Each May, a prominent report in The Wall Street Journal likely drives many U.S. workers to feel envious of the corner office.
The business newspaper’s 2014 CEO pay survey, published with help from management consulting firm Hay Group, showed Oracle Corp.’s former CEO Larry Ellison as the top paid public-company chief of 2013. Oracle valued Ellison’s total compensation package — which, like other CEOs, includes more than base salary — at about $77 million for the year.
Salaries for chief executives at S&P 500 firms, meanwhile, rose 5 percent in 2013 from the year earlier to a median of just more than $1 million, according to human resources research firm Mercer. And as corporate profits continue to rise, so does the likelihood that CEO pay will, too.
Executive pay has become a dicey issue thanks to the economic hardships brought as a result of the financial crisis. When the Wall Street government bailout left bank executive salaries and bonuses mostly intact, it’s easy to see why the growth in executive pay can leave many hard-working employees resentful.
Still, despite such headline-grabbing figures, compensation experts say executive pay can be useful to talent managers looking for a way to communicate values to the rest of an organization.
“CEO compensation sets the tone for compensation in the organization,” said Gregg Passin, Mercer’s North American executive rewards practice leader. “As talent folks are thinking about succession planning, filling in the pipeline or finding replacements — whether it’s at the top of the house or farther down — understanding how much CEOs get paid is very important in achieving their objective.”
Competing Through Compensation
Chief among the advantages, CEO pay is paramount in the messaging an organization can shape around its top boss, both internally and externally. It shows the level of confidence a company has in its leader and the positioning it wants the CEO to have against industry peers.
Executive pay also establishes a company’s positioning in the marketplace, said Irv Becker, national practice leader of executive compensation at Hay Group. In other words, companies that pay their CEOs more are perceived as leaders in their industry.
“The livelihood of the organization depends on it and the shareholder return, which is what the board is responsible for,” Becker said. “It depends on CEO behavior and how they go about achieving goals.”
Internally, top boss compensation can make a statement about what an organization rewards, while also communicating the behaviors that are important to a company, said Peter Gundy, managing director of reward, talent and communication at benefits consulting and research firm Towers Watson & Co.
“The high-performing companies use it [executive pay] as a competitive differentiator, almost a competitive weapon,” Gundy said. “It makes a difference for them as they compete against other like-companies.”
Experts say talent managers can play a role in making sure CEO compensation aligns with organizational goals and values, with the way in which practitioners communicate executive payespecially important.
“Having an effective talent management function goes hand-in-hand with having sound compensation programs,” Gundy said. “The talent professionals are bringing the resources to the organization and helping to make strategic decisions about people. The compensation programs play a supporting role in helping to realize the performance.”
Pay for Performance
Aligning pay to executive performance is not a one-size-fits-all endeavor, however. No two companies are likely to have pay systems that are exactly the same.
Younger organizations, for example, are expected to offer annual incentive programs to their executives that reward based on growth; mature organizations, meanwhile, are more likely to compensate based on operational efficiencies and stock performance.
In either case, measures that link pay to performance should be aligned with a company’s strategy, said Rich Floersch, executive vice president and chief human resources officer at fast-food giant McDonald’s Corp. The reason: There needs to be consistency in what employees believe the company’s goals are and how they — executives included — will be compensated should it achieve those goals.
More Money, More Problems?
Although compensation might seem like an incentive for better performance, researchers at the University of Utah’s David Eccles School of Business have found otherwise.
According to their research, companies paying CEOs in the top 10 percentile of pay relative to their peers saw a 10 percent decrease in their stock prices over the next three years.
“Right now, the craze is to have lots of incentive pay, and that aligns the interest of the CEOs and shareholders,” said Michael Cooper, professor of finance at the university and leader of the study. “It looks like high incentive pay doesn’t necessarily do its job.”
The 2014 study looked at 1,500 top firms from the past 20 years as well as the characteristics of the highest paid CEOs from those companies. Cooper said higher-paid CEOs were also overconfident peers — so sure of their firms’ future performance they chose not to exercise their stock options the way others would — compared to lower-paid peers.
Overconfident CEOs tended to do whatappeared to be bad things for shareholders, such as investing too much or pursuing too many mergers and acquisitions. They also tended to have more tenure, which meant they had time to “stack the deck in their favor as far as the board goes,” Cooper said.
Firms with higher-paid, more-tenured and overconfident CEOs saw a 22 percent decrease in stock prices over the next three years, the study found.
At McDonald’s, Floersch said the company uses incentives not just when it is doing well. “When the company is not doing as well, we ought to send the right kind of message out both inside and outside that we’re not happy with the performance — and their rewards are going to show that,” he said.
McDonald’s President and CEO Don Thompson knows this firsthand, as news reports from earlier this year showed his total compensation in 2013 fell by more than $4 million to about $9.5 million amid sagging sales. Thompson participates in the same annual incentive plan as every other employee at the company, a McDonald’s spokeswoman said.
But performance goes beyond numbers. Hay Group’s Becker said talent management professionals play a role in building a balanced scorecard that takes into account both quantitative aspects — the financial performance of a company — and more qualitative factors, like how the CEO promotes company culture or represents an organization to the public.
“We don’t want a situation where you have great numbers but have a CEO who’s abusive or coercive,” Becker said. “We focus so much on the numbers, but what we should really be focusing on is how does the board manage the CEO, what kinds of behaviors do we want the CEO to have, and how do we make sure we balance those behavioral indicators with financial metrics.”
Talent management can influence the board’s oversight of executive performance by inserting themselves into the conversation. Becker said the head of talent should stand before the board of directors at least once a year to develop their voice by discussing succession planning, senior management, talent development and expectations for CEO behavior.
As much as top-of-the-house pay affects the senior level of an organization, it can also play a role in the sentiment of lower-tier employees. Experts say aligning pay with performance breeds trust and loyalty in employees throughout the ranks by communicating a company’s values and, more important, its commitment to those values.
Specialty grocer Whole Foods Market Inc. uses complete compensation transparency as its strategy to influence executive compensation and organization-wide performance. The Austin, Texas-based company publishes a wage disclosure report each year listing the compensation of all of its employees, executives included. CEO Walter Robb earned a salary of a little more than $3.2 million for the company’s fiscal 2013, according to its annual proxy statement to the Securities and Exchange Commission.
“We believe by doing this, we engender an environment of transparency, openness and trust,” said Mark Ehrnstein, executive coordinator of team member services at Whole Foods, which also caps its executives’ salaries at 19 times that of the average full-time employee. The company says such compensation transparency helps keep its annual turnover rate at less than 10 percent.
McDonald’s, for its part, sends out a commitment survey that asks employees for their opinion on the way executives are compensated, providing them with a sense that they have skin in the game.
“The people within an organization probably know better than just about anybody how the organization is being led and how it’s performing,” Floersch said. “People are watching those decisions very carefully, and when they seem like they’re sound decisions that make a lot of sense, the level of commitment and engagement can be stronger.”
To learn more about industry trends in executive pay, read the sidebar that accompanies this feature here.