Writing about "highflying executive pay" at Southwest Airlines, Washington Post writer Keith Alexander wrote on April 12, 2003, that the CEO's pay "excludes the $344,000 he gained from the sale of more than 31,000 shares of Southwest stock." There is a reason for excluding stock sales from pay. It isn't pay. Another report described another executive's loan repaid with interest as "stealth pay." Loans aren't pay, either.
Stock options are contingent pay, but the year of the payoff (if any) is not the only year in which they are earned. Consider what happened in 2001 to Larry Ellison, CEO and founder of Oracle. The 2002, Business Week story said Ellison "earned a special place in the history of U.S. compensation last year with the $706 million he pocketed from exercising long-held options." But "long-held options" cannot really be considered compensation for a single year, nor could their exercise be considered an increase in Ellison's wealth. In fact, the value of Ellison's options fell $2 billion in 2001.
Lesson Four: "Pay for performance" does not mean tying future pay to last year's stock performance.
Because USA Today defined CEO pay to include both past and future rewards from stock options, little wonder they could find no link between that measure and what happened to stocks that year. But the whole idea that there should be such a link is false.
If shareholders wanted CEOs to be paid on the basis of what happened to their stock last year, then CEOs could be paid entirely with a January bonus. But that would offer executives zero incentive to do better in the future. Grants of options, and to a lesser degree restricted stock, are contingent on future stock performance and employee retention. Such forward-looking incentives should never be linked to past moves in share prices. Yet business journalists continued to make this fundamental mistake, year after year.
In any event, CEO pay actually fell quite dramatically as stock prices did, even though some pretended not to notice. On October 20, 2002, Paul Krugman wrote in The New York Times Magazine that (estimated) CEO salaries from Fortune's top 100 had risen from a dismal low during the recession of 1975 to $37.5 million in 1999. Yet Fortune's 1999 figures, with their rosy estimates of the future value of new stock options, were inexcusably antique by October 2002.
The New York Times, April 6, 2002, had reported a 20 percent decline in CEO pay for 2001 alone. Doesn't Krugman read that paper? By October 2002, when Krugman's article appeared, it should have been painfully obvious that the paper wealth of CEO's in 1999 had been hugely reduced by the market's horrific decline.
For 2002, Fortune's estimate of average top 1,000 CEO salaries and benefits was $15.7 million -- down 58 percent from the obsolete $37.5 million estimate that Krugman treated as a current fact -- a drop of nearly 20 percent per year for three years, including Fortune's estimate of a 23 percent drop in 2002 alone. The magnitude and duration of that decline needs to be kept in mind today, as similar stories for 2003 begin to emerge, some possibly as deceitful as Krugman's was in October 2002.
Journalists who heretofore preached that CEO pay (including future incentive pay) should have fallen because stock prices fell ought now to find themselves trapped by their own reasoning. If they stick to past logic, they will have to write that most increases in CEO pay are fully justified by the spectacular rise in stock prices. But saying that, of course, would get them fired. So they will have to change the subject, perhaps by copying The New York Times' comical new ploy of suggesting CEO pay should never rise if employment falls.
It will be amusing to watch how those who specialize in griping about CEO pay every year now manage to bravely revise their stories to say that CEO pay should fall whether stocks rise or not. If this year's festival of journalistic indignation about CEO pay turns out to be even half as deceptive as previous years, I might even hand out (with appropriate ceremony) the coveted Krugman Award for Economic Trickery.
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Correction: Last week's column incorrectly referred to the Strategic Petroleum Reserve in billions of barrels rather than millions (specifically, 652 million on April 7). This does not affect my analysis or conclusion.