Worthy of their hire?

For reasons good and bad, CEO pay has reached dizzying heights, and is seeing global convergence, despite local variations

by Morice Mendoza, World Business
Last Updated: 23 Jul 2013

Next month, when he faces the judge’s sentence, Canadian-born businessman Conrad Black’s fall from grace may be complete. In July, a Chicago court found him guilty on four charges out of 13, including mail fraud and obstruction of justice. He stood accused, along with three other former executives of the newspaper company Hollinger International, of pocketing more than $60 million in non-competition payments made as part of various sales deals of the company’s newspapers. The money, it was argued in court, rightfully belonged to the shareholders.
As Black, also now known as ‘Lord Fraud’ (he renounced Canadian citizenship to accept a UK peerage), faces the possibility of spending the rest of his life behind bars, he might rue the day he ever felt the need to join the billionaires’ club.


Tom Bowers, author of Conrad and Lady Black: Dancing on the edge (HarperPress) reported on one telling moment when the Blacks were unable to transport their guest Henry Kissinger to Washington by jet because of a storm. Instead he needed to get to the train station and the fastest way was by helicopter. Amiel turned to her husband and said: “Why haven’t we got a helicopter, Conrad? The Kravises have one [a reference to the legendary buy-out king Henry Kravis, who had amassed a fortune of $2.6 billion].” Black’s smile froze: “We’re not rich like the Kravises.” It is in this milieu that one must view the trends for global executive pay.
While most ordinary mortals would be more than satisfied with a million dollars a year or so, the fact that the very rich have amassed huge wealth through stock options, or multi-million dollar bonuses awarded to traders in the top financial markets, has set the global bar extremely high.


In the shadow of such great wealth, remuneration committees seeking to attract the best global CEOs have to calculate the appropriate salary and incentive package in the light of the deals secured by other executives in their peer group. And it would be foolish to ignore the impact of the ultra-wealthy on the mind of the status-conscious executive.


Ted Dysart, managing partner with global headhunter Heidrick & Struggles, says that the recent boom in private equity business has influenced the corporate executive market. He recalls asking a senior executive at Home Depot why he had decided to leave, even though his prospects were good, and go off to run a smaller $900 million business for a private equity firm. The answer was the sheer scale of pay being offered. “He said that in 18 months he would have enough finance to guarantee his future and that of his children and that this did not depend on his being successful.”


US professors Lucian Bebchuk and Jesse Fried published details on the extraordinary rise of executive remuneration in the US – the country that sets the trend for the world – in their 2004 book, Pay Without Performance (Harvard University Press). Between 1992 and 2000, the average (inflation-adjusted) pay of CEOs of S&P 500 firms more than quadrupled, climbing from $3.5 million to $14.5 million. Much of this was fuelled by the fashion for issuing stock options as one of the key components of long-term incentive reward.


Following the financial crisis of the late 90s and early Noughties, in which companies such as Enron were grossly over-valued, the US introduced the new Sarbanes-Oxley accounting law to ensure companies included stock options as an expense on their balance sheets. However, US companies still provide stock packages – in many cases in the form of restricted shares where, for instance, the shares are held in trust for a few years until they can be vested. Bebchuk and Fried note in Performance Without Pay that the value of stock options granted in the 1992-2000 period jumped ninefold. “In 1991, the average large-company CEO received approximately 140 times the pay of an average worker; in 2003, the ratio was about 500:1.”


The trend continues to go upwards. This is the case in particular for CEOs who are regarded as star players. The market for top CEOs operates to some extent in a similar way to that for sports players of the calibre of soccer star David Beckham.


