The Reason Why CEO Is Paid Much in Business

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There’s not any shortage of headlines about CEOs getting paid seriously major money. Last week, for example, it was revealed thatMicrosoft CEO Satya Nadella obtained a 66% raise, bringing his total compensation to nearly $43 million.And this summerAbigail Disney, an heir to the Disney fortune,publicly criticizedCEO Bob Iger’s $66 million pay package, which is over 1,000 times the median pay of Disney workers.

While many CEOs aren’t as generously compensated as Nadella and Iger, they do fairly well.

In 2018, the median total compensation for S&P 500 CEOs rose 4% to $12.3 million, according to the most recent figures from the Conference Board. CEOs at the high end of that group were compensated more than $22 million, while people at the low end were paid approximately $6 million.

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One big consideration that goes into how much a CEO should be paidis what other businesses are paying. Compensation committees benchmark CEO cover against a self-selected peer group — often 12 to 20 companies which may be of similar size and sophistication, and also have similar business models, according to Robin Ferracone, CEO of Farient Advisors, an executive compensation consulting company.

Boards will also consider if not a candidate would be a first-time CEO, that will typically be compensated in the lower end of this scale.

When the selected candidate is forfeiting still-unvested stock awards at her current employer, the board may provide a one-time”make-whole” cover award to compensate for this reduction in addition to her usual compensation.

That is partially why internal candidates are usually less expensive than outsiders. “You’re starting them out in the very low end of the industry range. It’s a significant step up for them but fairly priced for someone free of CEO encounter,” Ferracone explained. “And you don’t possess the make-whole pay awards. They’re already at the company. They’re not walking .”

Plus, boards looking out for a CEO will need a proven commodity and that will cost them longer because an expert CEO will wish to get paid over the average, said David Swinford, CEO of executive compensation consulting firm Pearl Meyer.

Tying Pay To Functionality

CEO compensation packages typically include a base salary, a bonus program, two types of long-term incentives, also perks and benefits, Ferracone explained.

With investors demanding that cover be tied more closely to performance, an increasing share of CEO compensation is in company stock,particularly in long-term and bonuses incentive plans. For the first time last year, stock awards accounted for at least 50% of S&P 500 CEOs’ total overall compensation, the Conference Board found.

In the case of Microsoft’s (MSFT) Nadella, the vast majority of his $43 million pay package comes in stock awards. The same was true for Disney’s (DIS) Iger.

But stock awards have strings attached. Payment typically depends on if a CEO hits certain goals,which are primarily financial –for example,an earnings goal or a return on capital investment. There might be a few non-financial targets, too, like increasing diversity among the ranks or reaching certain safety goals.For example, Chuck Jones, who has been CEO of the utility firm First Energy since 2015, has to meet safety and diversity aims to receive his full incentive potential, Ferracone said.

Stock awards come in several flavors, including restricted stocks and performance shares. Each have their own set of principles and vesting programs and each differ in how directly they’re tied to performance. The executive could purchase 1,000 shares of restricted stock, a third of which will vest annually for three years.If the firm — and by extension its stock price — do well beneath the CEO, his pay from that award will be higher than $100,000.

If instead the CEO is granted 1,000 performance stocks, he will need to fulfill a given goal over time — for example, a normal return on investment during the next three years — to find the full payout. If only part of the target is fulfilled, he may find a partial payout, Swinford said.

In either circumstance, the $100,000 is exactly what gets counted as part of this CEO’s compensation annually it’s awarded, even though he can end up getting much more or less determined by where the share price is when the award vests. So a CEO’s published settlement number for a given year often isn’t a true reflection of what he takes home that season or that which he’ll eventually be paid.

Are CEOs Paid A Lot Of?

Most large public companies are now required to provide shareholders with a vote on CEO settlement under the SEC’s Say-on-Payrule. The vote results are not binding, and thus don’t require the board to take action. But they do allow boards know how burglars feel about the issue. The rule has only been in effect for 2 years. However far this year,investors have rejected just 2.5percent of cover package proposals, and the rate was similarly low annually, based on David Kokell, manager of US settlement search for Institutional Shareholder Services.

Considering that the Say-on-Pay rule went into effect, CEO pay has actually risen. Still, Kokell said,”[the principle ] has probably slowed the growth of pay. And it surely has had a dramatic impact on the makeup of high executive pay — leading in wide scale shifts to performance-conditioned pay opportunities.”

Even with this shift, however, it can be difficult to decipher exactly how well CEO cover is aligned with performance and customer value. CEO compensation packages have numerous moving parts that pay out over time. And different corporate actions, such as stock buybacks, or even the use of different accounting procedures, can change the very targets that CEOs are supposed to hit under their pay incentive plans.

Ferracone notes that attractive CEO candidates will be doing pay comparisons of their own prior to taking a position. “It is a competitive industry. CEOs will get the job done for the business that pays them quite for the job they are doing. They are no different than anybody else in that respect.”

And when boards grow CEO pay at a few companies, that could drive different organizations to pay more because their peer group norms go up.

“Do not confuse pay with what folks are worth.No human being is worth $20 million, but a lot of executives cost $20 million,” said Swinford.

Last updated: October 30, 2019

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