Who decides how much a CEO makes?

John W. Schoen Senior Producer • Profile • E-mail

With public companies putting the finishing touches on their annual reports, shareholders will soon learn the details of the latest round of CEO pay packages. Which has Arthur in Maine wondering: just how does a company decide how much to pay the CEO?

PAY TIME
How is CEO compensation determined? Especially with a CEO that had nothing to do with the formation of the company in which he is employed.
Art H. -- Waterville, Maine

CEOs of public corporations get paid based on the recommendations of the board of directors. The pay package can include salary, bonus, stock options, and deferred compensation, along with use of the “company” jet to fly to the “company” villa in Tuscany or Aspen and a limo to drive you to an expense account lunch. Some CEO deals even require the company to pay their income taxes.

The justification many CEOs (and their boards) give for lavish pay is that the very presence of the CEO increases the value of the company (and the company’s stock), so the top executives should get a nice slice of that gain. (Funny, though: few offer to give the money back when the stock goes down.)

There not a lot of evidence that CEOs with pay packages larded with goodies do a better job than those with more modest paychecks. One study found that companies that allow personal use of corporate aircraft, for example, tend to underperform the stock market by about 4 percent a year, over the 10 years covered by the study. (Considering that the total return of the S&P 500 index averaged about 10 percent a year over the past eight decades, that's not small change.)

So how do these packages get approved? Corporate boards usually include a subset of the board called the compensation committee. The problem is that many corporate directors (so-called “inside” directors) report to the CEO. So their judgment is not exactly impartial. (“Hey, boss: remember that raise I asked you for? One reason I need it is because I’m staying late working on your generous pay package for next year.”)

When it comes to “outside” directors (people who work for other companies), some CEO pack their boards with friends and cronies. So the board’s final decision is not always, well – above board. The Sarbannes-Oxley law took some steps to set rules on this, requiring certain new reporting procedures and holding directors personally liable if shareholders squawk.

You can read the details in the annual SEC filings that typically start rolling in over the next few months. These disclosures often make great reading -- if you have the patience to slog through the legal mumbo jumbo.

The problem is that not all the little goodies stuffed into these pay packages have to be disclosed. So the Securities & Exchange Commission recently proposed rules that would make it easier for shareholders to find out just how much of a company’s profits are being diverted to top executives. (So far, so good.)

Unfortunately, there is little in the proposed rules that would empower shareholders to do anything when they believe a CEO is overpaid. When it comes time to vote for new corporate directors, the candidates almost always run unopposed. Challenging those incumbents is expensive, and your average outraged shareholder doesn’t have the time or money to take on the company’s hand-picked candidates. Rare examples of challenges are usually funded by large shareholders like disgruntled money managers or well-funded corporate “raiders.” So disclosure of outsized pay, by itself, will do little to strengthen the link between CEO pay and performance.

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