You don’t necessarily even have to succeed at the job. There are plenty of examples in the press of high executive pay and huge severance payments, even when the execs have seemingly failed. The case most reported in the press in recent months has been Home Depot’s Robert Nardelli, who left the company with $210 million severance in spite of a falling stock price. In Switzerland, Thomas Minder, a businessman who is leading a campaign for greater transparency and accountability in executive pay, claims that Daniel Vasella, the head of pharmaceutical giant Novartis, is the highest paid boss of any listed company in Europe. In March, Minder calculated that Vasella’s package, including share options and restricted shares, was worth SFr44m ($37m), a figure contested by Novartis. It said Vasella was paid SFr21m ($17.5m) in 2006.


Piia Pilv, European partner for Mercer, explains how these rates are justified: “The argument in favour of these high packages is based on the fact that the labour market for this profile is quite limited, that it is hard to find good people and that the average tenure of a CEO is less than three years.”


Around the world there are variations in the scale of executive pay and a widening gap between the top executive and the echelons of executives below them. Pilv continues, “In the US there is a wide gap. But in Scandinavia the CEO’s pay is very close to that of other board members, whereas in the UK it is about 30% higher than the next board member.”


Much of this is to do with cultural differences. In more egalitarian societies such as in Scandinavia, there is less stomach ext month, when he faces the judge’s sentence, Canadian-born businessman Conrad Black’s fall from grace may be complete. In July, a Chicago court found him guilty on four charges out of 13, including mail fraud and obstruction of justice. He stood accused, along with three other former executives of the newspaper company Hollinger International, of pocketing more than $60 million in non-competition payments made as part of various sales deals of the company’s newspapers. The money, it was argued in court, rightfully belonged to the shareholders.


As Black, also now known as ‘Lord Fraud’ (he renounced Canadian citizenship to accept a UK peerage), faces the possibility of spending the rest of his life behind bars, he might rue the day he ever felt the need to join the billionaires’ club.


Tom Bowers, author of Conrad and Lady Black: Dancing on the edge (HarperPress) reported on one telling moment when the Blacks were unable to transport their guest Henry Kissinger to Washington by jet because of a storm. Instead he needed to get to the train station and the fastest way was by helicopter. Amiel turned to her husband and said: “Why haven’t we got a helicopter, Conrad? The Kravises have one [a reference to the legendary buy-out king Henry Kravis, who had amassed a fortune of $2.6 billion].” Black’s smile froze: “We’re not rich like the Kravises.” It is in this milieu that one must view the trends for global executive pay.
While most ordinary mortals would be more than satisfied with a million dollars a year or so, the fact that the very rich have amassed huge wealth through stock options, or multi-million dollar bonuses awarded to traders in the top financial markets, has set the global bar extremely high.

In the shadow of such great wealth, remuneration committees seeking to attract the best global CEOs have to calculate the appropriate salary and incentive package in the light of the deals secured by other executives in their peer group. And it would be foolish to ignore the impact of the ultra-wealthy on the mind of the status-conscious executive. Ted Dysart, managing partner with global headhunter Heidrick & Struggles, says that the recent boom in private equity business has influenced the corporate executive market. He recalls asking a senior executive at Home Depot why he had decided to leave, even though his prospects were good, and go off to run a smaller $900 million business for a private equity firm. The answer was the sheer scale of pay being offered. “He said that in 18 months he would have enough finance to guarantee his future and that of his children and that this did not depend on his being successful.”


US professors Lucian Bebchuk and Jesse Fried published details on the extraordinary rise of executive remuneration in the US – the country that sets the trend for the world – in their 2004 book, Pay Without Performance (Harvard University Press). Between 1992 and 2000, the average (inflation-adjusted) pay of CEOs of S&P 500 firms more than quadrupled, climbing from $3.5 million to $14.5 million. Much of this was fuelled by the fashion for issuing stock options as one of the key components of long-term incentive reward.


