Critics Cite Ways to Curb CEO Paychecks

July 25, 2006, 2005 — -- Well before they left their companies under clouds of suspicion and criminal investigations, Bernard Ebbers of WorldCom, HealthSouth's Richard Scrushy and Enron's Kenneth Lay were all noted for their lavish CEO salaries.

The size and frequency of executive scandals the last several years has put chief executive performance under scrutiny, but the pay scale for corporate titans has continued to soar.

"CEO pay has certainly moved more than anyone else's pay," said Steven Hall, president of Pearl Meyer & Partners, a compensation consulting firm.

The New York-based company estimates CEO compensation climbed 13 percent in 2004 to reach an average of nearly $10 million per year at the nation's top 200 companies ranked by revenues. Ten years ago, that figure was around $3.5 million.

Who Looks Out for Shareholders?

Few question that CEOs hold tremendous sway over the fortunes of their companies. But some shareholders and corporate consultants are beginning to question the lavish pay scales, stock options, pensions and buyout packages.

And it often appears that job performance is not even a factor. Former Hewlett-Packard CEO Carly Fiorina received a welcome package worth nearly $100 million when she joined the company in 1999. When she was fired last year, she reportedly received $21 million in severance -- despite a tenure that included poor revenues and heavy worker layoffs.

Last July, group of Morgan Stanley shareholders sued the company over the multimillion-dollar golden parachutes given to two short-term top executives, including former CEO Phil Purcell. Purcell was reportedly paid more than $106 million on his way out the door, even though the company's stock price has been slumping.

The lavish exit packages of underperforming executives continue to raise eyebrows.

And a recent study by Moody's Investors Service even suggested corporations that pay out extremely high compensation to high-level executives face a greater risk of potential credit default or downgrades in their ratings.

So why are these guys making so much money?

Keeping Up With the Joneses

Some business and compensation consultants believe there is a systemic problem within corporate culture. Companies don't want to lose face by paying executives less than what competitors are paying. Critics say that's led the inflation of executive pay to accelerate much faster than other management positions.

"The mantra of the market drives 90 percent of compensation decisions," Paul Hodgson, a compensation expert with The Corporate Library, a research firm, said in an e-mail interview with ABCNews.com.

Hodgson, who is also the author of "Building Value Through Compensation," said there were other factors driving executive pay. He said too many companies compare themselves to industry leaders rather than actual peers, often leading to overpaying for a CEO that may be running a much smaller company than a similarly paid competitor.

Pearl Meyer's Hall agreed companies should compare themselves to similar-sized rivals. But he said companies may run the risk of alienating potential candidates as well as driving away current employees.

"There have been companies that have tried to lower their pay scales, and as a result they lost talent completely. People ran out the door," he said. "Salomon Brothers tried it years ago, and they realized that if there are other places for people to go, they'll go."

But not everyone believes that is a significant danger.

"Looking at what peers in the industry are making should be of absolutely no consequence," said David Silverstein, president and CEO of Breakthrough Management Group, a business performance consulting firm.

Silverstein said most executives would leap at the opportunity to run a company, pointing out that there are only so many CEO positions that come available every year. Assuming a CEO position pays more than a candidate's current salary, the limited opportunities make it unlikely someone would turn down the chance to become a CEO, he said.

Bidding Against Themselves

Instead of measuring the market by the inflated industry standard, Silverstein said a better tactic would be to devise a pay scale that elevates a candidate's personal net worth by somewhere between three and 10 times. He thinks this, along with the clout of being the person in charge, should be more than enough to lure qualified people.

"Rarely are these guys being competed for," he said. "If you're giving someone an opportunity to increase their net worth by three, four, five times, wouldn't they want to do that? If you're offering someone the chance to become the CEO of an airline, how many other airlines are there out there for them to run?"

Another gripe of many compensation experts is the often poorly defined link between CEO pay and companies' long-term performance and shareholder returns. Silverstein said compensation packages are usually pegged to a company's short-term performance, while shareholders are more interested in a company's long-term potential.

"The reason why the amounts are so problematic is because there is usually so little connection to performance," said Lucian Bebchuk, a Harvard law professor and co-author of "Pay without Performance: The Unfulfilled Promise of Executive Compensation."

"A CEO can improve on short-term results by doing something like expanding the size of the company. That may lead to higher revenues at first, but doesn't necessarily help shareholder value."

Pearl Meyer's study of CEOs in the 200 biggest U.S. companies revealed that more than 50 percent of pay packages were tied to a combination of stock options and restrictive stocks.

Another 10 percent was pegged to long-term performance incentives, some evaluating a company's performance as far as 10 years down the road.

Five Years Down the Road

Critics say the task of corporate boards of directors and compensation committees, who often create pay packages, is to increase that small percentage. A CEO who is dependent on future performance for 40 percent to 50 percent of his or her pay is more likely to make decisions that will benefit shareholders, Silverstein said.

"When you're talking about Fortune 1000 companies you're usually talking about paying for what CEOs have done in the past, but investors invest in the future," he said. "A part of CEOs' compensation should be based on the companies' performance five years after they leave."

The power to make these changes lies in the hands of corporate boards. While shareholder complaints and even legal challenges like the one lodged in the Morgan Stanley case can draw attention to the escalating salaries, they often have little recourse outside of their voices.

Harvard's Bebchuk said change will require boards to divorce themselves from the pressure of competing with the current compensation model, one that may be dictating unrealistic inflation.

"The norms of the industry are what hold them back. Each one of them feels that they're not the reason for the poor public perception, so they're not doing anything to change," Bebchuk said. "The only way to tell the right total amount is within the context of a well-functioning market, but don't have a well-functioning market."