executive officers (CEOs) get paid lots of money for being the top
employees in the company. Why do they get paid so much? Like athletes
and actors, CEOs provide a level of talent that is required to produce
the desired product - in this case, a strongly performing company.
The skills and responsibilities that come with the job of CEO are
extreme and the number of people who can fill these roles is limited.
That is why the market has determined that people with these skills
are worth a lot of money to their companies.
about 20 percent of a CEO's pay is base salary; the rest is made
up of incentives based on the company's performance. The rationale
is that if the company is performing well and the shareholders are
making money, then the CEO should share in that success.
and directs all aspects of an organization's policies, objectives,
and initiatives. May require a bachelor's degree with at least
15 years of experience in the field. Relies on experience
and judgment to plan and accomplish goals. May preside over
board of directors.
pay sets a ceiling for the company
A CEO's compensation package affects everyone within a company.
Often it can be considered the yardstick by which all other employee
benefits and bonuses are measured and negotiated. Moreover, the
CEO's compensation may be an indicator of how well the company is
performing. This performance, in turn, could translate into a more
generous compensation package for individual employees who are savvy
companies establish pay structures, they define the compensation
for the highest- and lowest-paying jobs before filling in the compensation
for the jobs that fall in between. In the traditional internal equity
method of establishing a pay structure, the CEO's compensation sets
a ceiling for the company, and each level below is compensated at
a comparably lower level. If you know how well the CEO is compensated,
you can get a sense for how generous the company is likely to be
toward other employees as well.
make most of their money through incentives
As a general rule, base salary accounts for just 20 percent of a
CEO's pay. The other 80 percent comes from performance-based pay.
pay for the core role and responsibilities of the day-to-day
running of the organization. This amount is very often less than
$1 million because the IRS has imposed tax restrictions on "excessive"
bonuses for meeting annual performance objectives.
incentive payments for meeting performance objectives to be
achieved for a two- to five-year period. These awards are sometimes
described as performance shares, performance units, or long-term
stock awards as an incentive to assure the executives are
strongly aligned with the interests of shareholders. Because restricted
stock awards have an actual cash value when they are granted,
the proxy table shows these in dollars, not in shares.
options and stock appreciation rights (SARs) for increasing
share price and increasing the shareholders' returns. Options
have very favorable accounting treatment for the company, which
is why they are so common. Option grants are always shown as a
number of shares underlying the option. In a subsequent table
in the proxy is an estimation of the present value of each option
grant assuming a 5 percent and a 10 percent increase per year
in the stock price, or using a mathematical model (e.g., Black-Scholes)
to predict the value of the option.
compensation for CEOs goes beyond cash and stock
Although typically excluded from pay calculations, executive benefits
and perquisites are disclosed in the summary compensation table
and the retirement plan section of the proxy. They include the following.
executive retirement plans (SERPs), which may keep the executive
whole (that is, make up the difference) or better from a tax regulation
that prevents the executive from receiving a pension benefit that
exceeds ERISA limits ($135,000 per year or less based on the pension
plan). For a CEO making $2 million a year, a $135,000 benefit
may be inadequate for maintaining a comparable lifestyle.
insurance plans that provide a source of retirement income
and a richer death benefit to the executive's family. These plans
are used to guarantee retirement benefits from bankruptcy. Unlike
standard retirement plans that receive protection from bankruptcy
by the federal government, SERP benefits can be lost in the event
executive perquisites and other compensation for various programs
or negotiated deals that don't properly fit into the above categories,
including perks such as country club dues and financial planning.
These are often small numbers that disclose imputed income amounts
for those additional special benefits, but can also include some
very large amounts for items such as loan forgiveness, special
insurance programs, relocation expenses, etc.
most companies, most of a CEO's pay comes from stock or stock option
gains. At investment banks, most of it comes from annual bonuses.
Companies that pay the lion's share of compensation in the form
of stock options may pay little or no retirement. You can tell by
looking for a retirement table in the proxy statement. If the words
"SERP," "ERISA-excess plan" or "Top Hat plan" appear in the proxy,
then retirement is an important part of the executive's remuneration.
If not, then the executives are expected to retire on their ability
to make and save money on their cash and equity earnings.
philosophies often tie pay to company performance
The company's Compensation Committee Report on Executive Compensation
contains specifics about your company's compensation philosophy,
which affects all employees. It covers the following.
well your company pays relative to its peers.
the company sees as its peers.
the company's stock has performed relative to its peers and to
the stock market as a whole.
the company prefers to reward its executives through its total
pay practices, i.e., what proportion of an executive's total pay
comes from salary, bonus, stock options, and long-term cash plans.
the company measures its performance - net income (NI), earnings
per share (EPS), return on equity (ROE), return on assets (ROA),
revenue growth, etc.
criteria are used for determining the size of bonus payments:
corporate results, divisional results, individual goals; or whether
payments are discretionary.
degree to which your company is a success may be answered in the
annual and long-term incentive payout columns in the summary compensation
table. If you see large bonus payments, then it is likely that your
company is successful. Stock option grants and gains are also important
to look at. This information can be gleaned from three tables in
the proxy statement: the stock option grants table; the aggregate
option exercises in the last fiscal year and fiscal year-end option
value table; and the total return to shareholders table. If there
are large gains from stock option exercises and substantial amounts
in both vested and unvested stock options, it may be an indicator
that the company is well managed in the opinion of shareholders.
Good five-year shareholder returns in the total return to shareholders
table would certainly validate this opinion.
compensation is the norm in nonprofits
Nonprofit organizations typically offer compensation weighted heavily
toward base salary. In response to competitive concerns, bonuses
are becoming more prevalent as are special tax deferral programs
that help executives save for retirement. Unlike comparable programs
in for-profits, very few of these programs are broad-based. Participation
is limited to a select few.
watchdog organizations have been critical of the amounts paid to
chief executives of nonprofit organizations. But these employers
counter that they are competing for senior talent with for-profit
organizations that can offer incentives such as stock options that
are not available to them.
Bill Coleman, Senior Vice President of Compensation