Why Can't CEO Pay Ever Be Brought into Line?

It's spring, and what's more fun than baseball's opening day? Taking potshots at CEO pay. This is the time when proxy statements come out, CEO pay is disclosed (well, sort of disclosed, as we shall see), and bemoaned. The egregious excess of executive emolument is an evergreen issue. Every effort to rein it in fails. In 1993, a law eliminated the corporate tax deduction for pay above $1 million, except for compensation that was performance-related. The primary result: Pay skyrocketed, propelled by an explosion of stock-option and other non-salary rewards.

The corollary: CEO pay moved from being incomprehensibly high to incomprehensible, period. Odds are your pay is pretty simple: Salary + bonus + a company match in your 401(K) + a handful of options (if you're among the fortunate few). Your CEO's package is likely to have all of that plus two or three additional bonus plans (keyed to short-, medium- and long-term goals), restricted stock grants, deferred compensation, a special retirement plan, and a bunch of perks. The packages are so complicated that no big-company CEO can actually answer, "How much are you paid?" without an actuary.

This complexity serves the interest of everybody except shareholders and citizens. It's a meal ticket for executive compensation consultants. It's a smokescreen for the executives themselves. It fools investors into thinking that they are sharing equally in the gains of the men and women they have hired to be stewards of their wealth. (This is because stock options are nothing like real stock. Shareholders buy their stock with their own money, which they could have used elsewhere. Executives who get options have no downside risk, put no money down, and incur no opportunity cost; they buy shares from gains already locked in, and in the process usually dilute the real shareholders' investment because companies often provide the stock for options from newly issued shares.)

This spring we're seeing evidence of the latest failure to bring sanity to CEO comp. Last year's Dodd-Frank Bill requires companies to give shareholders a "say on pay" with a non-binding advisory vote every one-to-three years. Shareholders have wagged their fingers at their CEOs in a couple of cases so far; 34% voted against Monsanto's pay packages, for example-maybe because CEO Hugh Grant's salary went up even though the company's performance entitled him to no incentive pay. A board could ignore even a majority vote, of course, but it would be mighty embarrassed, which counts for something.

But "say on pay" isn't likely to amount to much. Few people in the executive-comp club like it, for one thing, which means they'll find ways to minimize its impact. The topic came up often at a conference of directors, headhunters, and HR leaders I attended a couple of weeks ago. The critics in the crowd seemed most concerned that the need to consult the owners would limit a board's "flexibility" to "use its best judgment" to construct the "right compensation package" for the "unique circumstances" of each company. I got to wondering where you draw the line between sophistication and sophistry.

But the biggest problem is the fact that it's almost impossible to decipher what executives earn. We're not getting "transparency"; instead, we're simply getting a better view of a black box. When I got home, I opened up the proxy statement of John Deere, a company of which I'm a happy shareholder, picking it because it was on the top of a pile. I wanted to make my own judgment about its top executives' pay. I gave up. The discussion--designed to give me an informed say on pay--is 40 pages long, including a dozen tables and graphs and several equations.

CEO pay ought to be motivating, reasonable, and comprehensible. It needs four items--no more, no less:

1) A salary-and if it's more than the tax-deductible limit, so be it; and if the limit's too low, let's raise it

2) An equal dollar value of stock (not options) bought at the market price every two weeks on payday; if you want to gross it up to cover the income taxes while requiring the executive to hold the stock at least two years, fine by me

3) A reward, no greater than 25% of salary, based on a clear (and unchanging) one-year financial target, such as total shareholder returns or return on capital employed

4) And a penalty (up to the amount of the bonus) for failure to achieve other targets that the board determines are important for the long-term health of the company but cannot be expressed in short-term financials, like sustainability or diversity.

Illustration courtesy flickr user ElvertBarnes