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Benefits and Pensions MonitorPlanes, Trains, And Fancy AutomobilesBy: Jim Helik The latest news story involving compensation matters focuses on Exxon’s retiring chairman who is set to take home a retirement package worth about $400 million. Benefits include the now-standard continuing use of the company jet (for professional purposes), a car and driver, a personal security detail, and, of course, plenty of cash and stock options. One of the checks and balances to help prevent any cases of over-generous executive compensation is supposed to be institutional and retail shareholder activism. The media too should be playing a watchdog role, with the threat of negative publicity acting as a strong incentive to keep compensation in check. Well, that is the way the world is supposed to work, but how does the threat of negative publicity play out? Press Articles It is timely that John Core and Wayne Guay, both of the University of Pennsylvania, and David Larcker, of Stanford University, have published a paper entitled ‘The Power of the Pen and Executive Compensation.’ In it, they review more than 15,000 press articles about CEO compensation and also use economic models that benchmark CEOs against their counterparts in similar firms, controlling for such variables as firm size and industry. The authors do this to answer two questions: How does the media select a CEO for a negative article on their compensation? Do firms and their managers find that this negative publicity is so costly that they end up making changes to their compensation and benefits policies in the future? In examining how the media chooses its stories on executive compensation, there is some evidence that the press makes adjustments for compensating economic determinants before it produces a negative article. For example, it focuses on excess pay rather than just large pay levels. Yet, there is also evidence of press sensationalism and a focus on the big targets making lots of money, whether they are overpaid by more objective measures or not. The median CEO had no articles appearing about his or her compensation. Negative press coverage is highly skewed with CEOs of larger firms with greater tenure (and one assumes a higher public profile) receiving more negative publicity. The press often focuses on large payouts from multi-year compensation programs and often regards exercised options as a component of a large annual pay.
Impact On Compensation But does this focus from the press have an impact on compensation in the future years? The authors researched this by looking at firms with negative media attention and examined the mean and median changes in above-average pay (after accounting for various firm variables) over the following two years. The 740 CEOs who received negative publicity had significantly lower two-year pay changes for total compensation and options than did the 6,671 CEOs of firms without publicity. But, there has often been a strong mean reversion when it comes to CEO pay. A CEO with high pay in one year will have lower pay in subsequent years, producing a natural negative two-year change in pay. When compared with a matched sample of high-pay firms with no publicity, the decrease is roughly the same. So, statistically speaking, negative press coverage does not lead to substantial changes in compensation practices. Compensation Packages However, negative press write-ups did result in some changes being made to compensation packages. The ratio of cash compensation to total compensation decreases after negative publicity. This suggests that firms make ‘cosmetic’ adjustments to avoid negative media attention in the future. There is a shift away from high one-year cash payouts, but without lowering the overall level of pay. Alternatively, CEOs may avoid exercising options for a few years, in other words ‘smoothing out’ option exercises. So the media could certainly be doing a better job here, focusing less on the $6,000 shower curtains purchased for the corporate apartment of Tyco International’s Dennis Kozlowski (which, according to the study, garnered 243 negative articles in just one year) and making less sensational and more nuanced calls between compensation that is merely high and that which is out of step with other firms, or the corporate results obtained. Yet, this study also shows that compensation decisions are largely insensitive to negative publicity. If this remains true, it means that the onus for being a corporate watch-guard shifts back to shareholders large and small. And if they don’t step up to the plate, the final guardian is government – and nobody wants that, do they? Jim Helik is co-author of ‘Energy Markets Risk Management,’a textbook published by the Canadian Securities Institute. He also teaches at the School of Business, Ryerson University in Toronto. |
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