A Look at CEO Pay

by Kevin F. Hallock, Linda Barrington

12|9|10

The amount of media attention devoted to CEO compensation may be waning, but interest in top bosses’ remuneration continues to simmer. The focus on top executive compensation is likely to intensify as the political debate picks up over extension of the “Bush Tax Cuts” and the 2010 proxy compensation data are released in 2011.

Company size matters

In the face of rhetoric about executive pay likely reigniting, it’s helpful to review an undisputed fact about CEO compensation in the United States — namely, CEOs running larger companies are paid more. Whether looking at the most recent 2009 data or going back over a decade, bigger companies pay their executives more, sometimes substantially more, than do smaller companies.

According to the just-released The 2010 U.S. Top Executive Compensation Report by The Conference Board, the median total CEO compensation in 2009 (i.e., the point at which 50 percent of the CEOs have higher compensation and 50 percent have lower) for the top executives of the largest 10 percent of U.S. public companies ($10,200,000) is almost 12 times that for their peers heading the smallest 10 percent of U.S. companies ($878,000). Total compensation includes cash and stock compensation as well as benefits like pensions and perquisites.[1]

Equally interesting is the fact that total compensation rises in a pretty uniform way as the size of the company increases. For example, if companies are ordered by revenues, every one-tenth step up the size distribution of companies is associated with roughly a 20- to 35-percent increase in the median CEO compensation. This pattern persists in companies up to about $8 billion in sales or for about 90 percent of all public companies (i.e., the 90^th percentile of the size distribution of companies).

For the top companies (largest 10 percent), however, bigger gives a much better kick to the median CEO compensation. Total compensation for the median CEO of the largest companies is more than 60 percent greater than that of the previous sized group. This may not be surprising, as the size of companies comprising the largest 10 percent is unbounded, with the revenues from the biggest of the big well over $100 billion.

The point here is not about “fairness” or “pay for performance.” It is simply to describe one of the most powerful patterns in CEO compensation: CEOs of larger companies are generally paid more, in some cases much more, than CEOs of smaller companies regardless of relative performance.

Mix of compensation also changes with size

A second undisputed fact is that the mix of CEO compensation is also correlated with company size. While the dollar value of median CEO salaries is larger for bigger companies, the compensation awarded to CEOs through variable or “at-risk” pay increases even faster.

The result: Compensation awarded in the form of incentives, stock and options is a larger fraction of pay for CEOs of larger companies. The smallest 10 percent of companies award to CEOs, on average, just over 40 percent of total compensation in the sum of incentives, stock and options, whereas two-thirds of total compensation is awarded in this way in the largest 10 percent of companies. In other words, the big differences among companies are largely due to various forms of incentive compensation, which are paid primarily through equity (stock and stock-related pay).

Scanning across industries makes these points a little more concrete. Median cash compensation in the recent data varies among industries from about $600,000 to more than $2 million. Median total compensation, however, varies from a high of $5.5 million in food and tobacco, for example, to a low of $964,000 in commercial banking.

Given all of the controversy about CEO compensation among commercial banks, it may seem implausible that CEOs in commercial banks are among the lowest paid of all CEOs. Note, however, that for financial services (noncommercial banking), median CEO total compensation is $2.7 million — 2.8 times that in commercial banks ($964,000). This seeming contradiction for the commercial banking industry has a number of sources, but among the most important is the fact that there are only a few very large commercial banks. By and large most banks are small, not only relative to the few largest banks but also to other large public companies.

It is important to note that there are large differences within, as well as among, industries. For example, although the median total compensation in commercial banks is $964,000, total compensation for the largest 10 percent of all commercial banks exceeds $4.3 million.

According to data gleaned from The Conference Board’s The 2010 U.S. Top Executive Compensation Report, the top 10 percent of CEOs in the food and tobacco industry, ranked by their total compensation, are awarded 20 times that of the 10 percent of CEOs in that industry with the lowest compensation. The utilities industry, while a strong second place to food and tobacco in terms of the median CEO total compensation, has much less spread in its CEO pay. The top (90th percentile) CEO total compensation in utilities is 10 times that of the CEOs at the bottom (10th percentile), half that observed for CEOs in the food and tobacco industry. (Figure 1)

More robust analysis of CEO compensation by size of company, albeit with less recent data, was conducted by Gabaix and Landier.[2] They chart the fairly tight historical synchronization between the six-fold increase in U.S. CEO pay and the six-fold increase of market capitalization. In other words, even before the financial crisis, CEO compensation tracked the rise (and fall) of company market capitalization as a result of the large role of stock awards in executive compensation. (Figure 2)

Importantly, U.S. CEO pay has not weathered this recession unscathed. U.S. public company proxies filed in 2010 show that CEO total compensation in 2009 declined over the previous year between 1.17 percent and  23.38 percent (year on year) in 12 of 22 industries.[3] A very similar pattern was recorded in 2008 as well.[4]

As we look into 2011 and U.S. economic recovery, it’s likely the correlation between company size and CEO pay will remain intact. It is also unlikely that any of the observed downward pressure on compensation levels of U.S. CEOs will have been large enough to quell public scrutiny and debate.

 

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[1] Total cash compensation is the sum of annualized salary, bonus and non-equity incentive compensation. Total compensation is the sum of annualized salary, bonuses, non-equity incentive compensation, the reported grant date present value of options, the value of stock awards, the change in pension value and earnings on nonqualified deferred compensation, and all other compensation.

 

[2] Xavier Gabaix and Augustin Landier, “Why Has CEO Pay Increased So Much?” Quarterly Journal of Economics, February 2008.

[3] Kevin Hallock and Judit Torok, The 2010 U.S. Top Executive Compensation Report, The Conference Board, R-1471-10-RR.

[4] Kevin Hallock and Judit Torok, The 2009 Top Executive Compensation Report, The Conference Board, R-1454-09-RR.

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