FREE KIC - NO. 13 OCTOBER 06

THE MAD MAD WORLD OF EXECUTIVE COMPENSATION

 I have a good friend who works for HP at their campus in Leixlip. Whenever we meet up we generally have a chat about how things are progressing at the company. I hadn’t seen him for a few weeks so I was dying to hear all the gossip, given all the revelations that have emerged in the last few weeks about members of the board hiring private investigators to find out who was leaking information to the media.
  Many years ago I read about the famous “HP way”, the culture of trust and integrity that had been central to the original founders beliefs. I had therefore been surprised to see just how much the culture had changed. When I met my friend the first thing I said was that Bill Hewlett and Dave Packard must be turning in their graves seeing what has happened at the company they founded. My friend then said that it all began to change when Carly Fiorini became the new CEO.

  $42m for doing a bad job!

 My friend said that she quickly moved away from the paternalistic approach that had worked so well. He then went on to express his horror at the amount of money she was given when she was eventually fired. He said that he thought it was about $50m. (I have since checked and it appears that it was about $42m if pension is included). Now to my friend that type of money is absolutely mad and so it made me think about how we have ended up in a world where somebody can get $42m for doing a bad job while a hard working dedicated employee will make just enough to keep a roof over his head, food on the table and a car on the road. I would classify my friend as that hard working dedicated employee who has spent the last few years trying to make sure that the SAP software applications in HP work. For all his hard work and dedication he will receive a modest wage and he has to watch with amazement at the monopoly money that is given to the executives.

  I know that American companies pay their executives the most but I was fascinated to come across a Forbes article outlining who got the biggest package in 2005. According to Forbes the CEO of Yahoo, Terry Semel, received a total package of $230m. Yes you are reading that properly, his total package including stock based payments was over $200m. If your package was less than $38m you didn’t make it into the top 25.
  In third place on $124m was William Maguire of United Health Group. This is the same William Maguire who resigned a few weeks ago because he backdated option grants in order to maximise their value. I guess he really needed an extra few million!

  There has been a lot written about this phenomenon and I get the impression that the majority of people do not believe that this scale of compensation package is appropriate. I think that it is crazy to suggest that this is necessary to attract talent. I can guarantee you that talent will be attracted by far smaller compensation packages.
   American companies giving these packages allow executives in other parts of the world to say that they are relatively under paid. I think I have read on a few occasions various people saying that European companies need to pay their executives more because good executives could be lured to America. In other words if we are to change this crazy situation we really need to start in America.
   I believe that people need to put more pressure on the owners of American companies to change the current situation. You might ask me how can this be done. I believe that the big American institutional investors (Fidelity, Vanguard, Calpers etc) need to start voting against these pay packages. If an investment company does not do this well then the ordinary investor who gives his/her money should withdraw that money and give it to a firm that will take the lead.
   A good example of this occurred in the UK in 2003 when the proposed £23m pay package of JP Garnier in Glaxo was voted down. The only fund manager to openly declare that they were going to vote against was Morley. This was the type of leadership that should be rewarded by investors giving them more money to manage.
  Here in Ireland we almost had an example of this earlier this year when over 40% of shareholders voted against the decision to give a €579000 compensation package to Gary Kennedy who lost out to Eugene Sheehy in the race to become CEO.
  I look forward to the day when there will be a majority voting against the packages of leading executives.

   Looking at this whole argument from a different perspective I just want to explain why I think executive pay should be a lot less. I have met a large number of leading executives from companies all over the world and at the end of the day I struggle to believe that many of them have done anything fundamentally creative or innovative. Even if they have done a good job I believe that current compensation packages are still far too generous. I believe that the gap between the ordinary worker and leading executives should be less.
 John Chambers CEO of Cisco is doing a great job but a 2005 package of $40m is far too high. I am not sure exactly what it should be but I believe that it should be a lot less. If John Chambers was paid say $5m he could still make himself a lot wealthier by investing in Cisco shares if he honestly believed that his genius was going to create enormous added value.

  Was this man worth $40m in 2005?


 When Cisco was trading at $18 I recommended it as a good investment because I believe that John Chambers has done a good job. He may be doing a good job but if I had the chance I would still vote against his compensation package. (If you want to vote you have an added problem that if you own your shares through a nominee account you will probably never get the chance to use your vote. Surely technology will soon allow this to change. I want to be able to vote and I want fund managers acting on my behalf to vote). I hate to think what a sub contract worker assembling Cisco equipment in China earns but I think that I can hazard a guess that it is quite low. I believe that morally I cannot justify this gap.

 Returning finally to my friend in HP. I know he feels that he cannot do anything about the $42m compensation that was given to Carly but at least it should be brought to the attention of as many people as possible and that if enough fuss is made about it eventually things might change.
 


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Siobhan Power