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COMMENTARY : Average U.S. CEO Boosted Pay 21% in '95, to $4.5 Million


We already knew that 1995 was a great year for shareholders--stocks rose about 35% in value last year. And we already knew that 1995 was a lousy year for employees. Many became victims of downsizing--or, as company public relations people like to say it, rightsizing. What's more, those who kept their jobs saw their pay advance by only 2.8%.

So what is the fresh news today? Well, chief executives of major public companies walked into their treasuries and hauled out record amounts of pay last year. Based on a study I just completed of 356 companies--all of them among the 500 largest U.S. companies based on market value--your typical CEO increased his pay nearly 21% to $4.5 million.

Put another way, your typical CEO lapped his own workers 7.4 times last year. Now, given the age of major-company CEOs and the fact that most of them could probably shed a pound or two, you'd think it would be the younger, fitter workers who would have lapped their CEOs. But in a pay race, no one has stronger legs than a CEO.

Total pay ranged from an almost immeasurable (by CEO standards) $264,000 for John F. Gifford, head of Silicon Valley-based Maxim Integrated Products, to the $65.6 million earned by Lawrence M. Coss, CEO of St. Paul, Minn.-based Green Tree Financial Corp.

It turns out that 21% of the variation in CEO pay can be accounted for by differences in company size. Larger companies tend to pay more than smaller companies.

It also turns out that a further 10% of the variation in CEO pay can be accounted for by differences in shareholder return (i.e., stock price appreciation plus reinvested dividends) over periods of one, two and three years. In this case, better-performing companies tend to pay more than poorer-performing ones.

If 21% of the variation in pay has to do with company size and a further 10% has to do with company performance, that means that 69% of the variation in pay has nothing to do with either company size or performance. Perhaps the best way to categorize this unexplained variation is to say, "Your guess is as good as mine!"

That's troubling, however, because, in a truly efficient market, the vast majority of the variation in pay levels ought to be explained by rational factors. And that's also troubling for shareholders, who might have come to believe the pronouncements of company after company last year to the effect that they were putting more and more emphasis on pay for performance.

With only 10% of the variation in CEO pay levels attributable to differences in performance, there is obviously a long way to go.

Of the 356 companies in my study, 45 were headquartered in California. As a group, those 45 are no different from companies situated elsewhere in the country. Some pay a lot more than they should and others pay a lot less than they should. Collectively, California companies cannot be characterized as either high payers or low payers.

Although average total CEO pay rose by 20.7% in 1995 compared with 1994, various components of the overall pay package rose at different rates. Base salaries increased by a much more modest 6.5%, although that rate was still more than double the rate of increase for the average American worker.

The combination of base salary and the bonus for annual performance rose by an average of 13.2%--not a surprising figure given that 1995 was generally a pretty decent year for American companies.

But the real action in CEO pay continued to revolve around various long-term incentives--especially stock options. The size of stock option grants grew by 31.5% in 1995 compared with the previous year. And in 1994, stock option grants grew by 42.1%. If you compound the two increases, the size of stock options has almost doubled in two years.

If you want to predict the number of bushels a farmer will get from his fields, you need to take account of two factors. The first is the number of acres planted and the second is growing conditions, such as soil quality, rain and sun.

The same is true of stock options. The first factor is the size of the options being granted and the second is the performance of the stock market after the grant is made.

However, most people, when thinking of stock options, concentrate only on growing conditions--in this case, the performance of the stock market. Indeed, most people think that what an executive will receive from a stock option grant is totally related to his company's stock performance.

But there is that little matter of the number of acres being planted. And, as has just been observed, the number of acres companies are devoting to stock options has almost doubled in two years.

Granted, growing conditions in the stock market may not for many years be as robust as those in 1995. But when the number of acres being planted has almost doubled, they don't have to be as robust. Those stock option farmers are likely to be harvesting some bumper crops over the next five to 10 years.

* Graef Crystal is a San Diego-based executive compensation expert and author of the Crystal Report.

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