Some 25 years ago I attended a crowded and agitated shareholders meeting for a Fortune 500 company. During the meeting, a shareholder held up a large and colorful chart for the meeting attendees to see. The chart showed the change in the CEO’s compensation compared to shareholder return over the past several years. Impressively, the CEO pay had grown by roughly 300%. As I struggled to see the second line charting shareholder return, I noted the flat line running along the x axis indicating little to no growth for shareholders. When challenged by this graph, the CEO stated that his pay was “comparable” to what other Fortune 500 CEOs were paid. The shareholder proposal to freeze the CEO’s compensation got a surprising 30% of the vote and both the Board and management were visibly shaken.
This story captures many of the dynamics of the “say on pay” issue that remain important to this day. This topic can be an emotional one for shareholders and Boards, and emotions can be both volatile and unpredictable. Here are my observations on this issue:
1. The “status” argument doesn’t hold water anymore. Today’s shareholders want value, which is driven by corporate performance. Being told that large compensation packages are required for “captains of big ships” doesn’t resonate. Today’s CEOs and Boards should expect to answer the question regarding executive compensation in terms of performance and the shareholder experience.
2. CEOs may overrate their value. There are actually only a handful of companies where shareholders may feel a CEO is absolutely indispensable—and at those companies, the shareholders may be willing to give the CEO a “pass” on issues such as compensation because the CEO brings that much value to the table. These are usually situations where the shareholders have experienced significant appreciation.
3. Things can turn quickly. Shareholders can be surprisingly relaxed with executive compensation when things are going well, but they can agitate quickly finding big pay packages outrageous when the tides turn. This can create a material disconnect between shareholders and the Board when executive compensation has grown to very high levels and the company is no longer performing.
As a directors and officers underwriter, I am wary when I see a company with a very large executive compensation package. It could signal future trouble should the company’s financial situation falter. But in the marketplace the rule of thumb seems to be that the climate for bigger and bigger pay is quite good so long as the company and the stock are doing well. It’s when they disconnect that I sense trouble – and it’s headed towards the Board.
About the Guest Blogger:
Tony Galban is senior vice president and underwriting manager responsible for the directors and officers (D&O) liability business for Chubb Specialty Insurance (CSI).
In the past, he has worked in various D&O underwriting capacities for Executive Risk, which was acquired by Chubb in 1999. Previously, he worked for nine years at Aetna Life & Casualty as both a casualty underwriter and as a senior product specialist for general liability coverages.
He is a graduate of Wesleyan University in Middletown, Conn.