Executive Excess Part 1
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GRAEF CRYSTAL: What I really want to do is to talk about some general central themes because as you know, this has been one hell of a year for executive pay.
PAUL SOLMAN: Graef Crystal, a former executive compensation consultant, has been warning of the CEO pay explosion since his 1991 quasi-bestseller, In Search of Excess, and in articles and speeches ever since.
GRAEF CRYSTAL: How are you going to get up in front of workers and say, “you’re going to have to put in, pull in your pay belt,” when you can’t even see the CEO’s pay belt because of the enormous pay gut that’s overhanging it.
PAUL SOLMAN: We caught up with Crystal at a meeting of institutional investors at the Plaza Hotel in New York, where we’d gone to ask him, “how did CEO pay diverge so much from that of the common worker?” Fittingly, perhaps, we interviewed him in the lap of luxury — in a room named after the CEO, in a sense, of 17th century France, Louis XV.
PAUL SOLMAN: The dust jacket of your book here says, “the modern American CEO is a cross between an ancient pharaoh and Louis the XIV”– we’re in the Louis XV room here, we tried to get the XIV for you but we couldn’t– and he’s paid so much more than the ordinary worker that he hasn’t the slightest clue as to how the other 99.99 percent of the country lives.” That was 11 years ago. You don’t seem to have made much of a dent.
GRAEF CRYSTAL: No, I haven’t.
PAUL SOLMAN: If anything, Crystal’s impact — as you’ll see — was to make the pay gap wider. The setting seemed ever more appropriate as we reviewed the numbers.
GRAEF CRYSTAL: I did a study in 1973 of major company CEO’s and they were earning about 45 times the pay of their workers. In ’91, it was 140 times. Today it’s just a little bit south of 500 times. It’s like Al Jolson, “you ain’t seen nothin’ yet.”
PAUL SOLMAN: Consider what these CEO’s got paid over the last three years: Cisco’s John Chambers — $280 million, while Cisco’s profits and stock price plunged. Dennis Kozlowski of now reeling Tyco — $332 million, not including some $600 million allegedly redirected for his personal use. Oracle’s Larry Ellison — $795 million, some $700 million in 2001 alone from cashing in stock options just before Oracle’s stock price began its swoon.
Now of course many people think CEO’s should be highly paid, and some think, the higher the better — even the three quarters of a billion Larry Ellison made.
BOB PAVEY, Venture Capitalist: I think we need a world where Larry Ellison can make three quarters of a billion dollars. I wish it were Bob Pavey instead of Larry Ellison.
PAUL SOLMAN: Venture capitalist Bob Pavey has publicly supported big pay packages for years, especially for entrepreneur CEO’s like Oracle’s Ellison, Microsoft’s Bill Gates.
BOB PAVEY: Ten years ago when I was in Washington, a regulator said to me, “the worst thing in the world is having people around like Bill Gates. He’s making way too much money. It’s bad for our economy. It makes us seem like we’re greedy.” No, I don’t buy that. You need one or two people who make incredible amounts of money and motivates everybody else to work longer and be more productive and to create more jobs and create a more vibrant economy.
PAUL SOLMAN: Harvard’s Rakesh Khurana, however, is dubious. For years, he says, corporate America has preached less hierarchy, more shared responsibility. So how come CEO pay has kept diverging from that of workers?
RAKESH KHURANA, Harvard Business School: Is it that those workers are now less important and less necessary? In fact, I would argue contrary. And so ironically when you see a greater sort of concentration of wealth among a small group of people and a greater disparity between that small group and everyone else, that sort of flies in the face of the sort of more egalitarian, flatter organization that we are trying to build.
PAUL SOLMAN: But so what say defenders of CEO mega-pay, like attorney Joe Bachelder.
JOSEPH BACHELDER, CEO Pay Consultant: Boards of directors in this country are seeking outstanding leadership, and they consider the CEO to be the single most important factor in the future success of that company measured by the next five or ten years.
PAUL SOLMAN: And it might just be that the CEO isn’t doing a whole heck of a lot but just enough to tip the balance to make the difference.
JOSEPH BACHELDER: That in many cases is the case. In World War II, Eisenhower, Admiral King, George Marshall stood out because of their capacity to lead large groups of people and armies and navies to win the war. They were capable of translating ideas into action in a broad based group. Same thing with a CEO to be effective.
PAUL SOLMAN: What puzzles, or perhaps angers, institutional investors like these, however, is that in the 1990s, CEO pay was rising regardless of corporate performance as measured by profits.
GRAEF CRYSTAL: The easy part of pay for performance is high pay for high performance. CEO’S absorb that in their mothers’ milk. The hard part is low pay for low performance, that’s the part they don’t get.
PAUL SOLMAN: Indeed Graef Crystal, among others, has found almost no link between CEO pay and profits over hundreds of firms.
GRAEF CRYSTAL: Every study comes out about the same. If you’re trying to explain why one CEO makes more than another, the most potent single factor that will explain it is the size of the company.
PAUL SOLMAN: That is, the bigger the company, the higher the CEO’S pay regardless of profits, which according to Rakesh Khurana, tend to depend on factors outside the CEO’S control.
RAKESH KHURANA: What industry are you in. This accounts for somewhere between 30 percent to 50 percent of the variance of firm performance or the likelihood of firm survival. The next factor is, what year is it? Is the economy doing generally good or bad. This accounts for somewhere around 20 percent of the firm’s variance. Now I’m not saying that CEO’s never make a difference, but these factors really wash out the amount that a single individual can do to affect firm performance.
