CEO Patriot Pledge: Interesting Idea, Bad Math

Posted by on February 12, 2009 at 8:51 am.

dollar flagBob Rosner over at CNBC has suggested the following CEO Patriot Pledge:

As an executive my primary motivation is to act for the good of my company, not just my own financial gain. No one at our company will earn a guaranteed base salary more than 40 times of our lowest paid worker and we will offer the same health care and 401(K) matches to employees as we do for executives. We support pay for performance, so when our company’s performance serves investors and employees, we’ll share in the gains. When our company’s performance does not adequately serve our investors and employees, we’ll share in the sacrifice.

Bob claims that inappropriately high executive compensation is a ripe source of capital for employing more people.  The general idea of CEOs aligning their comp with company performance is great, but Bob’s supporting examples, conclusions and resulting pledge are seriously flawed.
The prime examples Bob uses for CEOs doing it right and wrong are Tom James of Raymond James Financial and Robert Iger of Disney.  I’ll start by saying I’ve had the opportunity to meet Tom James and I’m a big fan of his, as an entrepreneur and a manager.  I’ve never met Robert Iger, but I also know you don’t get to his level without creating value on many levels.
Bob quotes James’s $325K base salary, less than 20 times the salary of RJF’s lowest paid employee.  He then quotes Iger at $51 million, but that looks like total comp — various sources quote Iger’s base salary as $2,000,000.  That exaggeration, however, is just a small piece of the bad math at play here.
James owns over 13 million shares of Raymond James, or about 11% of the company — not including any additional shares he may have in various family trusts.  That 11% is worth north of $250 million!  This is a high % for a CEO of a multi-billion dollar enterprise; but that’s what you get when a CEO was also the founder. 
Iger, on the other hand, was not the founder of Disney and his total package reflects this.  He owns just 576K shares of Disney, or about .03%.  That’s worth about $10 million.  
Given the huge disparity between their ownership positions, 11% vs. .03% (a 300X disparity), let’s consider what happens when they create shareholder value.  When James creates 10% of shareholder value, he creates about $230 million of total shareholder value, and his personal shareholder value grows by $27M.  When Iger creates 10% of shareholder value, he creates about $3.9 billion of total shareholder value, but his shareholder value grows by just $1 million!  No wonder non-stock compensation is so different for those two CEOs, demonstrating why base salary is a terrible measure for comparing CEO comp packages and as a litmus test for CEO/company “patriotism”.
It’s also worth noting that the arbitrary 40X ratio (CEO base salary vs. lowest employee base salary) is equally wrong-headed.  If the goal is aligning interests of employees and shareholders, then pay should relate to the employee’s potential to impact shareholder value.  The idea that the least-paid employee at Disney is responsible for 1/40th the shareholder value as the CEO strains reason.  I’m a big believer in employee empowerment up and down an organization, but the reality is that CEOs of large corporations impact shareholder value at a scale orders of magnitude larger than the least paid employee.  I like to think I was a talented, underpaid young engineer when I started at IBM, but I didn’t come close to creating the $180 billion of shareholder value Lou Gerstner did over his tenure.  Understandably, comp packages mirror that real-world responsibility and disparity of impact.
(Pre-emptive comment: Remember, I like Tom James and I don’t know enough about Robert Iger to form an opinion of his skills.  They were the examples Bob used and my math relates to the shareholder value at stake for their positions and relative ownership.  I’m also a strong believer in performance-based compensation, just not when it’s driven by arbitrary comparisons to other employee salaries rather than driven by shareholder value responsibility.  If people create value, they should earn more and if they destroy value, they should earn less — the magnitudes are all relative to the responsibility they hold and the market price for their skills.)

3 Comments

  • Kris Aebischer says:

    Dan – I would say that paying Iger more (in base salary) because he owns a smaller percentage only exacerbates the problem. I don’t have the link in front of me but you’ve probably seen the Michael Lewis piece on the end of Wall Street where he talks about Investment Banks having CEO’s w/o significant equity and how that trend in the 80’s ultimately led to the problems we’ve seen recently.

  • VC Dan says:

    @Kris: I can understand your observation. My core point was that using base salary for setting arbitrary ceilings is missing the point that compensation is a total package — especially if the prime example used (Tom James) involves a CEO who was also the founder.

    Most of the largest corporations in question aren’t still run by their founding CEO with significant founding ownership so comparing their base salaries to Tom James is misleading.

    A decent conclusion from the James/Iger comparison could be that we need more founder CEOs, but you can’t draw anything valuable from comparing their base salaries.

    So, taking James/founders out of the equation, how should base salaries compare between a CEO managing $30 million of company/shareholder value and a CEO managing $30 billion of company/shareholder value? I would guess the janitors in those two companies would make about the same, but should the CEOs make the same given their relative impact on shareholder value?

  • Kris Aebischer says:

    Dan – I agree that if Company X is 5 times bigger than Company Y you probably are should be looking at a bigger base salary for company Y. But holding that variable constant I don’t see any reason James’s personal stake in the company should matter. I definitely agree we need more founder CEO’s (or if not founder then a higher equity stake).

    I’m having flashbacks to all those economic theories about incentive alignment! Definitely an interesting debate in the current economic times.

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