Soaring Executive Pay, Decades of Failed Restraints
Instead of Damping Rewards, Disclosure, Taxes, Options Helped
Push Them Higher Return of Golden Parachutes
By Joann S. Lublin and Scott Thurm
The Wall Street Journal
Thursday, October 12, 2006
In 1993, activist investor Ralph Whitworth shuttered United
Shareholders Association, a group that was trying to tackle the
contentious issue of executive pay. It looked as if his work
Federal securities regulators had just forced companies to
reveal details about pay and perks for top officials, in some
cases for the first time. The changes would "make boards think
twice" before approving compensation plans that couldn't be
justified, Mr. Whitworth recalls thinking. Around the same
time, Congress attacked executive pay for the second time in a
decade by removing tax breaks on compensation above one million
Since then, the average pay for chief executives of large
companies has quadrupled, according to Kevin Murphy, a professor
at the University of Southern California's Marshall School of
Business. The average last year was $10.5 million, a figure
that includes salary, bonus and the value of stock and
There are many reasons why Mr. Whitworth was mistaken in his
prediction, including the bull market of the 1990s, cozy
corporate boards and CEOs striving to keep pace with highly paid
athletes and entertainers. What's often overlooked is the role
of all the efforts -- by Mr. Whitworth and many others -- to
limit CEO compensation. For more than two decades, critics
tried to slow skyrocketing pay through regulations, legislation
and shareholder pressure. Few of their tactics worked. Many
As it turns out, disclosure requirements can push pay higher by
revealing to CEOs what their peers receive. Limiting one type
of compensation often encourages new types of pay, such as stock
options, which were pushed as a solution only to become tainted
by scandal. Now that shareholders are quicker to push out
poorly performing chiefs, CEOs are seeking more financial
guarantees. And if companies turn to outsiders, they often have
to pay extra.
Curbing executive compensation is "like moving Jell-O," says
Kayla Gillan, the former general counsel of the California
Public Employees Retirement System, or Calpers, the nation's
largest public pension fund. When it's limited in one area, "it
squirts out in another."
Mr. Whitworth disputes the idea that advocacy like his helped
make things worse. "To say there's a causal relationship
between reform efforts and high executive pay is not logical,"
the veteran shareholder activist says. Instead, he says he and
his peers erred in not focusing on company compensation
committees and their lack of accountability to investors. As a
result, he says, "CEOs still get whatever they can."
In recent years, CEOs have raced ahead of other Americans,
including their own lieutenants. Mr. Murphy calculates that
average CEO pay was 369 times as much as the average earned by a
worker last year, compared with 131 times in 1993 and 36 times
in 1976. Meanwhile, the average U.S. paycheck has barely kept
ahead of inflation in recent years.
Carola Frydman, a finance professor at the Massachusetts
Institute of Technology's Sloan School of Management, says the
pay gap between CEOs and other executives at the same company
has doubled since the 1960s.
Charles Munger, vice chairman of Warren Buffett's Berkshire
Hathaway Inc., and a longtime business partner of the famed
investor, describes executive compensation as "wretched
excess". In an interview, Mr. Munger says he hears complaints
even from "Republicans who grumble on the country-club porch"
about the resulting political turmoil over the pay question.
They're "mad at corporate America," he says.
The Securities and Exchange Commission recently set forth
another set of rules governing the expanded disclosure of top
executive pay and benefits. For the first time, it required
that companies reveal top executives' "total compensation".
Investors, too, are intensifying efforts to limit pay. They're
embarrassing some highly paid CEOs, trying to change corporate
bylaws and seeking to replace directors who bless exorbitant
There are already doubts as to whether these moves will be any
more effective than prior efforts. According to a survey by the
University of Southern California and executive-search firm
Heidrick & Struggles International Inc., 64% of directors say
they expect CEO cash compensation to continue to rise; 58% say
they expect stock compensation to continue to rise.
Many CEOs say they're paid what they're worth. The Business
Roundtable, a group of big-company CEOs, says compensation has
roughly kept pace with stock-market returns for the past
decade. Using different methodology than that employed by Mr.
