US: CEO pay disparity rears its head

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By Francesco Guerrera and Daniel Pimlott \ Dateline: Financial Times
October 8th, 2007

When, in November last year, Jeffrey Immelt said that paying chief executives wildly more than their senior managers was “lunacy”, he probably did not realise he was opening a fresh debate on a thorny issue for corporate America.

Since those comments by the head of General Electric, the question of “internal pay equity” – the gap in compensation between chief executives and their most senior underlings – has climbed up the corporate governance agenda.

After years spent focusing on the absolute value of the princely pay packages commanded by corporate leaders, shareholders, and to a certain extent regulators, have begun looking at boardroom inequality.

Their argument is that a large differential between those at the top of the corporate ladder and those just one rung below – chief financial officers, division heads, or even superstar sales executives – is a symptom of a deeper malaise.

Christopher Ailman, who manages more than $170bn for the California State Teachers’ Retirement System (Calstrs), believes that a yawning gap between the pay of top executives points to weak corporate controls.

“Paying chief executives an excessive amount relative to their number twos is a warning signal that the chief executive may have the compensation committee sewn up and that the board is not doing a good job of the succession plan,” he says.

Others warn that funnelling a large part of the executive compensation pool to the boss can eventually damage shareholders by demoralising the senior managerial cadre and future chief executive candidates.

“A large differential can actually harm performance because it is demotivating for the senior managers,” says Ann Yerger, executive director of the Council of Institutional Investors, which groups pension funds with over $3,000bn under management.

Mark Van Clieaf, managing director of compensation consultancy MVC Associates International, says directors should police pay equity more aggressively. “Large shareholders are asking about it, regulators are asking about it, so directors should take a look at the issue and learn to do a better job,”

Yet, in the multi-faceted, legalistic world of executive compensation, few dare quantify what an “excessive” differential actually is.

A study by the Financial Times confirmed the widely-held assumption that, on average and including all compensation, chief executives earn twice as much as their closest lieutenants.

That gap has been steadily rising since the 1960s and 1970s, partly due to the recent explosion in options awards for chief executives.

But some internal pay chasms are bigger than others. In such cases, which include student loan lender SLM and biotechnology group Genzyme, the question is whether CEOs are “worth” such a multiple of their number twos.

For example, last week, the chocolate group Hershey announced that Richard Lenny, chief executive, would hand over the reins to David West, chief financial officer, in December. Last year, Mr Lenny’s total compensation was nearly seven times higher than Mr West’s.

Will Mr West’s pay now be boosted to reflect his promotion? And why was there such a large gap between the chief executive and his would-be successor?

Hershey was unavailable for comment.

But other companies criticised new rules on how to report executive pay and pointed to the share price performance achieved under their chief executives, their responsibilities and length of service.

Centex, a homebuilder, said the new “summary compensation table”, which includes the value of unexercised options in the tally of executive compensation, “oversimplifies to the point of misleading about the context” of pay awards.

The company, whose chief executive Timothy Eller earned nearly five times as much as co-president David Barclay, said that by counting previous years’ option grants, the table magnified the compensation of long-standing executives.

A spokesman for Black & Decker, the hardware manufacturer, said that one of the reasons for paying Nolan Archibald, chief executive, $10.2m compared with the $2.2m received by Michael Mangan, chief financial officer, was that Mr Archibald had headed the company for more than 20 years. Mr Mangan has been in his position since 2000.

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