[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 Amazon.com; he got options on 2 million
shares. Daniel H Schulman left AT&T in August to head Priceline.com. 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.