Murphy, the group says the typical CEO makes 179 times as much
as a typical U.S. worker.
"I made a lot of money. I became wealthy," says Harvey Golub,
CEO of American Express Co. from 1993 to 2000. "My shareholders
became even wealthier."
During Mr. Golub's tenure, American Express's shares rose more
than sixfold and its market capitalization climbed to $65
billion from $10 billion. "How much of that $55 billion should
I get?" he asks.
Mr. Golub was paid roughly $57 million in salary, bonus and
restricted stock over eight years. He also exercised options to
buy shares valued at $92 million. When he stepped down as CEO,
he held options valued at $114.5 million and received an
additional 990,000 options. Because he soon after retired as
chairman, investors don't know how much Mr. Golub made from
exercising those options. He declines to divulge the figure.
Mr. Golub is a director of Dow Jones & Co., publisher of The
Wall Street Journal.
In his 1936 State of the Union address, President Franklin D.
Roosevelt railed against "entrenched greed" at American
corporations. At the time, the average compensation for the top
executive of a big company was about $95,000, according to MIT's
Ms. Frydman, equivalent to $1.4 million in today's dollars.
Reflecting the more egalitarian societal values, as well as
punitively high marginal tax rates, executive pay barely budged
in the prosperous post-World War II decades. In 1970, Ms.
Frydman says, average CEO pay was no more, adjusted for
inflation, than it was in 1940.
Then, in the late 1970s, the culture of pay started to change.
After a decadelong bear market soured executives on stock and
stock options, they began to seek out other forms of
compensation, aided by a budding industry of pay consultants.
Among the most inventive CEOs was the late Steven J. Ross, chief
of Warner Communications Inc. and later Time Warner Inc.
The son of an oil-burner salesman, Mr. Ross built a media empire
from a chain of funeral parlors and parking lots. He weathered
a federal investigation, fought with partners and investors and
fended off takeover attempts from Rupert Murdoch, among others.
In 1981, Mr. Ross took home more than $22 million, including
gains on stock options, making him the first executive to crack
$10 million in annual compensation, according to Mr. Murphy.
In addition to a salary and a bonus pegged to Warner's profits,
Mr. Ross received a dizzying array of other types of
compensation, including stock, stock options and multiple forms
of deferred compensation. Between 1973 and 1989, he took home
$275 million, according to Graef Crystal, a former compensation
consultant who is now a columnist and critic of executive pay.
The 1980s witnessed a flourishing of different types of
compensation, following President Reagan's deep cuts in the top
rates of income tax. Some of the techniques were seemingly
unrelated to performance, such as "signing bonuses" for new CEOs
and "guaranteed bonuses". In 1981, Occidental Petroleum Corp.
CEO Armand Hammer was promised a bonus of at least $240,000.
Another new technique was the "golden parachute," a sizable sum
promised to executives if their company was taken over. Without
such assurances, boards worried that executives might oppose a
deal that was good for shareholders out of concern for their own
In 1983, Bendix Corp. CEO William J. Agee received $3.9 million
over five years after his aerospace, auto-parts and
machine-tools concern was acquired by Allied Corp., an
industrial conglomerate. It was one of the decade's first
bruising takeover battles, sparked by Mr. Agee when he tried to
buy aerospace and defense firm Martin Marietta Corp. The size
of his parachute, as well as the circumstances in which it was
paid, created a furor.
The following year, Congress slapped a special tax on golden
parachutes. "The Bill Agee Bill," as some at the time dubbed
it, taxed awards valued at more than three times an executive's
average compensation over the previous five years.
Rather than curbing pay, the law had the opposite effect.
Despite a few well-publicized examples, golden parachutes were
rare before Congress intervened. In a survey of companies named
in either the Fortune 1000 list or the S&P 500 index, a mere 8%
gave at least one executive a golden parachute before the law
was passed. By taxing parachutes at a certain level, Congress
in effect blessed their existence. It also gave the technique a
Baxter International Inc. adopted golden parachutes for its CEO
and 22 other officers for the first time in 1985, promising
executives twice their annual salary and bonus. A Baxter
spokeswoman says the parachutes came at a "tumultuous" time of
mergers in the industry.
