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Romancing the Stone with Executive Pay By Stephen J. Butler

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The Winter Olympics and the sport of curling brought to mind the compensation of CEO's. In curling, we have the 42-pound stone that slides toward a target while guys with brooms sweep to change the ice quality and influence where the rock will stop. I'm reasonably convinced that the stone is going to go where it wants to go and that all the sweeping will have only a marginal effect. I have the same feeling about CEO's whose companies, all too often, are going to go where they want to go. So why do some company leaders get paid so much? When I hear that someone is being paid $100 million for a few years' work, I often think that the directors could have found someone equally competent who would have done the same job for $10 million plus the prestige and perks.

It's fair to ask the question since this is our retirement money, invested in mutual funds, that is arguably being squandered to the extent that these salaries could be a misallocation of resources.

We can start with Carly Fiorina whose bonus, if the HP-Compac deal goes through, will be about $60 million. There is no apparent requirement that the merger be successful when measured, say, five years from now. In the same vein, Bank of America senior execs pocketed, in a few cases, over $100 million each when they agreed to sell the bank. To his credit, Lafayette's own Peter Bedford was the lone voice among the directors who said the deal would be a disaster for the bank, its stockholders and its California employees, and he turned out to be right. The nicest people in the world can always find a rationale for what they feel like doing, and a corporate officer who stands to make a nine-figure personal gain can set aside the dictates of his or her conscience in the face of an intense yearning to do the deal.

On the surface, it appears safe to say that a CEO's compensation should be tied to the performance of the company's stock. Unfortunately, 70% of any company's stock performance is a function of what the stock market as a whole is doing. The tide raises and lowers all the ships. Moreover, some economic conditions make it easier to show increased profits. What does the CEO have to do with these strokes of good fortune? Measurements of CEO leadership, for compensation purposes, need to take the stock market and the economy out of the equation.

Let's take Mickey Drexler at the GAP. He is a very smart retailer with a long history of making good decisions. He has been paid roughly $500 million over the past five years, which, to offer some perspective, is the equivalent of giving a single employee of the GAP the entire Bank of America building in downtown San Francisco. Now, we have this problem where young women want clothes that display their belly buttons. My wife, who used to love to buy tasteful GAP products, experiences only a crisis in confidence when she shops there even though she looks great in anything.

Could Mickey have been overpaid for a company's success that might have been attributable to many other things besides his leadership? If he had been offered one-tenth the money, would he have thrown his pay checks on the floor and stomped on them like the unsatisfied Drexel Burnham bond traders used to do? This is just a guess, but I think he might have accepted far less money while continuing to enjoy a life in San Francisco at the helm of one of the greatest success stories in retailing. Today, the GAP might have an extra $450 million to spend on solving their problem.

I have to believe that large, successful companies depend upon a reasonably deep bench. Some of my best friends are directors of major U.S. companies, and when I badger them on this point, they maintain that there is a very small universe of CEO's who demonstrate all that is necessary to run a major company with thousands of employees. Many "wanna-be's" have tried and failed. It is an exhausting job with a huge amount of responsibility. I agree that the rare individual who shepherds a company through years of good times and bad deserves a ton of money. I once heard the theory that gifted CEO's have an excess of seratonin in the blood, which enables them to endure having to tell others what they don't want to hear. However, if I point out that some successful CEO's may have just been at the right place at the right time, these director friends counter by saying, "they had the sense enough to be there, and that was part of their genius." For the record, there is generally a very rapid turnover of CEO's across corporate America.

If there is any panacea, it is the steady accumulation of company stock. Key management should just be content to be paid major portions of a reasonable compensation in stock that the company buys in the open market. Lou Gerstner, in his turnaround of IBM, insisted that his 300 senior mangers own at least as much IBM stock as their annual salaries. The cost gets reported as an expense like any other cost of running the business. Stock OPTIONS, by comparison, are a loose cannon on the deck that substantially dilutes the ownership of existing stockholders at an uncontrollable rate. Microsoft, at one point, had unexercised stock options that would have diluted by one-third the company's entire outstanding share value.

I think it is terrific when company employees, from top to bottom, get rich because of their success over time as reflected in the price of their stock. My bone of contention is with the payment of nine-figure incomes to a growing number of managers recruited from outside who appear on the scene and receive instant, disproportionate gratification for just a few years' work. When this happens, it's as if the "invisible hand" of free markets is just waving "goodbye."

In the end, the mutual fund industry should step up to the plate with a collective effort that will spread the cost of activism and benefit all who invest through that industry. After all, the industry has a lot to gain. It controls 10% of all the money in American stocks, and that market share will only grow. It's time to set up a clone of Institutional Shareholders Services (ISS) to flex some muscle and pressure directors who are in a position to directly influence one of the major cost components of an operating company. Directors, otherwise pressured by management, might appreciate having an opposing view to blame when they have to "just say no."

BUYandHOLD does not recommend any securities. The securities mentioned above are being used for illustrative purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy.