Your Questions / Our Answers

Webinar: Most Overpaid CEOs 2019: Are Fund Managers Asleep at the Wheel?

February 21, 2019
Rosanna Landis Weaver, As You Sow
R. Paul Herman, HIP Investor

PAY RATIO QUESTIONS

What level of compensation ratio do we consider to be "normal" or desired, as in other countries?

The USA CEO to worker pay ratio is highest average in the world at 350:1. The United Kingdom is next at 201:1.  In the Netherlands the ratio is 171:1; in Switzerland it is 152:1. In Germany, where workers are represented on boards of directors, it is 136:1.

Pay ratio information is also being used in taxation. The city of Portland, Oregon is expected to collect $3 million from big brands based in town as well as local firms by levying a 10% surtax on firms that exceed the CEO Pay ratio of 100:1, and 25% surtax when the CEO pay gap exceeds 250:1. Similar pay gap tax bills have been introduced in California, Connecticut, Illinois, Massachusetts, Minnesota, and Rhode Island.

Of course this issue is one that goes back quite far. A favorite quote from reformed pay consultant Graef Crystal is, “Plato told Aristotle no one should make more than five times the pay of the lowest member of society. J.P. Morgan said 20 times. Jesus advocated a negative differential--that's why they killed him.”

Couldn't a company decide to boost its average median salary, by outsourcing the worst paid jobs?

That is one of the issues that was raised by many as the SEC sought comment letters on this rule. Ratios can in fact be manipulated, as can many elements of compensation. The decision to outsource jobs opens a company to supply chain risk, however, and one hopes a corporation wouldn’t make such a serious decision on this basis.

Companies aggressively lobbied the SEC: first to try to prevent the disclosure at all, then, failing that, to shape how this CEO Pay ratio would be calculated. There are variations that would be useful.

How can the median salary of a company be made reliable?

Recommendations on best practices have been shared with S&P 500 index companies by a coalition of institutional investors. By providing more ore information to shareholders on how pay is calculated, then the more insightful the evaluation of pay. Categories of supplemental information called for include:

  • Identification of the median employee’s job function

  • Breakdown of the workforce by job function and/or business unit

  • Geographic location of the median employee

  • Country-level breakdown of global employee headcount

  • A breakdown of full time vs. part time employment status

  • Use of temporary or seasonal employees

  • Use (or non-use) of subcontracted workers

  • Tenure and experience of the workforce

  • Workforce education levels and skillsets

  • The company’s overall compensation philosophy

  • Employee compensation mix (benefits and incentives)

  • Alignment of CEO pay practices with pay practices for other employees

Few companies provide this level of detail today. Though companies that calculate “human capital value,” truly evaluating “people as an asset,” have included Infosys and several other India-based firms.



METHODOLOGY & REPORT QUESTIONS

For companies with co-CEO pay, are compensation combined in your reporting? e.g., Oracle?

Yes. While most firms have one CEO, when there are co-CEOs, the compensation is combined to represent the Office of the CEO. Oracle overpays both its co-CEOs in all of our reports the past five years. For several years Chipotle made the list for this reason.

How many Overpaid CEOs made list due to a one year incident (e.g. CSX)?

We don’t have the exact count on this, Wynn Resorts and CSX are examples. It is appropriate to include such situations because it is often in the hiring or departure of an executive that the most problematic packages are approved. They subsequently contribute to the ratcheting up process of executive pay. CSX is an example: the board did not conduct proper diligence in the hiring of a CEO who was terminally ill, and included contract provisions that were completely unjustified.

In this presentation, the benchmark used for stock performance is the S&P500. Has a CEO pay study been made where performance of companies is compared to the average of their industry? If so, how does the CEO salary pay correlate with the alpha of that industry? (Industry alpha: the difference between the stock performance of a company vs the average of its industry)

This analysis is possible, but has several challenges: the number of comparables, which could be easier with 11 sectors of the S&P (health care, tech, materials) and more difficult with 100+ industries (which may leave only   a small number of comparable firms). Another challenge is that if a large group or all of the firms in that industry are overpaid, then the amount or percentage overpaid will be understated. We will continue to explore ratios like industry alpha in future reports.

Does the S&P 500 benchmark used in this study take into account the distribution of dividends? If for example there are two identical companies, including their CEO pay, but one pays any profits as dividends, and the other does not and retains the cash as reserves, it is likely that the second one's stock price would rise by the amount of cash not distributed. So depending on the benchmark used, if it is pure stock price change, would that be an incomplete measure of the financial performance of the companies?

Total Shareholder Return (TSR) includes both capital gains and dividends paid to shareholders - which is the investor standard for rewarding shareholders. TSR also accounts for splits and other corporate actions.

In your regressions should the returns be adjusted for the industry rather than compared to the entire S&P 500?

This can be another variation of the analysis; one challenge is how widely or narrowly to define the sector or industry (there are 11 sectors, and 100+ industries), to ensure a large enough comparable dataset.  Also, that analysis may not account for whole industries being overpaid.

If your regression already has pay relative to TSR as a factor in the regression itself, can you really draw the conclusion top paid CEOs from that regression underperform? Have you run a regression on absolute CEO pay to performance?

Yes we have, the regression is based on Absolute CEO Pay to Absolute TSR performance over five years. (There is not a relative factor in the regression model.)

Data on underperformance lagging overpaid is interesting but have you done the control analysis of looking at the converse - whether underpaid CEO companies overperform?

Essentially yes, as the report shows in the segmentation of the S&P500 analysis less the Most Overpaid 10, 25, 50, and 100. Returns are higher when Overpaid CEOs are excluded. Also, "underpaid" CEOs frequently include founders at Google and Amazon and similar firms, where the founder/CEOs have enough equity and don't feel compelled to pile on stock grants or stock options -- except at some firms, like Oracle’s Larry Ellison.

Is there some way to make recommendations for CEO pay for companies and sectors? This would be to provide an outside perspective to the paid-for consultants to the boards as well as public and transparent more rational approach.

These specific recommendations are beyond our current scope. Proxy Advisory firms such as ISS, Glass Lewis, and Egan Jones do very specific analyses but do not make recommendations. Compensation consultants are hired by Boards for this.


QUESTIONS RELATED TO VOTING

Do the big three investment fund managers (Blackrock, Vanguard and Fidelity) vote against the most overpaid CEOs or is there no pattern?

There is some pattern among the very top of our list of the most highly overpaid. For example, of the top five overpaid CEOs, Blackrock voted against three, Vanguard voted against four, Fidelity voted against two, and State Street voted against four. In other words, on the companies with CEOs we selected as the most overpaid two large investors – Vanguard and State Street – agreed 80% of the time. However, the pattern fades as we go down the list. Of 15 overpaid CEOs ranked six through 20 on the list Blackrock voted against three, Vanguard against six, and Fidelity against one. State Street voted against four, and abstained against an additional five.

Do you know what percentage of pay packages have "no" recommendations from proxy advisors?

ISS recommended voting against 11.8% of the CEO pay packages at S&P 500 companies, and 33% of the 100 most overpaid CEOs. This year the ISS SRI policy recommended against approximately 14% of the overpaid pay packages, and a policy tailored to Taft-Hartley pension plans, recommended against 24%.

Glass Lewis recommended shareholders vote against 9.5% of CEO pay packages at S&P 500 companies, and 27% of the 100 most overpaid CEOs.

Egan-Jones Proxy Services recommended voting against approximately 30% of the CEO pay packages at S&P 500 companies, and against 49% of the 100 most overpaid CEOs.

Segal Marco Advisors, which has one of the most rigorous analyses of CEO pay packages, recommended shareholders vote against 42% of CEO pay packages at S&P 500 companies, and 70% of the 100 most overpaid CEOs.

Do you think that the pension funds vote against extreme CEO pay because the managers of pension funds are paid less than the mutual fund managers who also receive huge pay packages often for not beating the market?  They just have different sense of what a fair level of pay is?

That is an interesting theory, but there may be other reasons. It is possible that pension funds are responding differently because they have different constituencies. Recent research highlights inherent conflicts large funds have against voting against pay. Harvard Law School professors Lucian Bebchuk and Scott Hirst analyzed these asset managers and found that they have strong incentives to under-invest in stewardship and defer excessively to the preferences and positions of corporate managers; in addition, read Patrick Jahnke’s paper “Asset Manager Stewardship and the Tension Between Fiduciary Duty and Social License.”

When the SEC enacted rules requiring mutual funds to report their proxy votes, it was intended to enable fund shareholders to monitor the votes. However, for most investors, there is no transparency because reporting is done in thousands of unsortable PDFs. You’ve done a fantastic job pulling this data on pay votes from those reports but shouldn’t the SEC revisit their 2003 rule and require funds to report in real-time, in a sortable format?

Yes. There’s been tremendous change in technology and disclosure could and should be improved dramatically. Here is a list of some funds who do disclose in real time (courtesy of James McRitchie from CorpGov.net)


REFORMS AND LARGER QUESTIONS

Are there ANY firms that include CSR rankings or ratings in their evaluation of CEOs?

