Wednesday, February 25, 2015


[I was fascinated by the workings of American capitalism. This column from Business Standard of 19 June 2000 is about the pay of chief executive officers.]

America’s richest CEOs

When an Indian manager thinks of a CEO’s position, he thinks first of the perks, and then of his salary. Now he may also give a thought to stock options if he is in software. The horizons of the American manager are broader. Perks are, of course, substantial; they may, for example, cover free holidays for him and his wife, personal use of the corporate jet, moving expenses, multiple dwellings, etc. But apart from salary and perks, there are substantial bonuses, depending on the company’s performance; they may be simply a percentage of the year’s profits, but can depend in complicated ways on long-term performance. Increasingly, companies are engaging CEOs who agree to specific improvements in corporate performance over a number of years.
But the most popular form of performance pay is stock options – a promise to sell to the CEO a certain number of the company’s shares at a predetermined price. The more the market price goes up, the higher the value to the CEO of the stock options. They build in a direct incentive to raise the market price of the company’s shares.
Thus it happens to Jack Welch, the CEO of General Electric, is the highest paid CEO. In 1999 he got a salary of $3.3 million, a bonus of $10 million, and other incentive payments of $31.3 million – a total of $44.7 million. But he was by no means the richest CEO. Bill Gates, the CEO of Microsoft (a post he has since yielded to Steve Ballmer) got a salary of a mere $400,000, and a bonus of $223,000. But the value of his accumulated equity and options was $70 billion, far dwarfing Jack Welch’s $105 million.
These two men typify the rift emerging between the old and the new economies. In the old economy, the stock market places a low value upon the company; so to attract good CEOs, it has to pay a high annual income. In the new economy, stock appreciation is high, and the CEO is paid a high proportion of his income in options. Thus after Jack Welch, the highest annual compensation is that of William Wise of El Paso Energy. This well run electric utility is virtually a pariah in the stock market; so of his $105 million of wealth, $71 million is actual shares. Whereas the wealthiest man after Bill Gates is Larry Ellison of Oracle ($8.4 billion), and the next richest is Henry T Nicholas III of Broadcom ($4.8 billion); almost all their assets consist of options. The New York Times collected the financial details of 100 CEOs of old-economy companies and 60 new-economy companies. The average pay of the former was $3.5 million; of the latter, $911,000. But the average assets – own-company shareholdings and options – of the former were $78 million; of the latter, $1.9 billion.
Someone of CEO calibre would be in his 40s and would have been in the corporate game for 20 years at least. He would have enough money to retire – or at least to live well for a few years. He does not need big pay; he is in a position to take a gamble. So old-economy managers are vulnerable to the lure of the new economy; and an increasing number are taking the plunge,leaving old-economy companies to head new-economy ones, taking a big drop in pay but earning options. Last June, Joseph Galli left as CEO of Black and Decker, the company that makes wonderful motorized hand tools, to head; he got options on 2 million shares. Daniel H Schulman left AT&T in August to head At lower levels, defections are common.
Old-economy companies have to pay their executives more to retain them, but hardly with options, for their share prices have been falling for the last year. None’s so fast as that of Philip Morris, the cigarette maker Its CEO, Geoffrey Bible, had $94 million’s worth of options at the beginning of 1999. Over the year, its share price fell 56 per cent; and the value of his options fell to less than $1 million.
So old economy companies that offer options are having to offer a lifeline – that if the price of their shares falls below a threshold, they would buy them back from the CEOs at the limit price. Others give their CEOs restricted stock – they give the shares free if the CEO stays with them for a minimum number of years. Yet others relate pay to other indicators of performance – usually profits.
Still, the volume of outstanding options is so large that it hangs like a cloud over the stock market. Stock options, restricted options and such employee share entitlements were 7 per cent of all outstanding shares in 1989; ten years later, their share had gone up to almost 14 per cent. Company shareholders had something to worry about: if those options were cashed, there would be considerable dilution of equity, and chances of share appreciation would be greatly reduced. This is why options are not the preferred choice of corporate activists. These are shareholders’ advocates who seek to make companies more accountable to shareholders and to increase shareholder rewards. They want CEOs and other managers actually to hold shares of the companies they manage, and thus to reduce the conflict of interest between managers and shareholders. So it happens that for the sake of reputation or as a result of shareholder pressure or by exercise of options, American CEOs come to have substantial shareholdings.

What happens when share prices fall? Companies become attractive buys. Their CEOs or promoters buy the shares in the market and obtain control over the company. And since company buybacks are allowed in America, many of them borrow to buy their own shares – taking the company private, as it is called. There are “promoters” in the US as there are in India; and whenever the stock market goes down, publicly held companies are taken private and go under promoters’ control.