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Ray Suarez talks with analysts about the pay and perks given to the former head of General Electric, Jack Welch, and other corporate CEOs .
In the 1990s, Jack Welch was the epitome of an American business star. He was highly praised and highly paid for his work as general electric's chief executive officer. During his 21-year tenure, the company grew into a $480 billion conglomerate. Retired since last year, Welch is now making another kind of news.His compensation package has come under fire.
According to papers filed by Welch's wife in divorce proceedings, GE has been footing the bill for a variety of expenses, including a $15 million apartment on Central Park West, 24-hour access to a private jet, and tickets to shows and sports events, plus a $9-million-a-year pension. In his "Wall Street Journal" opinion piece today, Welch said he'd paid for tickets and other perks, and said he'd give up or reimburse GE for most other benefits. And in an interview on "Wall Street Week" on Friday, Welch maintained he'd earned some of the perks in lieu of millions of dollars in cash compensation.
In this particular deal, I sacrificed millions of dollars. Not that I am some generous sacrifice; I'd prefer to have what I had. But it was an employment contract. I fulfilled my obligations. GE did fantastically. It increased market cap $250 billion over the time frame, became number one market cap in the world, most admired global company for five years in a row.
An investigation by the Securities and Exchange Commission will examine whether Welch's lavish benefits were properly disclosed by GE. The outcry over Welch's golden parachute comes at a time of ongoing corporate scandals.
Tyco's former CEO, Dennis Kozlowski, was indicted on charges of fraud. Kozlowski and the Chief Financial Officer took home $466 million in salary and perks over the last three years by selling Tyco shares. The former chairman of WorldCom, Bernard Ebbers, got a severance package guaranteeing him an annual salary of $1.5 million for the rest of his life. Ebbers' deal with WorldCom also gives him soft terms for repaying the company more than $400 million in loans. WorldCom filed for the world's largest bankruptcy in August.
So how are these pay packages determined? And are they fair? We put those questions to Rakesh Khurana, an assistant professor at Harvard Business School, and the author of "Searching for a Corporate Savior: The Irrational Quest for Charismatic CEO's."
And Robin Ferracone, a partner with Mercer Human Resources Consulting, an executive compensation consulting firm. Robin Ferracone, let's start with you. Who decides whether Jack Welch is worth paying in this way for the years after he leaves the company with various kinds of perks and quite a large pension?
Well, usually it's the compensation committee of the board of directors. The board of directors has the ultimate responsibility, and the board delegates that responsibility to the compensation committee.
When we look at a company's assets and liabilities and try to assess it in the conventional way, what… is it believed that those kind of payouts do for a company?
Well, very often in terms of just executive pay, the CEO needs to be fairly compensated for what he or she brings to the table. The job is very unique and it's very demanding.
So compensation committees look externally to what other CEO's are making in order to get their cues. Post employment, the executives are expected to be good citizens of the corporation, are expected still to represent the corporation well. They may even be expected to do work for the corporation. Those are all things that are taken into consideration in designing an executive pay program.
Mr. Khurana, what does allowing Jack Welch the use of an apartment in New York, access to the GE Boeing 737 do for GE?
Well, I think what it says to me is that Jack Welch in this situation was given a pay package that was really not known to both investors and to the rest of the sort of world. I sort of spend a lot of time studying proxy statements in my own research, and I did not know that this was available to him. I think it's an extension of the sort of super star CEO mentality that had been created over the last 15-20 years in which a CEO was sort of thought to deserve everything he got because he created all this value for the corporation. The reality….
The reality is that you can't just say Jack Welch created all that wealth. There's over 300,000 people who work at General Electric. And to sort of assume that a single individual single handedly created all that wealth borders on irrational.
Well, is there a sense in which we can say that over his 21-year time… you heard Mr. Welch himself citing the accolades he's won, the accolades the company won during his time at the helm…that he can grab a share of that.
Well, I think Jack Welch has been a great CEO and I applaud him for the job that he's done but we have to realize that Jack Welch is the product of a GE system. General Electric has had a great string of CEO's for almost a century now. Reginald Jones, who was his predecessor, was as highly regarded as Jack Welch, if not more highly regarded.
The focus should really be on that GE produces good leaders and the focus should be on the system rather than the individual personality in that situation. Does Jack Welch deserve a portion of the value he created? Of course he does. Does he deserve the amounts that he's been getting? I think that there's a question about that. One of the reasons he took back his excess retirement pay was because he even believed that there may be an issue around that.
Robin Ferracone, Jack Welch himself was part of the ushering in of an era when we knew exactly how much value added somebody putting a door on a refrigerator was bringing to the company or packaging light bulbs, and he was known as a cost cutter and a payroll cutter for many years. Can we as reliably know how much value added an executive brings?
