In Defense of CEO Pay

In their new book, Myths and Realities of Executive Pay (Cambridge University Press, 2007), Ira Kay and Steve Van Putten argue that the heightened interest—and outrage—over high executive pay is unfounded. The Watson Wyatt Worldwide executive compensation consultants argue that most companies really do tie CEO pay to corporate performance. Workforce Management New York bureau chief Jessica Marquez recently spoke to Kay about his book.

Workforce Management: What are the major myths about executive pay and why do you believe they are myths?

Ira Kay: A major criticism of executive pay is that CEOs are overpaid. What people mean by that is they are overpaid relative to the performance of the companies they manage. Critics who say this believe the reason for this disconnect is due to managerial power, which basically says that executives have enormous power over their boards of directors, who just rubber-stamp their pay packages. Both aspects of that statement are false.
When people say there is no pay for performance, they are looking at the wrong measure. They are looking at pay opportunity, meaning they look at new grants of stock an executive gets in a year. Then they look at the stock price appreciation for that year and say there is no correlation between pay and performance.

For example, a CEO of a high-paying company and a CEO of an underperforming company could each get $5 million worth of stock option grants in 2006. So critics see the compensation of the CEO of the underperforming company and say that’s not pay for performance. But in fact, those stock option grants might not be in the money, while the CEO at a high-performing company might make $8 million from those grants. We need to look at realizable pay. That is what they actually make.

WM: But aren’t the floors on executive pay so high that it doesn’t even matter if it’s linked to performance?

Kay: The minimums on executive pay aren’t high because the executives are setting their own pay. It’s because of the labor market. Boards are agreeing to pay this much because they think the executives are worth it. The executives are highly motivated by the upside. There are people who are outraged by how much [former Home Depot CEO] Robert Nardelli and [former Hewlett-Packard CEO] Carly Fiorina made when they left their companies, but they were disappointed too, because they should have made hundreds of millions of dollars.

WM: How do you know that executive pay contributes to company performance?

Kay: It’s very hard to prove causality. But if you look over time, executive pay has risen with high performance at companies. These executives take enormous risks. They buy companies and they sell companies.

WM: Why do you think companies should align employee compensation with performance?

Kay: Research shows companies that give employees stock or options outperform those companies that don’t give employees access to stock or options. The recent accounting rule changes that force companies to expense options are now causing companies to move away from that model, and it concerns me.

WM: But even if a company aligns employee pay with performance, won’t employees see the huge discrepancy between what they are making and what their CEOs are making?

Kay: My impression is that while some employees think their CEOs are overpaid, most employees at successful companies do not begrudge their CEO’s high pay. I am worried about how these issues affect morale and productivity, but morale at U.S. companies is fine.

Workforce Management, September 24, 2007, p. 8 — Subscribe Now!