Monday, April 27, 2009

How CEOs Earn

The Logic of Life by Tim Harford has some interesting information on how CEO's get paid, besides the normal salary, that is. Some of it is common knowledge, but not all.

Here goes ...

[S]ome of the design features of these stock-option-based compensation plans are a little suspicious. Options are often reset when share prices fall: what was once an option to buy shares at a hundred dollars apiece becomes an option to buy shares at fifty dollars apiece, as long as the company is doing badly enough. ... [T]he offer to CEOs seems to be: 'If the company share does well, your options will make you a killing. If the company share price falls, don't worry: we'll make sure you make a killing anyway.'

There are other suspicious aspects of CEO pay. ... [O]ne favourite is the 'reloadable' option, which rewards CEOs if the share prices bounce around a lot, because they can lock in the most fleeting gains. Another is the 'backdating' option, where the companies hand out particularly generous options but disguise their generosity by fibbing about when the option was actually awarded. Economists spotted the backdating by noticing how often options were being handed out just before the share prices rose, making the option very valuable. Either the timing was impossibly lucky, or the official dates were phoney, and the options had been backdated to maximum advantage. ... (One of the most remarkable examples of backdating was at Apple, the makers of iPods and Macs. They granted backdated stock options to their CEO, Steve Jobs, some of which were supposed to have been approved at a 'board meeting' that Apple later admitted didn't actually take place.)

In my previous life, when I was naive, I actually believed that CEOs get paid because of the value they generate. I used to think, "How much value they must be generating to get paid so handsomely???" Now I know differently. The CEOs get paid handsomely for the value they have generated before they became CEOs. That must have propelled them to the post of CEO in the first place. So, CEOs reap what they have sowed before they became CEO. Now that cannot be such a bad thing. Or is it?

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