Setting Executive Salaries

You are a member of the board of directors of a large, multinational bank that is looking to hire a new CEO. The previous CEO did as well as he could to guide your company through the recession, but everyone agrees a new leader, with a fresh vision, is needed to lead the bank back to profitability.

You have been assigned to a committee who will create the new CEO's compensation package. Five years ago, this would have been an easy assignment; put together a multimillion-dollar deal with cash, stock options, and tons of perks; however, these are different times. You do not want to give out a lucrative package which will be too high given the average company employee in today's business environment. What would your employees think? What would the public think? At the same time, you are worried if you do not offer extraordinary compensation, you will never find the right person for the job.

One of the committee members shows up to a meeting with some research on CEO salaries. She reports there are many CEOs who have taken drastic cuts in their pay. David Cote, the CEO of Honeywell, took a 57 percent salary cut. Vikram Pandit, the CEO of Citigroup, receives just $1 as a salary and has publicly vowed not to take any additional compensation until the company returns to profitability. In fact, it appears CEOs (and companies) across the country have lowered their expectations. A survey shows CEO pay decreased by 8.6 percent from the previous year, and since 2000, CEO pay is down nearly 40 percent. It includes a 23 percent decrease in perks like private planes, security details, and country club memberships. Although you certainly do not expect your new CEO to work for nothing, it does give you some hope this person would be willing to lower his or her demands a bit.

As the committee member continues her report, she points out a disturbing trend. Although the total package CEOs receive is down, the amount of cash they receive is up 8.3 percent, and their average cash bonus is up 7.9 percent to $2.1 million, while the amount they receive in stock options is down nearly 30 percent. What has changed? It means more companies are placing less emphasis on long-term incentives. Instead of using stocks to link CEO pay to a company's performance, many companies are emphasizing short-term thinking by giving CEOs lots of cash. Even if the company does not perform well, their executives will still benefit financially.

You and the rest of the committee are left to wonder how to find the right approach. Can you find the right CEO with a reduced salary package? Do you ask your new CEO to accept more stock options, so his/her financial well-being is tied to the company's? Do you offer as much cash as possible, with the hopes of attracting top-flight talent?

1. What are the advantages and disadvantages of tying an executive's pay to the company's performance?

2. How would you explain to concerned shareholders and employees why it is so important that the CEO receive a multimillion-dollar salary package?

3. How much input would you give company employees in making a decision on executive pay?