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CEO Compensation: Does It Make Sense?
November 5, 2008

Chris Bengs
Research Analyst, www.WhatAreTheyPaid.com

CEOs have been in the news a lot lately, and for all the wrong reasons. Many have had to answer questions about the pay they receive and whether or not that pay is justified.

At WhatAreTheyPaid.com we believe that executive compensation should be fair to shareholders. If the goal of publicly-held companies is to maximize shareholder value, then CEO pay, and executive pay in general, should be closely tied to the performance of the company. Since CEO pay has been questioned so much lately, we felt it would be appropriate to conduct a study to see how compensation correlates with the CEO's responsibility and success. This study compared CEO compensation with company size, profits, and growth.

We chose to look at the Dow 30 since they provide a good cross-section of well-known companies and the Dow Jones Industrial Average is commonly used as a measure of the stock market's performance. Additionally, our company has a database that was readily available for analysis. Looking at these companies, we found no correlation between any of the variables chosen and CEO compensation! We compared the three areas to every category imaginable for compensation: bonuses received, cash incentives, stock awards and stock options received, base salary, and the combination of all these categories (total compensation). None of these comparative studies showed any evidence of correlation.

Size

To measure the size of a company, we chose to look at two variables: (1) the number of employees in a company and (2) market cap (the number of shares outstanding multiplied by the stock price).

The number of people employed by the Dow 30 companies ranged from 60,000 to 2.1 million. When comparing this variable to our 2007 total compensation measurement (salary + bonuses + non-equity incentives + stock awards + stock options), we get the following graph:

Employees v. Total Pay

As you can see, there is no relationship between the number of employees controlled by the company and CEO pay, thus CEOs do not necessarily get paid more to manage a larger company.

Market cap is not only a good measurement to judge the size of a company, but also the company's value. It is a measurement commonly referred to by analysts when they evaluate a company. The Dow 30 companies again represent a wide range of company types, based on market cap. The Dow 30 market cap range is from $5.6 billion all the way up to $402 billion. When compared again to our total compensation measurement, the graph is as follows:

Market Cap v. Total Pay

Yet again we see absolutely no correlation between these two variables. Even CEOs themselves talk about the challenges of managing a small company versus a large company. So why are the CEOs managing the $5 billion companies getting paid the same as the CEOs managing the $200 billion companies?

Profits

To measure the profitability of the Dow 30 companies, we chose to look at the net profits earned in the year 2007 (the most recent data for all 30 companies), and the change in net profits earned from 2006 to 2007. We aimed to discover whether or not CEOs would be compensated more if their companies were more profitable. The same randomness we found earlier was found here as well. The chart comparing net profits from 2007 to our measurement for total pay looks as follows:

Net Profits v. Total Pay

If profits weren't even related to how much a company pays a CEO, what would be? Perhaps looking at company growth was the answer.

Growth

To measure growth we compared CEO pay to the change in EPS (Earnings Per Share) over the last 5 years for each company. Growth vs. Total Pay again showed no significant relationship. We will spare you the graph, which looks very similar to the previous graphs. We also compared this growth measurement to the separate categories of compensation: salary cash incentives, stock awards, etc. Thinking that the total cash bonuses received by CEOs (bonus + non-equity or cash incentives) should be closely aligned with growth, we thought this comparison would at least show some relationship:

Growth v. Total Bonus

We did indeed find some semblance of a relationship with the companies experiencing little to no growth. Once past about 10% growth rate, however, the total bonus figures become very erratic. This was the closest relationship we could find, but still not nearly strong enough to hang your hat on.

Conclusions

Since no relationship exists between CEO pay and the size, profits, or growth pattern of a company, there is no reason to believe that these Compensation Committees are doing an adequate job of aligning CEO pay with shareholder interests. All this says is that CEO pay is based on the ability of the company to negotiate a good deal with the incoming CEO and/or his representative. Therefore, a company-by-company analysis is needed to evaluate the compensation programs of publicly-traded corporations.

At WhatAreTheyPaid.com that is exactly what we do. We have already begun by looking at the Dow 30, and we intend to expand this analysis beyond those 30 companies to include the top 500 companies in the country. Not all companies are doing a poor job at rewarding the performance of their executives, but many are. To see which companies in the Dow Jones Industrial Average did a good job in 2007, see our Fair Pay Index and review our company-by-company analysis.

The practices put in place to evaluate and reward CEOs is an indicator of policies throughout the company. CEO pay is important because it not only indicates how well money is managed at the top, but also when it comes to giving out money to the other executives and managers. Well-aligned programs can not only save companies millions of dollars at the CEO level, but even more when multiplied throughout the company.

In many corporations today CEO compensation does not make sense, but with increased scrutiny, we hope it will in the future.

Chris Bengs is a Research Analyst for WhatAreTheyPaid.com. To contact Chris Bengs regarding this article or other related topics, send an email to feedback@whataretheypaid.com.