By 1991, more than half of the top companies in the survey
provided parachutes to certain executives, according to
Executive Compensation Reports, a newsletter.
The parachute law also spawned a new form of compensation:
payments to cover the new taxes. By 2004, 77% of 1,000 public
concerns tracked by consulting firm Towers Perrin offered such
tax compensation, known as a "gross up," compared with 10% in
James F. Reda, a New York pay consultant who began working in
the field in the late 1980s, recalls: "It was an easy argument
to sell to boards, that it's just money going to the government,
so why penalize these people?"
Critics of executive pay say boards, stocked as they often are
with CEOs and retired CEOs, rarely need to be sold on pay
packages. Mr. Buffett, well known for his dislike of
ostentatious compensation, joined the compensation committee of
Salomon Inc. after taking a stake in the investment bank in the
late 1980s. In 1990, when Salomon's profit declined, Mr.
Buffett voted against bonuses for top executives, a rare event
inside U.S. boardrooms. Mr. Buffett was outvoted and hasn't
been asked to serve on a compensation committee since.
Compensation panels are "tail-wagging puppy dogs meekly
following recommendations by consultants," Mr. Buffett wrote in
his 2002 letter to Berkshire shareholders. For an outside
director to oppose these recommendations "would be like belching
at the dinner table."
In spring 1990, Richard Koppes, then general counsel of Calpers,
convened a meeting of corporate lawyers and activist investors
at Morton's Steakhouse in Washington, D.C. Ira Millstein, a New
York attorney and longtime adviser to the boards of General
Motors Corp. and Walt Disney Co., urged investors to focus on
executive pay. "You shareholders can do something about it," he
To better align CEO pay with shareholder returns, activists
started urging a wider use of stock options. Options give the
holder the right, but not the obligation, to buy shares at a
specified price. They become valuable only when a company's
share price increases.
Calpers began publishing a "target list" of overpaid,
underperforming CEOs. Its initial top target was Rand Araskog,
chief executive of conglomerate ITT Corp. Mr. Araskog, the son
of Swedish immigrants, graduated from West Point. After fending
off corporate raiders, he spent a decade dismantling ITT, a
sprawling conglomerate whose businesses stretched from
telephones to timber. In 1990, Mr. Araskog's compensation rose
82%, to $7.3 million, the same year ITT shares fell 18%.
In September 1991, Mr. Araskog met Mr. Whitworth, the investor
activist, at the offices of his group, United Shareholders.
"I'm tired of being the poster boy for executive compensation,"
Mr. Whitworth recalls Mr. Araskog saying. "What would you do?"
On a yellow legal pad, Mr. Whitworth sketched a plan that paid a
modest cash compensation and plenty of options. Mr. Araskog
"tore it off and took it with him," Mr. Whitworth says. Two
days later, the chairman of ITT's compensation committee
chairman called Mr. Whitworth and declared, "Rand is going to
take you up on your offer". Mr. Araskog says he doesn't dispute
Mr. Whitworth's recollection.
As a result, ITT gave Mr. Araskog options for the first time --
170,000 with an initial value of $3.5 million. The board also
revamped its long-term performance plan and moderated Mr.
Araskog's salary increases. The CEO received a 6% raise in
1992, down from a 17% raise the year before. Mr. Araskog says
ITT embraced options partly because making money under the old
performance plan was "next to impossible".
With subsequent grants, Mr. Araskog held options valued at $17.8
million by the end of 1995 when ITT broke itself up and sold off
the pieces. He retired in 1998 and received $15 million in
Other top CEOs took up the concept. In 1990, H.J. Heinz Co. CEO
Anthony J.F. O'Reilly received options to acquire four million
shares. The following year, Leon Hirsch, chief of
medical-products company U.S. Surgical Corp. received options
for 2.75 million shares valued at $170 million, more than 100
times his annual salary and bonus.
