Ritholtz: CEO's Paid for Volatility, Not Performance

Making the Janitor's Annual Salary . . . Every 3 Hours!

The inimitable (and frequently bombastic) Barry Ritholtz, author of The Big Picture blog, has a great post today dissecting absurd CEO compensation titled "American Pastime: Overpaying CEO's."

His piece basically picks up where my post last Thursday ("Parsing Occidental CEO Ray Irani's 'Excellent Performance'") left off.

If you don't have time to read my post, here's a one sentence summary: Occidental's Ray Irani got paid more than $1.5 billion since 1990 for deftly outperforming the overall stock market by . . . less than 2%!

In fact, once you scrutinize Occidental's board of directors and how they got there, it would be more accurate to say that Irani paid himself that money.

The only thing I omitted from my post was a stunning little factoid explaining why galloping exec comp seems to have slowed down in recent years.

Namely, sometime in the last decade, The Conference Board, which represents CEO's at the largest publicly traded companies, successfully led an effort to redefine the ratio of CEO pay to that of the rank-and-file.

So, whereas for decades the ratio had been "top-to-bottom," i.e., comparing the CEO to the janitor, in recent years it has been redefined as the CEO's pay relative to the average worker's pay.

Ergo, you get an instant, big contraction in the ratio.

As a result, instead of (accurately) reporting that exec comp has ballooned from 30:1 to something like 1,000:1 in the last 30 years or so, the mainstream media ("msm") now universally reports that the ratio is "only" 400:1.

How . . . 1984-ish.

Ritholtz on Exec Pay

But I digress.

Once you navigate the assorted F-bomb's and "colorful language" in a typical Ritholtz post, his underlying arguments and logic are unassailable:

Five Steps to Shareholder Wealth Transfer

1. The Board of Directors, usually cronies of the CEO (often hand picked by him) forms a compensation committee. To appear “objective,” the committee hires an outside compensation consultant.

2. The compensation consultants are themselves well paid whores, who rather than turning tricks outside the Holland tunnel, offer up absurdly generous comp package. They deliver what they are paid to: They provide cover for the boards to make an otherwise indefensible giveaway of shareholder monies in the form of cash and stock options. It is typically called “Pay for Performance,” but that is a horrific misnomer, as we see in step #3. The comp committee approves the consultants’ nonsense, forwards it to the Board, who rubber stamps it.

3. Here’s where things get interesting: If the stock price rallies, the exec can exercise and cash out, risk free. If the stock price falls, the exec requests a new round of options — or even easier, asks for a repricing of the old ones.

4. After the options are repriced, the exec simply waits. Whether the market rallies or falls . . . you simply go back to step three. Repeat until stock options are in the money. There is no risk or outlay of cash on the part of execs.

5. True “performance” is not a factor. Stock prices can rally for a vast range of reasons having nothing whatsoever to do with management or CEO performance. The market can rally, a sector can come into favor, or even when the Fed can cut rates.

This is not pay for performance, it is pay for stock price volatility.

Actual performance would look at factors such as peer profitability, sector performance, SPX index gains. Bonus payments and stock option exercise should be for gains OVER AND ABOVE these factors — but sadly, rarely if ever are.

--Barry Ritholtz, The Big Picture

Ritholtz's policy prescription is equally blunt, on target -- and politically far fetched (which he readily acknowledges).

Read the full post for the particulars . . .

Parsing Occidental CEO Ray Irani's "Excellent Performance"

Obscene Exec Pay: Exhibit A

In a year when pay for chief executives overall fell, Ray R. Irani came out on top.

The longtime head of Occidental Petroleum was awarded total compensation of $52.2 million, up from $49.9 million in 2008.

The oil company's directors believe in "excellent pay for excellent performance," and Mr. Irani's leadership resulted "in exceptional returns for stockholders," said a spokesman.

--"Occidental Chief Tops Pay List"; The Wall Street Journal (4/1/2010)

Gee, if only I'd bought stock in a company like Occidental, I thought to myself, my portfolio would have done so much better last year (instead of melting down, like almost everyone else's).

Then I realized: I did buy stock in Occidental.

In 1989.

"Ray and Me"

That coincides almost perfectly with Mr. Irani's tenure at the helm of Occidental, where he has been CEO since 1990.

So, how has my investment done in the 21 years I've been an Occidental shareholder?

Not nearly as well as Mr. Irani.

From a purchase price of $15 per share then, my Occidental stock has appreciated to almost $87 today.

That's an almost six-fold increase -- not too shabby, huh?

Parsing the Returns

While it may not be shabby, it certainly doesn't qualify as stellar, either.

That's for the following three reasons:

One. Inflation. A dollar in 1989 isn't worth a dollar anymore; it's worth just a little over half that. That's because the CPI has just about doubled during that interval.

So $15 in 1989 buys the same as $30 today, reducing my 6x return to a little less than 3x.

Still not bad, though.

Except that you have to factor in how much time it took for that to happen.

Two. Annual Rate of Return. Tripling your money over two-plus decades certainly sounds good.

In fact, however, that corresponds to a rather mediocre annual return of just over 5%.

For much of that period, plain vanilla CD's yielded 5%-plus.

Three. Taxes.

If I sold my Occidental stock today, I would pay capital gains taxes -- a tame 15% by historical standards, but still not nothing.

Because capital gains taxes aren't indexed for inflation, the taxable gain would be $87 minus $15, or $72; 15% of that comes to $11. So, that leaves me with $76 for my two-plus decades as an Occidental shareholder.

How much of that is attributable to Mr. Irani's "excellent performance?"

And how much did Occidental's board of directors -- ostensibly representing shareholders like me -- think Irani should be compensated for that?

Mr. Irani's "Excellent Performance"

The answers: "less than you might think," and, "a sh*tload."

What casual readers of The Wall Street Journal don't know, but long-time Occidental shareholders (like me) do, is that Irani's 2009 jackpot was hardly an aberration.

According to Forbes magazine, here's what Mr. Irani has been paid the last several years:

2009: $52.2 million
2008: $49.9 million
2007: $54.4 million
2006: $415 million
2005: $81 million
2004: $64.1 million

Surely, Moses was paid less for shepherding the Jewish people out of Egypt.

So is that what Mr. Irani did?

Hardly.

Go back to the $15-to-$87 appreciation in the stock during his tenure.

Just using "nominal" dollars (the normal kind), that corresponds to a compound annual return of just under 9%.

Not 20% a year. Not 50% a year. Nine measly percent!! (Not even).

Making that number look even worse is what the average S&P 500 stock did during Irani's two decade tenure: it appreciated almost 7% a year.

So, is Mr. Irani a consummate corporate talent?

You bet he is: at getting a pliant board of handpicked directors to pay him a ransom that would make a king blush.

Not Just Wall Street

Local Exec Cashes In While Company Crashes

If you're disgusted by financial executives hauling in tens of millions while their companies crash and burn, it might be consoling to think the phenomenon is limited to Wall Street.

Unfortunately, it's not.

As the Star Trib reported yesterday, the former CEO of MoneyGram, Philip Milne, received a $13.1 million severance package. The company's headquarters are just off 394 and 169, in St. Louis Park.

So how did the shareholders do? Their stock is trading at a little over $1 a share, down 96% the last year.

Incredibly, the entire company is only valued at about $90 million.

An old Wall Street joke asks, "how do you make $1 million on Wall Street? Start with $10 million."

In Mr. Milne's case, the equivalent would be, "how do you create a company worth $90 million? Start with a company worth $2 billion."