Originally one post, I’ve broken it into two parts. Today is how corporate executives are paid. Tomorrow is how they should be paid.
The hot topic for this week is going to be executive pay lead by Merrill Lynch’s and Wachovia’s recent news. We’ve all hated how much corporate executives made over the years but we’ve never really stood up and cared. Well now that our tax money is being used to bail out these companies the executives were leading, all of a sudden we’re out of our chairs.
And rightfully so. Executive pay in the United States is higher than any other country in the world relative to the average pay of an employee. Moreover, the ratio has increased substantially over the past few decades. Depending on how it’s measured, the average compensation of a Fortune 500 executive is between 100 to 400 times the earnings of the average worker at that company. 100 times may be appropriate in a good year, but they are making that when it’s good and bad.
But we’re getting ahead of ourselves. First we must look into the structure of executive compensation. Executive compensation, or any compensation for that matter can be broken up into 5 parts (us peasants just don’t get some of the categories).
Base Salary: We all get this in some form or another. Typical among the big firms might be $1,000,000, but it can be lower and higher.
Short Term Incentives: Also called bonuses, this is the reward for doing your job. I get a (very super almost offendingly) small bonus; but I don’t understand why any of us are paid bonuses, when all I did was what was expected of me. Executives often see bonuses many times their actual salary.
Long Term Incentives: Retirement. Previously it was a pension for you old people and government types. Now we get these in the form of matching contributions to 401(k)s. Executive plans are much more complex.
Benefits: For most of us, this is insurance.
Perks: For most of us, this is pens and sticky notes, and that isn’t even official. Executives have access to limos, free car leases, relocation assistance (they might buy you a house), and of course those jets we always hear about.
It all seems pretty simple, but in executive world it gets much more complicated in the short and long term sections. When you hear about an executive getting a $500 million compensation, most of that is coming in the form of equity offerings and bonuses. You know what a bonus is. Equity offerings come in a few different forms and stock options are perhaps the most familiar. Company granted stock options are an incentive to increase profitability in the company, thus driving up the stock price, which is the ultimate goal. An executive might be offered $1,000,000 in stock options (this is not that same as $1,000,000) that they can cash in on in 5 years. The stock price grows 10x the value the options were issued in, and the executive is able to net a 9x gain. Restricted stock is another option. This is a gift of actual stock that will not be granted unless certain conditions are met.
To keep from looking bad, executive salaries are kept low and they make up for it with these equity options. A hidden advantage of this platform is the taxation. You see, the salary is taxed at the normal income tax rate, 35%. However the income from the equity offerings is taxed as capital gains, which is currently at 15%. That will keep millions in their pockets.
I’m not interested in a long rant about how outrageous this is and why as leaders of the company they should set an example. You’ve heard all that and the simple fact is, if the board of directors told you your pay this year would be $250 million, you’d be a liar if you said you wouldn’t take it. For $250 million I’d be willing to go through any amount of stress or ridicule they must endure. While I think executive pay is out of line, my only real beef is: Why is my bonus a percentage of my salary and theirs is a multiple?
It isn’t worth your time to delve into that either. Instead I want to propose two alternative compensation strategies that everyone can get behind. Tomorrow.
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
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