June 15, 2011
Beware of the $1 a Year CEO
This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.
There is no shortage of interest in CEO pay, with most people fixated on CEOs being paid too much. But I find it equally appropriate to also check the facts when CEOs are paid too low. Earlier this month I had the chance to read Mina Kimes’ Fortune Magazine article, “A $1 CEO Isn’t a Bargain.” And when I started to look at other articles published on the topic, it was interesting to see headline grabbers like “$1 CEOs and What They Make Now” by Meg Mollmann, and “Citi CEO Pandit’s Salary Soars to $1.75 million from $1,” posted across multiple media outlets.
We have all read stories about certain CEOs who want to align their interests with shareholders by throwing their hat in the proverbial “$1 per year salary” ring. Some of this altruism is indeed as it appears. When Rick Wagoner, former Chairman and CEO of General Motors, decided to take a $1 a year salary in 2008, it was clearly in response to dire straits at GM and its impending bankruptcy. Similarly, Jeff Bezos of Amazon and Steve Jobs of Apple take virtually no compensation year after year because they stand to earn more in ownership value than in salaries or bonuses if their companies do well. These cases make sense.
However, some of the $1 a year cases are not so altruistic; instead, they are more opportunistic. In my recent book “Fair Pay, Fair Play: Aligning Executive Performance and Pay,” I talk about what happens when organizations create an extreme risk oriented pay mix—where executives give up fixed, less leveraged, pay in exchange for more variable, more leveraged pay.
Some leverage makes sense. After all, the pay system needs leverage in order to align pay and performance. But leverage, taken to an extreme, can also create an incentive for the executive to take on undue risk. Moreover, executives, being smart, expect to be compensated (and sometimes, overcompensated) for taking on the higher risk. This happens when fixed compensation is traded off for outsized variable compensation, and when short-term incentives are traded off for outsized long-term incentives.
In fact, research conducted by Steve O’Byrne, a respected consultant in our field, shows that on average a CEO receives more than $1 in target equity value for every $1 of target short-term compensation surrendered. In other words, with this greater risk, executives sometimes earn outsized pay for the performance delivered. So, the $1/year salary, while sometimes done for exactly the right reasons, can also be a ruse for executives to earn more while seemingly earning less – the ultimate sleight of hand in the magical world of executive compensation.
One recent example that has drawn skepticism is Citibank’s CEO Vikrim Pandit. In addition to his salary going from $1 to $1.75 million, Citigroup recently released an 8-K (the report of unscheduled material events or corporate changes), filed May 18, 2011, describing Pandit’s new discretionary award opportunity. This potential award includes $10 million in deferred stock for three rather qualitative performance hurdles: (1) regulatory considerations (such as capital levels and ratios and the results of Citi-wide risk management efforts), (2) an organizational culture focused on responsible finance, and (3) talent development (such as the quality of succession and development plans across a broad group of senior managers). While these qualitative measures are certainly important, the optics on this award opportunity aren’t great since it looks like Pandit is making up for lost salary through this discretionary award – which means he did a lot better (and shareholders did worse) than if the company had just stuck with paying him the salary.
Another example which I wrote about in “Fair Pay, Fair Play: Aligning Executive Performance and Pay,” is Copart. This is a company in which the CEO and president both gave up their salaries and bonus opportunities in April 2009, the nadir of the economic decline, in return for a five-year upfront option deal. Our analysis showed that given the options granted, these two executives could earn up to three times their prior potential compensation at a median 10 percent total shareholder return (TSR), and five times their normal compensation at a 30 percent TSR. In this case, as in the Citibank case, shareholders likely would have done better had the executives been compensated fairly in accordance with a more conventional compensation plan.
So, just because a CEO’s salary is low, investors and compensation committees should not throw caution to the wind. Instead, they should ask and answer the following questions:
– Is there a fair trade-off between the reduced salary and enhanced incentive opportunity at expected levels of performance? Do we know what the executive’s Performance-Adjusted CompensationTM will be at various stock price outcomes?
-Will the increased risk in the system encourage undue risk-taking?
-Is there philosophical agreement on what will happen if performance does not materialize? In other words, if performance is poor, will the CEO really walk away with $1, or will he or she be “made whole?”
So, there you have it. Even the $1 a year salary can leave compensation committees exposed to criticism for paying “no matter what” vs. paying for performance.
Robin A. Ferracone is the Executive Chair of Farient Advisors, LLC, an independent executive compensation and performance advisory firm which helps clients make performance-enhancing, defensible decisions that are in the best interests of their shareholders. Robin Ferracone is the author of a recently published book entitled Fair Pay, Fair Play: Aligning Executive Performance and Pay, which explores how companies can achieve better performance and pay alignment. Robin can be contacted at firstname.lastname@example.org.