Home Fair Pay Index Ratings of the Dow 30 Companies Research Glossary Links Contact Us		Research CEO Compensation: Does It Make Sense? November 5, 2008 Chris Bengs Research Analyst, www.WhatAreTheyPaid.com CEOs have been in the news a lot lately, and for all the wrong reasons. Many have had to answer questions about the pay they receive and whether or not that pay is justified. At WhatAreTheyPaid.com we believe that executive compensation should be fair to shareholders. If the goal of publicly-held companies is to maximize shareholder value, then CEO pay, and executive pay in general, should be closely tied to the performance of the company. Since CEO pay has been questioned so much lately, we felt it would be appropriate to conduct a study to see how compensation correlates with the CEO's responsibility and success. This study compared CEO compensation with company size, profits, and growth. We chose to look at the Dow 30 since they provide a good cross-section of well-known companies and the Dow Jones Industrial Average is commonly used as a measure of the stock market's performance. Additionally, our company has a database that was readily available for analysis. Looking at these companies, we found no correlation between any of the variables chosen and CEO compensation! We compared the three areas to every category imaginable for compensation: bonuses received, cash incentives, stock awards and stock options received, base salary, and the combination of all these categories (total compensation). None of these comparative studies showed any evidence of correlation. Size To measure the size of a company, we chose to look at two variables: (1) the number of employees in a company and (2) market cap (the number of shares outstanding multiplied by the stock price). The number of people employed by the Dow 30 companies ranged from 60,000 to 2.1 million. When comparing this variable to our 2007 total compensation measurement (salary + bonuses + non-equity incentives + stock awards + stock options), we get the following graph: As you can see, there is no relationship between the number of employees controlled by the company and CEO pay, thus CEOs do not necessarily get paid more to manage a larger company. Market cap is not only a good measurement to judge the size of a company, but also the company's value. It is a measurement commonly referred to by analysts when they evaluate a company. The Dow 30 companies again represent a wide range of company types, based on market cap. The Dow 30 market cap range is from $5.6 billion all the way up to $402 billion. When compared again to our total compensation measurement, the graph is as follows: Yet again we see absolutely no correlation between these two variables. Even CEOs themselves talk about the challenges of managing a small company versus a large company. So why are the CEOs managing the $5 billion companies getting paid the same as the CEOs managing the $200 billion companies? Profits To measure the profitability of the Dow 30 companies, we chose to look at the net profits earned in the year 2007 (the most recent data for all 30 companies), and the change in net profits earned from 2006 to 2007. We aimed to discover whether or not CEOs would be compensated more if their companies were more profitable. The same randomness we found earlier was found here as well. The chart comparing net profits from 2007 to our measurement for total pay looks as follows: If profits weren't even related to how much a company pays a CEO, what would be? Perhaps looking at company growth was the answer. Growth To measure growth we compared CEO pay to the change in EPS (Earnings Per Share) over the last 5 years for each company. Growth vs. Total Pay again showed no significant relationship. We will spare you the graph, which looks very similar to the previous graphs. We also compared this growth measurement to the separate categories of compensation: salary cash incentives, stock awards, etc. Thinking that the total cash bonuses received by CEOs (bonus + non-equity or cash incentives) should be closely aligned with growth, we thought this comparison would at least show some relationship: We did indeed find some semblance of a relationship with the companies experiencing little to no growth. Once past about 10% growth rate, however, the total bonus figures become very erratic. This was the closest relationship we could find, but still not nearly strong enough to hang your hat on. Conclusions Since no relationship exists between CEO pay and the size, profits, or growth pattern of a company, there is no reason to believe that these Compensation Committees are doing an adequate job of aligning CEO pay with shareholder interests. All this says is that CEO pay is based on the ability of the company to negotiate a good deal with the incoming CEO and/or his representative. Therefore, a company-by-company analysis is needed to evaluate the compensation programs of publicly-traded corporations. At WhatAreTheyPaid.com that is exactly what we do. We have already begun by looking at the Dow 30, and we intend to expand this analysis beyond those 30 companies to include the top 500 companies in the country. Not all companies are doing a poor job at rewarding the performance of their executives, but many are. To see which companies in the Dow Jones Industrial Average did a good job in 2007, see our Fair Pay Index and review our company-by-company analysis. The practices put in place to evaluate and reward CEOs is an indicator of policies throughout the company. CEO pay is important because it not only indicates how well money is managed at the top, but also when it comes to giving out money to the other executives and managers. Well-aligned programs can not only save companies millions of dollars at the CEO level, but even more when multiplied throughout the company. In many corporations today CEO compensation does not make sense, but with increased scrutiny, we hope it will in the future. Chris Bengs is a Research Analyst for WhatAreTheyPaid.com. To contact Chris Bengs regarding this article or other related topics, send an email to feedback@whataretheypaid.com.