come about, in the US, won't solve the problem on their own. Rather than passing legislation that sounds good in the headlines (The Economist: “Fixing the Fat Cats”) but achieves little reform at the office, the most significant recovery for the ransoms paid to many senior executives would be to overhaul how boards of directors are established and operated — to make them legally accountable for the company’s performance and representative of all stakeholders, including the work force. Keep in mind that when salesman Willy Loman asked for a golden parachute, he only needed fifty dollars "to set his table.”

Flickr photo by World Affairs Council of Philadelphia: Former Citigroup Director and executive Robert Rubin. Is that the size of his bonus?

Matthew Stevenson, a contributing editor of Harper’s Magazine, is the author of Remembering the Twentieth Century Limited, a collection of historical travel essays. His next book is Whistle-Stopping America.

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CEO Bonuses

The answer to the question “CEO Bonuses: Who Pays the Price?” is the shareholders. It is the profits that should be paid out as dividends or used to buy back shares to boost dividend yield that CEOs capture with unwarranted bonuses. Bonuses are warranted for successful long term growth or profitability of a company and can be commensurate with the magnitude of the profit generated (which can be large). This profit sharing (in the form of bonuses) should extend to all employees in proportion to their contribution to that profitability. However, generating growth and ultimately profit for shareholders (individuals, pension funds, peoples retirements funds, etc.) should be the goal of any publicly traded company. If this is not the case, why would anyone save (other than to put it in a sock under their bed) or risk their money by investing it.

The current cause of the problem:
As a CEO told me while I was in college, “If you want to be a CEO, then get on as many boards as you can.” CEOs are on boards and boards determine who is hired and their compensation. This has allowed a go-along get-along culture to develop with respect to compensation that is often disconnected from performance.

Root of the problem:
The failure of shareholders to appoint board members that act in their interests. As the author correctly notes, “many mutual and pension funds, which own the large positions in many public companies, are required by charter to vote with management.” This happens less in companies owned by individuals, families or a few large shareholders as was more common in the past.

Addressing the root cause:
Shareholders need to do their duty. In particular, this means that pension fund and mutual fund managers need to properly execute their fiduciary duties by voting in board members that look out for shareholders needs and not CEOs’ wants. As with so many things, this is easier said than done.

Seems kind of silly

What stops any corporation from instituting such measures already if shareholders think it will make them more money? There are a huge number of corporations out there. If limiting executive pay either made more money or simply saved wasted money, why aren't plenty of them experimenting with this? If it worked, more people would be jumping on this. It's easy to focus on the giants of the corporate world and forget about the rest.

The bottom line, so to speak, is that if this really would save companies money and increase shareholder value then a lot of companies would already be trying this out. Instead this seems like a disconnected academic idea that sounds so reasonable yet has nothing to do with reality. It's simply wishing about how the world should be and not the way it is.