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Money for nothing - Warren Buffet on why most CEO compensation models are broken
CEO compensation plans should be simple.
Berkshire Hathaway’s is among the simplest. Warren Buffet gets paid the same way as every other Berkshire shareholder - when the stock goes up. Other then his modest $100K salary, that’s all there is. It’s simple, shareholder aligned, and you could write it on the back of a table napkin.
Contrast that with today’s overly complex, unwieldy, misaligned CEO comp plans. Take the ever popular 10 year, fixed-price options plan (who wouldn’t). This plan locks in the value of stock options at a fixed price over time. On the surface this seems reasonable - to get a bigger payout, the CEO needs the stock to increase in price.
The problem is that the CEO can increase the stock price without delivering any value.
With fixed price options, many CEOs are taking the easy way out and simply using the company’s retained earnings to buy back stock at the end of the year, thus reducing the number of shares outstanding. Simultaneously, this increases the price of the company’s stock, while delivering no value to the shareholder (in what might have otherwise been dividends). This manager owner conflict is also never mentioned in proxy materials that request approval of a fixed-price option plan.
Getting fired today can also be particular bountiful for CEOs. Save for Bob Nardelli of HomeDepot, I can’t think of too many jobs that pay $210 million for a job poorly done.
Warren’s point is many of the models used today to compensate CEOs are misaligned with shareholders (fixed price options being one of them).
Warren feels that a shareholder revolt is necessary to bring back sanity to what is increasingly becoming a crazy world when it comes to CEO comp plans. By shining a light on the issues plaguing the industry, we can hopefully soon see real change in how CEOs are compensated and aligned with shareholder interests.
May 7th, 2007 at 11:54 am
I can think of cases when CEO pay should not be directly tied to stock performance.
When entire industries are particularly hard hit due to situations outside of the CEO’s control, entire sectors can suffer. I’m thinking of incidents such as the travel industry after 9-11.
However, a good CEO will be instrumental in minimizing losses and preparing the company for future opportunities. Even though the company stock might get pummeled during this period, you want to make sure a good CEO sees you through. Perhaps in this time, you might want to gauge your executive compensation by comparing your company stock to your competitors or other players in the sector or industy.
May 7th, 2007 at 9:39 pm
Another thing I realized about bogus compensation is that it hurts all investors. How is a stockholder supposed to complain that a CEO is only worth, say, 85% of his pay when there are such blatant abuses?
May 7th, 2007 at 11:53 pm
I hear ya mswayne.
I hope you believe that converse is also true - in that a CEO should not be overly compensated for delivering below average returns in a rising market.
By that i mean, if the stock market is rising at 15% per year as it was from 1982 - 1998, then returning 8-10% on capital isn’t that impressive.
I agree with you though. CEO pay should not blindly be tied to stock price. What drives me nuts is when CEO’s are rewarded for poor performance.
Thx for the comment.
May 8th, 2007 at 2:35 am
Yep. Totally hear you on that.
September 22nd, 2007 at 2:54 am
Cool.
November 10th, 2007 at 2:32 am
Nice
November 20th, 2007 at 8:52 pm
Nice!
December 5th, 2007 at 6:10 pm
When retained earnings are used to buy back stock, this benefits shareholders, since the shareholders will own a greater part of the company, provided that the share price is low. If the share price is high, then a dividend should be issued. High CEO compensation hurts the shareholders.