A small but increasing number of firms are beginning to include environmental metrics in their executive pay incentive structures. These metrics include Greenhouse Gas (GHG) reductions. We are not aware of ESG ratings/ranking like MSCI, Sustainalytics, ISS, or HIP Investor’s ESG Ratings being used in CEO pay yet. According to this Harvard Business Review article, the authors counted 2% of CEO Pay packages at S&P500 firms include an environmental metric, and 5% of CEO Pay at S&P500 include a safety metric (https://hbr.org/2017/08/its-time-to-tie-executive-compensation-to-sustainability).

How do women board directors change the level or process of CEO compensation? How might women be offered more board opportunities?

We are not aware of any studies that consider this, but it certainly is possible. Too often directors have deferred to compensation consultants. Any new directors that join a board may be more apt to question “That’s how we’ve done it in the past.” Articles that highlight how diversity on boards helps generally can be found here, here and here.

Conclusion from an investment perspective seems to be not to own these stocks. How do you think that should work with an engagement / proxy voting point of view, which is not really compatible with selling / not owning?

We are not providing investment advice nor does As You Sow ever provide investment advice as you can read on our disclaimer. The outperformance/underperformance information is included more to emphasize why we think pay is a risk factor. Because overpaid CEOs are a structural risk and many large investors are universal owners with broad exposure to the markets, investors should consider taking a stronger stance overpaid CEOs.

Smaller funds and individual shareholders have the option of making decisions on the basis of individual stocks and can consider the financial downside risk of particular companies. Some funds opt to remain engaged with companies they find problematic. For example, the Sierra Club Foundation is 99% divested of fossil fuel firms, but files shareholder proposals with its remaining 1% share of allocation in energy firms.  

What is an actionable model for the compensation committees given the upward competitive pressure on executive comp?

Board members need to be a true “check and balance” on CEO pay. Boards have a responsibility to understand CEO pay themselves and link to metrics like Return on Invested Capital, and not rely too strongly on consultants. Steven Clifford was on a compensation committee when he began asking questions about compensation and was told “that’s just the way it is done.” Clifford did independent research and ultimately ended up writing a book, “The CEO Pay Machine: How it Trashes America and How to Stop it” which I’d highly recommend.

How did the US come to think enormous wealth is deserved because wealth is a sign of intelligence?

In other words, why do people know so little about the mechanism of capitalism; for example, how much public money started and supports private entities? (I’m looking at you Lockheed, Google, Oracle, and Microsoft.)

Those are bigger questions than we can answer here, but ones we spend a lot of time thinking about. Robert Frank’s “The Winner Take All Society” from 1995 is an excellent place to start, and looks very prescient.  

Also see this educational feature from PBS on Inequality and its effects: https://www.pbs.org/newshour/show/how-economic-inequality-might-affect-a-societys-well-being, which interviews researcher Richard Wilkinson and Professor Kate Pickett, who document a deeper dive into inequality in societies in their book “The Inner Level.”

Have you developed any model shareholder proposals to address CEO pay?

New York State Common retirement fund and some others have filed proposals calling companies to “reexamine their CEO and executive pay and adopt policies that take into account the compensation of the rest of their workforces.”

As You Sow has filed shareholder proposals calling on boards to adopt a policy requiring that senior executives retain a significant percentage of shares acquired through equity compensation programs until two years following the termination of their employment (through retirement or otherwise). Such equity retention policies help promote long term focus.

HIP Investor has advocated for several years that CEO Pay should be escrowed, just as in mergers, acquisitions, or home buying. The role of the CEO is to manage future risk, cultivate long-term opportunities, recruit and mentor the leaders of the future, and avoid surprises. To do this effectively, CEO Pay could be escrowed for 5 to 10 years to ensure long-termism.

Can you name any S&P 500 companies that do a good job on CEO compensation?

Firms that value stakeholders as much as shareholders are typically well-managed and proactively manage future risks.  Firms that apply metrics of cash flow, and avoid accounting metrics, typically have a better grasp of the economic rewards and implications. Firms that address both future value (Total Shareholder Return) and trends of current value (Return on Invested Capital) balance today and tomorrow. Firms that include ESG (environmental, social, governance) metrics are examining factors that are root drivers of value creation and risk reduction for all stakeholders. This is an area where we hope to do continued research.

How do compensation committees typically respond to significant "no" votes on pay?  

Many companies have enacted reforms following a significant vote against CEO pay packages. Two years ago I/Rosanna wrote a series of blog posts on how low approval CEO pay votes lead to real pay changes. Often if a company has one particularly bad practice they will address that particular issue. For example, several companies that had a guaranteed minimum bonus have eliminated them. Other companies have chosen to utilize negative discretion. Sometimes companies change performance metrics and weightings. There are even some cases, most recently at Disney, where CEO pay is actually reduced.