Following the financial crisis of the late 90s and early Noughties, in which companies such as Enron were grossly over-valued, the US introduced the new Sarbanes-Oxley accounting law to ensure companies included stock options as an expense on their balance sheets. However, US companies still provide stock packages – in many cases in the form of restricted shares where, for instance, the shares are held in trust for a few years until they can be vested. Bebchuk and Fried note in Performance Without Pay that the value of stock options granted in the 1992-2000 period jumped ninefold. “In 1991, the average large-company CEO received approximately 140 times the pay of an average worker; in 2003, the ratio was about 500:1.”


The trend continues to go upwards. This is the case in particular for CEOs who are regarded as star players. The market for top CEOs operates to some extent in a similar way to that for sports players of the calibre of soccer star David Beckham.


You don’t necessarily even have to succeed at the job. There are plenty of examples in the press of high executive pay and huge severance payments, even when the execs have seemingly failed. The case most reported in the press in recent months has been Home Depot’s Robert Nardelli, who left the company with $210 million severance in spite of a falling stock price. In Switzerland, Thomas Minder, a businessman who is leading a campaign for greater transparency and accountability in executive pay, claims that Daniel Vasella, the head of pharmaceutical giant Novartis, is the highest paid boss of any listed company in Europe. In March, Minder calculated that Vasella’s package, including share options and restricted shares, was worth SFr44m ($37m), a figure contested by Novartis. It said Vasella was paid SFr21m ($17.5m) in 2006.

 

Piia Pilv, European partner for Mercer, explains how these rates are justified: “The argument in favour of these high packages is based on the fact that the labour market for this profile is quite limited, that it is hard to find good people and that the average tenure of a CEO is less than three years.”


Around the world there are variations in the scale of executive pay and a widening gap between the top executive and the echelons of executives below them. Pilv continues, “In the US there is a wide gap. But in Scandinavia the CEO’s pay is very close to that of other board members, whereas in the UK it is about 30% higher than the next board member.”


Much of this is to do with cultural differences. In more egalitarian societies such as in Scandinavia, there is less stomach for such high pay differentials. But the overall global trend, particularly for people regarded as world-class, is moving inexorably upwards. Vicky Wright, a senior consultant at Watson Wyatt, agrees. Those who want to understand the future trends in pay for executives should look first to the US, she says. However, trends will differ in other countries, shaped by local culture, tax and regulations. “The combination of current share plans used in companies today has meant that executive remuneration has risen at much faster rates than is the case for other managers. However, there is a different tolerance level of these differentials. Where there are more egalitarian cultures they find it more difficult to swallow them.”


Kevin Abbot, a senior consultant at PricewaterhouseCooper’s human resource services division, believes this internal executive pay gap is becoming a major worry for companies – even in the US, where traditionally there is a greater tolerance for high pay. In a poorer country like India, Abbot adds, the differential must be huge. “This creates social pressures because it seems unfair to people. But the real pressure will come from within organisations where executives have to call on their staff to go the extra mile to achieve higher levels of performance and increasingly their staff may turn around and say, ‘Yes we understand that, but can you please explain to us what determines the distribution of reward in this company?’”


TV Mohandas Pai, HR director for the Indian IT services company Infosys, is in a good position to assess the impact of high salaries in India. He says that with the economy growing at 9% a year it has never been a better time to be an executive in India, with some salaries reaching the $6-7 million level. As with many emerging markets, the trend for long-term incentives is beginning to be felt. With a great deal of talent coming into the country from outside and companies such as IBM establishing big centres there, the desire for stock options is on the increase. However, most companies offer variable performance pay such as bonuses, Mohandas Pai says. There are two issues that cause tensions in India, he adds. The first is envy. “One of the challenges in India is that people do make comparisons. They feel unhappy if they think their neighbour is getting more money than they are.” The best way to deal with this, he says, is to make everything as transparent as possible. The second cultural difference in India relates to what Mohandas Pai terms the “worship of poverty”. He continues, “The political class still thinks poverty is a good thing. But if people don’t get the market rate for their work they will go elsewhere.”


