Tuesday, 17 April 2012

Nice job if you can get it!

Based on the Forbes chart reproduced below, one can see that the gravy train of CEO compensation has resumed its unstoppable acceleration.

Assuming the current average CEO pay and an average return of 5%, an investor would need to invest 200 million to achieve this level of income. Since there are no risk-free opportunities paying this type of return one must conclude that investors would be better off by “buying” a risk-free CEO job that pays this level of compensation.

Nevertheless, as shocking as these numbers are, they hide the true scale of the problem by mixing CEOs that are founders or significant investors in their companies (where compensation and dividends may be mingled) with CEOs that are simply managers. In particular, it hides the outrageous pay in the so-called managerial capitalistic sector.

This sector is run by the second type of managers. It includes all companies where control is exercised not by the owners but by incumbent management, and it can be divided in two broad categories – licensed monopolies/regulated firms and companies with a high level capital dispersion preventing individual investors from exercising control (typically companies with a float in excess of 95%).

The absurdity of such pay packages can be illustrated with reference to the greediest and the worst performing CEO, based on the Forbes list and SADIF Analytics rankings respectively. The first is John H Hammergren the CEO of McKesson´s, a drugs & biotechnology company, who earned a 6-year average compensation of $50.79 million. The second is Daniel R Hesse the CEO of Sprint Nextel, the telecommunications operator, who earned a handsome $.6.6 million last year. Their basic cash compensation and respective company´s stock price performance are depicted in the two charts below.

And, what have they achieved during their recent tenure? McKesson´s investors had a 6-year annual total return of 9% (a paltry 2% above the industry ETF), while Sprint´s investors total return was a huge loss of 31%. Another way to see what is at stake is to take the case of a large shareholder in McKesson´s, for instance the 8th largest (Glenview Capital Management, with a stake worth about $414.1 millions). They would need to have invested almost $250 million to earn an amount equivalent to just half of what the CEO made. That is, they would be better off by trying to “buy” the job for themselves.

Large organizations are bureaucracies whose short term performance is to a large extent independent of their leaders. Indeed, like governments, most would not notice if the CEO/President had taken a long leave of been replaced by a dummy. And, likewise those leaders who really shape their future would perform as well whether they earned 800k or 1600k.

So the sky-rocketing of management pay sparked by the rise of managerial capitalism in the 1980s is not a matter of performance reward but truly a case of CEO-Kleptocracy.

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