What do you make of the argument that overall CEO pay is a tiny portion of overall company market cap, and therefore, not problematic?

From a shareholders perspective the issue may not be the amount of pay but the system set up. The structure of pay can incentivize a short term focus and increase risk. Too often metrics reward short term thinking and can distort important decisions on resource allocation. In HIP Investor’s experience rating thousands of companies over more than a decade, companies with CEO Pay ratios over 400X and up to 1,000X cause morale problems with staff, and seem to then follow a culture of a “king” who reigns, and distorts allocations to future value creation like R&D and new products.  Most shareholders invest for a long-time horizon.

A long term risk to society’s sustainability is income inequality, and CEO pay feeds directly into this challenge. Pikkety and other academics have shown that income inequality is broadly problematic and a destabilizing force in a democracy. Inside companies, employees judge the rate and ratio of pay, and how well they are compensated. Higher CEO pay ratios erode employee loyalty and productivity.

In addition the structure of pay can incentivize a short term focus and increase risk.

What metrics would you suggest be used to pay CEOs a compensation that best lines up with employees and shareholders? How should CEO pay be more fairly calculated?

Customer satisfaction, customer renewals, and customer referrals (such as telephone companies "friends and family" promotions) can drive higher revenue and growth. Employee engagement and satisfaction can drive happier, more productive employees -- and can include factors beyond just compensation. "Externalities" like Greenhouse Gas (GHG) Emissions intensity, which can be quantified, but not yet appearing on financial statements, are a future risk. These 3 factors contribute to a more balanced scorecard of performance. In addition, either putting CEO pay in escrow for 5 to 10 years or requiring lengthy holding periods on equity would ensure longer-term decision making, cultivating of top talent, and more time to see if risks and opportunities play out as expected.

What are some questions to ask compensation committees to ensure that they are setting compensation instead of the compensation consultants?

What independent sources of data are you using? Have you taken the time to look yourself at peer companies pay formulas and structures (rather than relying only on the consultant’s analysis)? Pay special attention to companies added to peer groups that drive pay. This year Schlumberger, an oilfield services company added Netflix – which recently adopted an extremely high cash pay salaries model – to its peer group. Did the directors understand why a streaming media company was being compared to an oil services firm?

How do we further empower shareholders to demand more accountability? In particular, what is needed to embolden more opposition among pension funds?    

Knowledge is empowering and we hope that our Overpaid CEOs research helps serve that purpose. For a shareholder to approach a trustee with a vague suggestion that the fund should take a stronger stance against excessive pay will be easier when evidence and case studies can highlight that a more balanced, thoughtful approach can do better.

If there are remaining research questions or points that need to be made, where do the panelists see those areas?

If we had the resources, we would research the directors who serve at these companies, to see if there are overlaps among different directors; highlight companies with best practices, including transparency, performance, and accountability; and to research the companies that are most overpaid repeatedly and see if they share a compensation consultant.

No one has mentioned that the shareholders are also getting ripped off as these same dollars to pay CEOs could be used for dividends and distributions to shareholders. That would seem to be big why isn’t it being mentioned?

Surplus cash flow and profits can go to: Customers for lower prices (like Amazon), to Employees (like Costco), to Suppliers, to R&D for new products (like Apple), to taxes (though companies beat this down), to Dividends for Shareholders, to CEOs for compensation, or to Share Repurchases (for shareholders and CEO pay gains based on EPS). Of these choices we agree that CEO compensation is often the worst choice a board could make, and sadly it is one of the most common.

Are so-called "ESG funds" or "Socially Responsible funds" by and large voting responsibly?  Which "SRI" fund companies are the worst performing, in terms of their voting records on executive compensation?

This is covered in the report, in the section on Socially Responsible Investing Funds. Domini has been the leader in levels of opposition, but we’ve seen other votes improve. Notably, Green Century funds formerly had a policy to abstain from all votes on CEO compensation but changed its guidelines and this year opposed 80 percent of the 100 most overpaid CEO pay packages.

What accounts for the wide dispersion in vote results among the public funds? What methodologies are being used by some to scrutinize complex pay packages more intensively than others?

Pension funds use a variety of different approaches to voting practices on pay. We believe there is a trend to bring voting in-house and/or strengthening guidelines and asking proxy advisors to take a more powerful stance against. To see some of the items that drive votes against pay packages most frequently go to

What do you think it will take to get more pension funds engaged on this issue?

Pressure from the teachers and firefighters and beneficiaries they represent. Florida pension responded post-Parkland shooting to divest gunmakers. This can happen with other pension beneficiaries too. It’s your money.  Speak up. Vote. Complain. Apply your power.