April 16 , 2003

Not surprisingly, the U.S. Congress does not want to use the people's money to prop up the salaries of airline executives.  Following Congressional grants after 9/11, several airlines increased the pay of their executives even as they were asking for wage concessions from their employees. 

Of course, the argument for such pay is to "keep" the key executives. 

Remarkably, airlines continue to function when "key" executives retire.  Elsewhere in corporate America, special grants are given to retiring executives.  If you wanted to motivate them, why surprise them with retirement grants such as were given at General Electric?

I already have written about executive compensation.  The method of comparing to other executive pay is not what economists would use. 

According to economic theory, the marginal worker in a skill class should be paid the value of what that worker is producing.  To pay more would erode profits.  To pay less would discourage others from wanting to work for the company.  As a result, too few of that skill class would be hired. 

Unfortunately, the theory fails with executives.  Most corporations would not want more than one CEO, CFO or C anything.  Decision making would be seriously impaired. 

As a result of the uniqueness of corporate executives, compensation experts have devised a three tiered system for compensating them. 

The first tier is base pay.  This is what an executive would receive in order to fill a spot.  Thus, an adequate financial officer, an adequate information officer, and an ordinary operating officer would earn only base pay.  As adequate executives are not special and do not need to be kept, this should be a pay scale that could find a comparable replacement. 

Although compensation experts usually ask what the comparable job pays in similar types of companies, I would look at what the person being paid the next rung down is paid.  More likely than not, that person will be the replacement.  Of course, the additional responsibilities should require a substantial raise.  Probably as much as a doubling might be appropriate for that heightened responsibility (but certainly not more). 

The next tier is bonus.  Executives should have all their bonus at risk.  Unfortunately, compensation experts have begun to compare bonus packages to determine appropriate compensation.  Certainly, no CEO should get a bonus when the enterprise value is falling (unless, of course, the person was hired to stop the leakage and has slowed the flow).  That executives almost always earn some bonus despite performance is where some of the executive compensation has gotten out of control. 

Of course, bonuses should be related to what an executive can do.  Financial officers may get a small piece for lowering costs of gathering financial information or increasing information flow for operational efficiencies.  Information officers may get something for lowering technology related costs and seamlessly introducing new procedures. 

Thus, some compensation would be based on corporate objectives other than earnings.    In addition to earnings, sales, employee turnover, customer satisfaction and other major corporate objectives would determine the bonuses for most officers.  The CEO should only receive a bonus if budget objectives are achieved or exceeded.  Under no circumstance should the size of the bonus exceed the size of the gain in earnings.

Failure to deliver what was promised in the budget would eliminate the bonus.  (You would have several levels of bonus so the executive does not low ball the budget).  If world conditions are at fault (a clearly overworked excuse), the budget can address them next year. 

The third tier is compensation for increasing the value of the enterprise.  Stock options are appropriate here.  Again, the executives should not receive more than the value created.  I would expect a fixed percentage of stock to be provided in the form of options over a period of years.   I would use a long period for vesting to "keep" the executive.  An executive who leaves for other than retirement loses unvested options. 

I have no problem with executives getting wealthy with options.  The problem arises when executives  dilute the ownership of investors by getting options even as they are reducing the value of the enterprise.

In 1980, the average CEO received total compensation at 41 times the average shop worker's wage.  In 1990, total compensation had climbed to 82 times.  Admittedly aided by unusually favorable stock performances, average CEO compensation was 411 times that shop worker in 2000. 

I don't know what number is right for CEOs, but I am sure that the rate of ascent is way beyond economic reason.   And Congress has a right to ask why if you go to them for a grant of the people's money. 



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