Yesterday, The Weakonomist introduced you to how executives are paid. Today, that same brilliant mind will explain his two ideas on how executives should be paid. They should be paid in pennies.
No, they should be compensated properly. My first method is a scaling of the salary of a low-level employee on up to the CEO. Let’s say the company tree is a 6 tiered model. This means there are 6 levels going from a low-level employee on up to the CEO. No matter how large a company is 6 tiers is often enough. Now let’s say the low level employees average $30,000 a year and their manager’s average pay is twice that. At $60,000 a year, their manager of course makes twice that. As this scales up you get to a CEO that makes $960,000 (See below).
Tier 6: $30,000
Tier 5: $60,000
Tier 4: $120,000
Tier 3: $240,000
Tier 2: $480,000
Tier 1: $960,000
You’ve likely noticed the CEO pay is fairly close to what I said a typical CEO might make yesterday ($1,000,000). The difference being this is total compensation including the perks and retirement and all that jazz from yesterday. $1 million was simply the base pay before. Moreover, the $960,000 is a cap, the CEO cannot earn more than that. If the CEO wants more money, he has to start at the bottom and increase the average salary of the peons. This is the same as saying the CEO cannot make more the 32x the average a low-level employee makes. If he wanted to raise his cap to $1 million, everyone on the low level would get a raise of $1,250. That’s a harder pill to swallow for a board of directors when you think about how much additional money you must shell out just to give the CEO an increase of $40k. For perspective, a $100,000 raise for the CEO costs the company $3,125 per peon. This doesn’t even include what would have to be paid out to middle management.
Having this written into the directive of the company would keep executives in check. $960,000 a year is more than enough for anyone to live. As much as I want the $120,000 Audi R8 and $130,000 Aston Martin V8 Vantage Roadster, I can live with one.
But all of this may not be enough. Being a CEO should be a sacrifice. Like the President of the United States, taking over the job should be a civil service, not a promotion. (Ignore Obama, most presidents in the past 2 decades have taken pay cuts to get into the Oval Office). The CEO should desire the position over all else, and be willing to sacrifice potential pay in order to do so. Though more radical, I actually believe the below method of compensation to be best for keeping the goals of the CEO in line with the goals of the company.
Base salary should be around $100,000. This is merely a method to get the CEOs general expenses covered. However the base salary is only the beginning. Most of the CEO’s pay will come from the bonuses. Sounds familiar right? This time though the bonuses aren’t decided by the board, they are directly related to the profit a company makes.
When a company has a profitable quarter, the CEO will receive 0.005% of the profits of that quarter.
For perspective, Exxon made over $14 billion last quarter, a record amount. That CEO would have netted $7,000,000 from that quarter alone. Translated to a yearly amount that’s $28 million. Now Exxon is setting records left and right, and a more appropriate calculation may be on a $1 billion profit for a quarter, which would net the CEO $500,000 in the quarterly bonus.
But I’m not done yet. While incentiing the CEO to maintain profitability is great, the real incentive is growing profit. There is another part of the plan. Exxon made over $11 billion in the second quarter of this year. That means during the 3rd quarter profits grew by $3 billion. The CEO gets a cut of that growth as well: 0.01% to be exact. That is more than the rate for the normal profits. 0.01% of $3 billion nets the CEO another $3,000,000 on top of his $7,000,000, or $10 million for the quarter. That makes for the potential of a $40 million year. I would actually say that the CEO did earn $40 million.
Obviously, this is much less than the CEO of Exxon will actually make this year. But what if next year oil plummets to $5 amid a depression and they make no profit? Then the CEO makes only $100,000. All this pay could come in any form the board sees fit when hiring a CEO. But it should be in a contract and made publicly known. Of course $40 million is a lot of money, but even crappy CEOs will make more than that on a mediocre year, and when you include the “retirement packages” they get the amount is much more substantial. To summarize, this is what I truly believe a CEO should be paid.
$100,000 a year base
0.005% of profits
0.01% of profit growth
No additional stock options, none of that bogus mess. Their pay is directly tied to the profitability of the company, which best represents the shareholders that own the company. No other way will truly incent the CEO to seek maximum profits out of every quarter. Finally, a compensation package that’s fair.
Yes there are other details to be worked out of a plan like this, but I’m not a one-dimensional business blog. We have other things to move on to.