Well, that's a very interesting question because if you think about it, if you're looking at executive pay packages, you're basically appraising how much an executive is worth. And if you think about that as it pertains to real estate and you look at a three bedroom two bathroom house, that's a lot easier to appraise because there are a lot more comparables than a mansion with 15 acres on beachfront property.
So the CEO is akin to a mansion… there aren't that many comparables. And boards of directors and compensation committees are taking their best guess. They are also trying to do what's in the best interest of the company with respect to designing incentives so that the CEO's interests are in fact in the end in line with shareholders. That's an art form; it's not a science.
But let me check. It sounds like you're saying that CEO's when we're trying to figure out how much they should be paid are more reliably compared to each other and constitute a market in and of themselves than we would compare them to other employees in that same company; like a videotape editor at a GE-owned television station or someone who is making a microwave oven somewhere in the world.
I think that's true. We can only look to the ratio of CEO pay to typical worker pay and see that it's risen very dramatically over the last 20 years. That's because CEO pay is being compared to other CEO's and not to the lower-level employees in the organization.
Rakesh Khurana, what does that two-tier market do?
Well, I think one of the sort of misconceptions is that there's actually a real CEO market. As much of the sort of corporate scandals are revealing there's not really a CEO labor market. Compensation consultants and others often face conflicting duties, for example, between whether they're working for the board and the shareholders or are they working for the CEO.
Moreover whose CEO's compare themselves to is often greatly and intensely negotiated by the CEO. Every average CEO likes to be compared to Jack Welch for example in setting their compensation. As a result of that, we kind of have had this ratcheting effect where no board wants to pay its CEO below the top quartile that other CEO's are getting because that would mean that you have a below- average CEO. And we've had this ratcheting effect that is sort of based more on relative pay, not necessarily on performance.
You've been writing about charismatic CEO's. It sounds like you're saying that that kind of rising tide of executive compensation is pretty well distributed. It's not just a couple of big names who are sort of pulling up the curve for everybody else.
That's right. It's not just been sort of high performers who have been richly rewarded. I think over the last 50 years there was the perception that there was sort of pay for performance. As we've seen in the sort of down market of the stock market since 2000, CEO pay has continued to either stay stable or go up in many instances. So there was more of a social fiction that CEO's fortunes were tied to that of the stockholder.
Robin Ferracone, a social fiction?
I think to some extent that's true. I think to some extent the pay side of the equation has been given more attention than the performance side of the equation. And one of the things that all of these scandals and all of this scrutiny has brought to light is to try to bring the two together. I think that's a healthy outcome of what we're seeing today. If you're going to give high pay, it needs to be in return for high performance.
I also agree that there has been a ratcheting up, and that ratcheting up is because of inartful selection of peer groups who are the CEO's' peers for pay comparison purposes and paying just at the 75th percentile without the performance also being the 75th percentile has been problematic.
Is this compensation board that you've mentioned, is the board of directors in general more likely to indulge a pay demand from a peer executive and then be more hard nosed with a production worker or somebody down in accounting or somebody in the mailroom?
I think it is difficult when someone knows somebody personally to look them in the eye and say, "That is not going to fly in this company." I think it has just become a lot easier given all the scrutiny that's been going on. I think in the end it becomes incumbent upon the compensation committees as well as the managements to be working in the best interests of shareholders.
Professor Khurana, these baubles that have gotten all this attention, jets, apartments, sports tickets, things like that, are they taxed in the same way as a paycheck is? Are they considered like a salary?
Well, I'm not a tax lawyer. I don't know the details of it. But my understanding is that this is income in kind and technically it's supposed to be treated as income.
So it's not to evade certain kinds of laws or anything. It's just part of the way… the lifestyle that we have come to expect these captains of industry to live with?
I'm not an expert in this area, but, you know, if it can be shown for being business expenses, then business can legitimately use that as an expense and therefore take a deduction for that. I think it points to though a more serious issue that's been pointed out, which is it's not just the growing gap between the CEO and the rest of the workers. I mean boards are obsessive about making sure that their CEO's are paid in the top quartile. And they obsess by making sure that the rest of the workers are being paid in the bottom quartile.
More of the issue has to do with the danger we've put into our organizations, the growing disparities between the CEO's and even the rest of the managers does not do well for basically ensuring loyalty of the other managers. If all the rewards in an organization go to a single person, this is not the way you can build long-term commitment among your employees and managers to invest in the company. And this is a terrible formula for building long-lasting corporations.
Professor Khurana, Miss Ferracone, thank you both.
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