At the time, "we never saw an [option] plan we didn't like," Mr.
Whitworth recalls. "People would say, 'How much is too much?'
We said, 'The sky's the limit as long as it's tied to stock
options,' which we equated to performance."
Shareholders expected option grants would displace other types
of compensation. More often, they were doled out as an extra.
As chairman and CEO of Chase Manhattan Corp., Walter V. Shipley
received a $750,000 salary and options for 90,000 shares in
1993. Four years later, he was granted options for 240,000
shares, with an estimated value of $3.8 million. Mr. Shipley's
salary rose, too, to $950,000.
The huge option grants began to trigger enormous paydays. In
1992, Disney CEO Michael Eisner exercised options valued at
nearly $127 million. The former studio head reshaped and
revived Disney in the 1980s and Disney's share price had risen
Amid the economic downturn and corporate restructurings of the
early 1990s, complaints about such awards found receptive
audiences. In 1992, Democratic presidential candidate Bill
Clinton made executive pay a campaign issue. Washington
The SEC said it would require more disclosure about
compensation, particularly stock options and executive perks.
The following year, after Mr. Clinton was elected, Congress
decided companies could no longer take tax deductions on
executive compensation of more than $1 million, unless it was
related to performance.
Neither approach slowed the upward march of executive
compensation. In fact, the disclosure rules allowed CEOs to see
what others were getting, encouraging a competitive spiral. The
tax law, meanwhile, drove up the compensation of CEOs who were
making less than $1 million. Executives considered the cap a
"minimum wage for CEOs," says Mr. Koppes, the former Calpers
SEC Chairman Christopher Cox recently said the 1993 law belongs
in "the Museum of Unintended Consequences," because it
encouraged the growth of "less transparent forms" of pay, such
as pensions and deferred compensation.
Ignoring the Caps
Some companies felt free to ignore the caps altogether,
especially as they wooed outsiders, a tactic increasingly used
by boards to fix succession problems. In the 1970s, says the
University of Southern California's Mr. Murphy, companies picked
outside CEOs about 15% of the time. By the 1990s, that had
risen to 27%. Last year, executive-search firm Spencer Stuart
says outsiders won 40% of the CEO vacancies at S&P 500 firms.
Eastman Kodak Co. in 1993 wooed George Fisher, the successful
chairman and CEO of Motorola Inc. Kodak offered a $2 million
salary, more than double what he was earning at Motorola. Kodak
didn't seem bothered by having to sacrifice tax deductions on
half the $2 million. Mr. Fisher says, "I don't remember that
was ever part of the discussion."
Mr. Fisher says the $2 million figure originated with his
attorney, Joseph Bachelder, who had negotiated a similar deal
for Louis V. Gerstner at International Business Machines Corp.
Kodak also gave Mr. Fisher a $5 million signing bonus, a $1
million guaranteed bonus in both 1994 and 1995, 20,000
restricted shares and more than one million stock options.
"Going outside can be frightful," says Alfred DeCrane Jr.,
former CEO of Texaco Corp., who has served as a director on four
compensation committees. "You can negotiate, but if you want to
close the deal, you have to close it."
Defenders of CEO pay say these contracts demonstrate the market
value of a successful executive. "There is an incredible
shortage of qualified people to manage and lead big companies
today," says Kenneth Langone, a veteran Wall Street figure. Mr.
Langone is a defender of two executives caught up in pay
controversies: Former New York Stock Exchange Chairman Richard
Grasso and Home Depot Inc. CEO Robert Nardelli. Mr. Langone
chaired the NYSE's compensation committee and is a director and
a co-founder of Home Depot.
Mr. Bachelder, who has been negotiating CEO contracts for 26
years, points to another factor: big paydays for athletes,
entertainers and money managers. "It's the Michael Jordan
principle," Mr. Bachelder says. "If he can get $30 million, I
have to get it."
Throughout this time, options remained a favorite pay tool for
an important reason -- they were effectively free. Options
granted at or above the market price of a stock did not have to
be recorded as a company expense in financial results.
