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How Soaring Executive Pay Drags Companies Down

Everyone knows the average American CEO earns a bundle. But a potentially more useful exercise is looking at how executive compensation compares with other corporate expenditures.

For instance, a recent analysis found that more nearly one-third of 483 U.S. companies paid more in cash comp (meaning salary plus bonus) to their top five executives than they spent on audits by outside accounting firms. At 153 of the enterprises, the estimated after"tax total comp topped 3 percent of their 2010 (GAAP) income from continuing operations. Thirty-two of the businesses paid their brass more than they paid the government in cash income taxes. And at roughly 13 percent of the technology companies examined in the study, median executive pay amounted to more than 5 percent of the firms' total research and development costs.

The kicker: For 37 percent of the companies, executive comp rose between the end of 2007 and 2010 -- during the worst of the financial crisis, in other words -- even as their market capitalization was falling. That's right. As these titans of industry were getting a raise, shareholders were losing money.

Executive comp as a cost center
The report, from investor research service The Analyst's Accounting Observer, highlights the importance of looking beyond a chief executive's comp in judging whether a company's pay practices are fair. It also underscores that at many companies, shareholders fare far worse than managers when a business hits the skids (click on adjoining chart to expand). Writes study author Jack Ciesielski (no public link):

The top five officers are part of a CEO's cadre of trusted executives; they're at least a part of the total management team that breathes life into the shareholders' collective assets. Consider them to be a major input into the production of shareholder returns, with a real cost, just like raw materials or any other purchased services. One difference: Managers try to keep other production costs low -- but for their own costs, they'll employ swarms of consultants to justify higher pay.
If investors thought more about the price tag on their managers -- especially in comparison to the cost of other inputs of production -- they might vote "nay on pay" every chance they get.
Ciesielski found something else -- after sliding in 2009, executive pay shot up nearly 14 percent last year. In all, U.S. managers forked out $14.3 billion to 2,591 corporate managers, more than the GDP of many countries. After taxes, exec comp at the companies in the study was equivalent to 1.2 percent of their net income from continuing operations.

Financial industry pay bounces back
Some industries have rebounded more strongly than others in terms of executive pay. One of the biggest gainers last year? Financial services. After comp in the sector declined 22 percent in 2009 and 25 percent the previous year, pay rose 24 percent in 2010 (see chart at bottom). Total pay among top execs in the industry has almost returned to 2007 levels, before the housing crash. The high-tech industry has proved the most resilient sector, with comp up nearly 29 percent over the period.

The impact of such trends goes beyond individual companies and shareholders, of course. Economic evidence suggests rising corporate pay is aggravating income disparity in this country. The U.S. ranks not only well behind Europe and the U.K. in economic equality, but also behind such nations as Cameroon and Ivory Coast. No disrespect to these countries, but that's nuts.

From this perspective, executive pay is less an ethical issue than one of simple economics. Clearly, "top" execs often aren't worth the money, which companies would do better to spend in other ways. And for the 90 percent of Americans whose wages have been stagnating for decades, lavish corporate pay is literally money out of their pocket.

Charts from The Analyst's Accounting Observer

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