First in a three-part series on executive compensation, in conjunction with IBJ's special report on the same topic, which begins on page 3. Next week: Is the value of executive talent a myth?
Executive compensation is the only wealth creation not determined by competition or by disinterested negotiation,
and not subject to tension between owners and recipients.
Producers of films, music and books risk personal funds when committing to projects and negotiating with stars. To the extent producers believe that Julia Roberts or Brad Pitt attracts patrons, higher fees and future bonuses are paid. The wealth of inventors is a result of sales of their inventions. Most salesmen are paid directly by the amount of product sold. Attorneys and accountants are paid by hours worked. The profits of small-business owners are related to both sales and to expenses they incur (and most new jobs are created by small businesses).
In contrast, an exaggerated share of the nation's wealth is paid to CEOs of public companies, their minions and directors, through agreements made inside boardrooms, by highly compensated individuals who commit other people's moneyshareholders' moneyand are not subject to effective oversight.
At Eli Lilly and Co., compensation decisions, including the amount of directors' fees, are approved by a board of 13 highly paid executives, nominated by or at least friendly to the CEO, who have voted for themselves close to $300,000 a year for board service, which is five times the salary of many teachers. A director's total income from corporate activities varies widely, depending on whether he is employed or retired, and on how many boards he serves, but could reach $20 million or more per year, or more than 300 times the income of teachers, and more than 50 times the amount paid to the president of the United States. Directors live well and pay well. Paying is easy. It is not their money.
To create an appearance of reasonable deliberations, boards hire compensation consultants who, I presume, would not long serve if they recommended $100,000 for the CEO or $3,000 for directors. (Directors of Berkshire Hathaway receive $2,000 to $7,000 annually. Its chairman, Warren Buffett, receives $100,000.)
A standard for the pay of Lilly's CEO is "the broad middle ground" of nine other pharmaceutical companies. Therefore, increasing compensation of one CEO affects the compensation of all.
Another standard is corporate annual performance targets set each year by independent directors meeting with the CEO. Since the CEO has more facts than anyone, he can propose targets that are likely to be exceeded, thereby increasing his compensation.
However, performance is not subject to executive control. As an oil company's profit depends on the price of oil, a pharmaceutical company's growth depends on patent expirations, research success, and actions of the U.S. Food and Drug Administration. A CEO can do little more than watch the passing scene. Also, one-year targets are flawed, because shareholders invest for years, not months. Indianapolis has notable examples of companies that appeared to do well for a few years, then had disastrous results due to decisions of the highly paid CEO. Society can pay Tiger Woods for visible performance, but no measurable standard exists for corporate executives.
Lilly's CEO is paid approximately $13 million. This is small compared to the $104 million received by the CEO of Motorola, or the $21 million paid at IBM. IBM's board includes the chairman emeritus of Lilly, whose private-jet expense to IBM meetings is paid by Lilly. The retirement plan of the CEO who retired last year was $30 million. Teachers retire with $50,000 to $500,000, depending on years of service and the plan's investment success. Teachers seem to live well with one house, one or two cars, and adequate opportunities to travel. Who needs more than that?
In a free society, no amount of jawboning, law or regulation can effectively control compensation. Only self-restraint, personal modesty and a reasonable sense of value can produce evenhanded decisions. In this edition of IBJ is a list of compensation paid to CEOs of Indiana public companies. Each person on the list should look in the mirror and ask, "Am I worth it?" If the answer is no, then do as Warren Buffett does: Accept less.
Guy is an Indianapolis money manager, certified financial planner and president of Wealth Planning & Management LLC.