Accounting regulators proposed changing this rule in 1993 but
backed off following opposition from Congress and Silicon
Valley. Then-SEC Chairman Arthur Levitt later wrote in his
memoir that failing to support the accounting change was his
"biggest mistake" as chairman.
A few directors tried to buck the option fad to little effect.
In the early 1990s, shareholder activist Robert Monks persuaded
fellow directors of Tyco International Ltd. to pay CEO L. Dennis
Kozlowski with restricted stock -- which requires a holder to
wait several years before it can be sold -- rather than
options. At Mr. Monks's urging, they also decided to deny Mr.
Kozlowski a bonus if Tyco's cash flow and earnings didn't grow
by at least 15%.
During a 1993 board meeting at a Tyco factory in Michigan, Mr.
Monks says, he called for independent board members to meet
privately and discuss even tougher ties between pay and
performance. Mr. Kozlowski and his predecessor, John Fort,
another board member, refused to leave the room, Mr. Monks
says. The following year, Mr. Monks was not renominated for the
In 1997, Mr. Kozlowski received 3.3 million options after Tyco
acquired security firm ADT Ltd. He later swapped some
restricted stock for more options. Between 1998 and 2001, Mr.
Kozlowski reaped more than $400 million in salary, stock grants
and gains from options, according to securities filings. Mr.
Kozlowski and his former finance chief were convicted last year
of looting more than $150 million from Tyco. Both are serving
prison sentences of as much as 25 years, and have appealed their
Asked for comment, a Tyco spokeswoman would say only that "prior
management is no longer in place."
In the bull market of the late 1990s, these awards led to
staggering paydays. In general, criticism of such deals was
relatively muted as smaller investors also benefited from rising
That changed in 2001 when Enron Corp. collapsed in an accounting
scandal. Others corporate debacles followed: WorldCom Inc.,
Adelphia Corp., Tyco. In each case, top executives massaged the
books to prop up the share prices that accounted for most of
In response, the Sarbanes-Oxley Act, passed in 2002, required
more timely disclosure of executive-pay deals and required CEOs
to return compensation based on financial results that were
later restated. The disclosure requirement squelched another
pervasive, but little-known, practice of the 1990s, a side
effect of the options craze: the "backdating" of stock
options. The long-hidden practice burst into public view this
year, and now more than 100 companies are under scrutiny for
manipulating the timing of option grants to generate even bigger
gains for executives.
By 2003, the average option grant fell nearly by half to $3.3
million, according to the University of Southern California's
Mr. Murphy. As a result, average CEO compensation actually
declined, to $8.7 million in 2003, from $12.8 million in 2000.
The following year, accounting rulemakers finally required
stock-option grants to be treated as an expense. Corporate
boards responded by distributing fewer options.
In lieu of options, boards distributed more restricted stock.
Some questioned whether this was progress; unlike options,
restricted stock retains its value even if share prices decline.
Other boards pledged to tie pay more closely to performance.
Big awards are now popping up when executives leave their
companies, regardless of performance. As of the end of last
year, then-Pfizer Inc. CEO Henry McKinnell accumulated $83
million in pension benefits, according to company filings. He
was ousted as CEO in July. During his five-year tenure, Pfizer
stock declined nearly 37%. Mr. McKinnell is set to remain
Pfizer chairman until his retirement in February.
His pension benefits "were awarded on the basis of many years of
service to the company, including years in which the company
significantly outperformed the market and its peers," says Dana
Mead, head of the Pfizer board's compensation committee, in a
Golden parachutes are back, too. James Kilts, CEO of Gillette
Co., received about $164.5 million in severance and other
benefits after the razor maker was acquired by consumer-products
giant Procter & Gamble Co. last year. North Fork Bancorp CEO
John Kanas received $185 million for selling his Melville,
N.Y.-based bank to a rival.
"By the time the payments are disclosed, the CEO is gone," notes
Sarah Teslik, a longtime corporate-governance watchdog. "The
worst that happens is a day's trashing in the press."
Write to Joann S. Lublin at
email@example.com and Scott Thurm at