Infosys’ leaders try to offset criticism of new wealth by showing restraint themselves. Notably, NR Narayana Murthy, the company’s chairman of the board and chief mentor, supported a policy by which the six founders (of which he is one) are not paid more in base pay than their senior managers. Murthy explains the reasons: “India is a very poor country and the gap between the rich and poor is very large. It is therefore important to demonstrate we are satisfied with lower levels of compensation.” He also believes that the difference between the highest and lowest salaries should be as low as possible, to show commitment to the company. “We the founders, who are well-to-do because of our stocks, can show our commitment to Infosys at least symbolically by taking lower salaries.”


INSEAD professor of entrepreneurship, Stanislav Shekshnia, notes that Russian executives are able to negotiate the type of remuneration packages that would make even US executives blush, some to the value of $10 million. Shekshnia recounts a recent example in which the CEO candidate called the shots while being recruited by a Russian company that had lost half its market value after listing in the UK: “It needed someone with operational experience and when that person was found, the negotiations took two months. The person was hiring the company, not the other way around. It agreed to give him 20% equity in stock options.” Half of this was for him and the other half to be distributed to his management team. Shekshnia believes this trend is a good thing, as it is more likely to motivate the CEO to make decisions which are in the long-term interest of the shareholders.


While there will always be differences in the scale and configuration of executive pay packages around the world, there is a greater level of convergence taking place than ever before, according to Abbot. “Just below the CEO there is little difference between the US, UK and elsewhere. Looking broadly across the world, there are degrees of convergence in both scale and structure.” The rise of M&A is one of the reasons for this, he says. It has brought teams of executives together on a greater scale and it soon becomes apparent that there is “little justification in paying two individuals differently when they are doing the same job”.


Mercer’s Pilv believes that the main global trend is towards performance-based pay. She makes a clear distinction between local practices and global ones. If the skills of an executive are best suited to running local operations, then their pay is likely to be benchmarked against the local market, she says. Where the executives are world class, global norms will apply.


Pilv also sees that companies are becoming better at designing performance-based pay packages. Ensuring that executives act on behalf of the shareholders is a long-running issue. If a CEO is paid in share options, for instance, they might be motivated to push for a merger to drive up the share price when that is not in the long-term interest of the company.


Many packages around the world are becoming more complex as companies try to ensure that their executives are motivated in a way that is aligned to the company’s goals, says Pilv. “Increasingly,” says Pilv, “companies also ask, does this remuneration package make sense for us? What performance measures most correlate with our share price?”


In China, there is a division between those executives who work in state-owned organisations and those who work for local, privately-owned firms keen to catch up with the West in compensation techniques. Incentives are mostly short-term, says Wei Zheng, principal consultant for Mercer in China. More companies want to offer long-term incentives and equity-based incentives, he says. But currently there are no taxation rules governing this area.
The pressure for transparency means companies must disclose executive pay – established practice in the advanced economies. In the UK and US, companies also have to disclose their performance measures so they are subject to even greater shareholder scrutiny. France and Ireland have followed suit and the Netherlands treats it as best practice.


The next level of ensuring the shareholders’ views are brought to bear would be to give them a binding vote over the remuneration of executives. This is what campaigners such as Minder are calling for in Switzerland. In Asia, the owner or controlling shareholder is often also part of the management team. So in theory, shareholder interests are naturally aligned with management, as they are one and the same. However, the lack of transparency means that bad practice can creep in. David M Webb, a former investment banker who now runs his own website (www.webb-site.com) on corporate governance in Hong Kong, says: “In the case of some small companies you can see the shareholders treating bonus payment like a personal family pension account.”


The future trend for executive pay is clearly upwards. This fact does not seem to be contested, though it may take some time before any other country matches the levels being paid in the US. More egalitarian countries such as Norway may prove to be the exception to this rule. But on this matter, Watson Wyatt’s Wright can have the last word: “If Norway wants to be internationally competitive and it only has Norwegian executive packages, it will only attract Norwegian executives.”

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