PAUL SOLMAN: So if the data are right and profits don’t explain CEO mega-pay, what does? One obvious explanation is the stock market boom, combined with the fact that in the 1990s CEO’s were given more and more stock options– the option to buy their company’s stock at bargain prices.
JOSEPH BACHELDER: Eighty percent of the growth in CEO pay is attributable to stock options and similar long-term incentives. Workers have not had that, and this multiple has gone up in large measure because of the stock market.
PAUL SOLMAN: But, that again begs the question: Why did CEO’s get what workers didn’t, and so much more of it? That’s the key to this story. And the explanation, says pay expert Graef Crystal, is a pay system that simply spiraled out of control.
GRAEF CRYSTAL: My first culprit, if I identify what’s causing this problem, would be the compensation consultants, because they are like the bees bringing the news of the marketplace.
PAUL SOLMAN: When Graef Crystal himself started as a compensation consultant in 1959, firms often paid CEO’s by formula: A multiple of the average worker — the old 40:1. But then they started relying on consultants to survey other firms yearly to set their own CEO’s pay. Crystal once polled 100 firms:
GRAEF CRYSTAL: Where do you like to position your CEO, the average, below the average, above the average. Well, one-third of the companies said, “We want to position our CEO in the top 25 percent, that way we can get better talent.” Two-thirds of the companies said, “We want to be at the average.” Not one company said we want to be below the average. So you actually have the Lake Wobegon effect: If one-third of the companies are chasing the top 25 percent and two thirds are chasing the average, you can’t even catch the average. Every year, what do you know? We’re behind again.
PAUL SOLMAN: In public radio’s fictional Lake Wobegon, all the children are above average; in real-life corporate America, all CEO pay now tried to be. But the consultants couldn’t have succeeded in ratcheting up pay without the boards of directors.
TOM WYMAN, Retired CEO, Harvard Business School: I’m embarrassed, because I’ve been on quite a number of boards that have… have been as passive as I think boards can no longer be on this subject, and I’m angry, because I think that an important American institution has been damaged.
PAUL SOLMAN: Tom Wyman is a former CEO himself — of CBS, and a couple of other firms — and a member of many boards. In theory, directors are supposed to look out for shareholders’ interests and thus, presumably, keep costs down. But instead, admits Wyman, they’re often part of a cozy system that boosts CEO pay with little regard for shareholders.
PAUL SOLMAN: How much time would you spend considering the pay package of the CEO?
TOM WYMAN: Maybe ten minutes or less.
PAUL SOLMAN: Ten minutes or less?
TOM WYMAN: On compensation.
PAUL SOLMAN: That’s it.
TOM WYMAN: Yes.
PAUL SOLMAN: Just a kind of rubber-stamp?
TOM WYMAN: Yes. Yes.
PAUL SOLMAN: Further ratcheting up CEO pay, says Crystal, is that in many companies, Enron for instance, the CEO’s handpicked board of directors is made up of CEO’s of other firms, each of whose own future pay hikes may depend on how big a raise he gives the CEO whose board he sits on.
GRAEF CRYSTAL: If you could trace that pay package, here it comes around and three months later we’re having a presentation and why this CEO’S not getting enough money. Little does he know that his own actions three months earlier caused his pay to look to be 20 percent too low.
PAUL SOLMAN: Disgusted with his role in the process, Crystal switched sides to write his 1991 book — part expose, part call for reform. But unwittingly, his efforts may have helped widen the pay gap by successfully pushing for full disclosure of executive pay packages in firms’ public filings. The average was now easy to compute, and each time a firm topped it, the average rose for all to see, including competitive CEOs.
GRAEF CRYSTAL: I like to joke that every CEO before he goes to bed at night stands in front of a mirror. He says, “Mirror, mirror on the wall, who’s the highest paid of all?”
PAUL SOLMAN: And then in the mid-’90s came a final factor to turbo-charge the process: Information technology, instantly alerting every firm and CEO about every pay hike every other CEO got.
GRAEF CRYSTAL: They’ll call you up. They’ll say, “I just looked at the proxy statement of so and so.” I say “really?” Say, “really, it was released an hour ago, and he got five million shares. And you know, you told… last month, a week ago, I screamed and yelled and I only got one million. So what are you going to do for me now?”
PAUL SOLMAN: So the publication of your book, which happens to come at a time when technology’s exploding with regard to disclosure, means that since people were trying to be above average to begin with
GRAEF CRYSTAL: It got worse faster, put it that way.
PAUL SOLMAN: So a host of factors interacted in the ’90s to drive CEO pay ever further from that of workers. And this contributed or interacted with another major shift that was taking place.
TOM WYMAN: I would explain it as, in only one way and it’s contagious greed in the fraternity of CEOs.
PAUL SOLMAN: Not that today’s CEOs are greedier people, says Tom Wyman — that’s just human nature — but that the social restraints that operated in his day ceased to function.
TOM WYMAN: I think that the environment changed and what became acceptable in the CEO world, seemed to be what everyone was doing. And Lord knows it was working in… as long as the market was flying.
PAUL SOLMAN: But the market isn’t flying any more, which after a year of corporate scandals raises the final question: Mirror, mirror on the wall, will CEO pay now start to fall?