But we know more today than ever about how over-the-top executive pay has become. That’s because there is an increasing amount of data available about management compensation, thanks to one little-known aspect of the Dodd-Frank Act. This has made it easier to compare executive compensation against corporate stock returns.
The results are rather startling and confirm what some of us have long suspected: The most overpaid CEOs actually destroy shareholder value. To quote a Harvard Law School study:
The 10 companies we identified as the most overpaid firms as a group underperformed the S&P 500 index by a gaping 10.5% and actually demolished shareholder value as a group with –5.7% financial returns.
Those in the best position to press for changes in executive pay are the giant fund companies like BlackRock Inc. and Vanguard Group Inc. Funds hold about 25 percent of all U.S. equities, according to Rosanna Landis Weaver, author of “Power of the Proxy,” a study of executive compensation.
There are some signs that this starting to happen. BlackRock told the Financial Times that in 2015, it “voted against 16 percent of management proposals on compensation globally.” Vanguard Chairman and CEO Bill McNabb said in an interview last fall that rather than only rely on proxy votes, the firm has been pressuring companies behind the scenes to pare back outrageous packages. That approach makes sense, given that the indexing giant, for the most part, can’t simply sell the stock of uncooperative companies without uncoupling their funds from the indexes they are trying to track.
But the reality remains that shareholders are paying executives big bucks for simply keeping a chair warm during a bull market. That isn’t performance-based pay; it’s dumb-luck-based pay.
Executives should be paid for how well they do relative to their peer group. Relative performance versus a company’s competitors provides a basis for justifying higher than average compensation. Basing pay on absolute stock performance tells you little about management performance if we are in a bull or bear market. How well the market is doing surely is not attributable to things management can control.
There are other readily identifiable, easily tracked metrics versus corporate peers that make much more sense to use as the basis for compensation. I would suggest starting with: a) revenue and earnings growth; b) return on invested capital; c) development and execution of long-term strategy; d) innovation and intellectual-property development; and e) market-share gains. Note that the stock price isn’t one of these metrics.
Executive pay should resemble a zero-sum game. If one CEO gets a huge bonus, it means he or she is doing better than the competition -- and management of those other companies should get much smaller bonuses. When you see all pay going up in an industry group, you know something’s wrong.
This column was provided by Bloomberg News.