How to Gauge a
C.E.O.’s Value? Hint: It’s Not the Share Price
Everybody knows that chief executives
receive bounteous pay as a matter of course. In 2015, for example, the
pay for a top corporate executive
at 200 large American companies was $19.3 million.
Less discernible, though, is who
actually earned their pay the most by increasing the value of the
companies they run by a commensurate amount. Such performers are not
to be confused with executives who work to propel their company’s
stock price. This pursuit can have fleeting benefits and disastrous
consequences, as Valeant International, the beleaguered drug company,
One reason it’s so hard for shareholders
to determine a chief executive’s value is that companies’ descriptions
of their pay packages are complex. For example, the discussion of
General Electric’s compensation practices took up more than 20 pages
of its 65-page proxy this year.
Any investor who plows through these pay
documents will recognize a common corporate theme: The amounts awarded
to the chief executive are aligned with shareholders’ interests
because the pay is grounded in the company’s performance.
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But companies use a bewildering array of
benchmarks in their compensation decisions. These gauges often vary,
even within the same industry, making apples-to-apples comparisons
difficult and hampering an investor’s ability to determine when an
executive is overpaid.
“It is amazing how complicated companies
make the proxy and how studiously they avoid the simple informative
presentation of relative pay for relative performance,” said Stephen
F. O’Byrne, president of
Shareholder Value Advisors, a
firm specializing in compensation design and performance measurement.
The most common performance metrics used
by companies can be problematic. Total shareholder return, according
to a recent
study by Equilar, a compensation
analysis firm in Redwood City, Calif., is the single most popular
measure related to pay at big public companies.
Companies love total shareholder return
in part because it is easy to calculate. But a company’s stock can
rocket even when its operations are being run into the ground. So
basing pay on total shareholder return can encourage an executive to
manage more for a company’s share price than for its overall health.
“When you look at total shareholder
return relative to pay, you’re not looking at the underlying returns
of the business,” said Mark Van Clieaf, managing director at
MVC Associates International, a
consulting firm. “That can take investors down the wrong path.”
A better way to measure whether a C.E.O.
has created value at a company is to look at its return on capital
over a period of years. This reveals how effectively a company is
using its own money to generate profit in its operations.
When you compare these returns to an
executive’s compensation, you see where pay is justified and where it
I asked Mr. O’Byrne and Mr. Van Clieaf
to analyze returns on capital among the top 200 companies whose
compensation was reported by The New York Times three weeks ago. The
goal was to see how the executive pay at each company stacks up
against its corporate performance and highlight which companies are
giving away the store to their chief executives and which are getting
their money’s worth.
Mr. O’Byrne and Mr. Van Clieaf began by
examining each company’s return on capital over the last five years
and then comparing it with companies in the same industry. This
resulted in a relative return on capital for each corporation.
The experts then compared each company’s
C.E.O. pay last year with that of its peers. This produced a relative
pay figure that could be set against its relative return on capital
over five years. The calculations were adjusted for company size.
Among the top 200 companies,
the study concluded that 74
overpaid their chief executives in 2015 based on five years of
underperformance in return on capital. The total overpayment last year
to the C.E.O.s at these companies, the study found, was $835 million.
Industries with the greatest outsize pay
were energy, technology, media, health care and consumer products, the
Companies high on the overpayment list
included Salesforce.com, a software company; Vertex Pharmaceuticals;
and the Vector Group, a tobacco concern.
All three companies had a return on
capital below that of their peers over the last five years, the
analysis showed. Nevertheless, the pay received by these company’s
chief executives was lush.
For example, at
Salesforce.com, return on capital fell 23 percent over the last
five years. As a result, Marc Benioff, its chief executive, received
almost $31 million more last year than was warranted by the company’s
performance against its peers.
Jeffrey M. Leiden of
Vertex Pharmaceuticals received
$27 million in excess pay based on the company’s negative 35 percent
return on capital over the period. And Howard M. Lorber, the head of
the Vector Group, was overpaid by $35
million last year when judged on the company’s 4.5 percent decline in
return on capital during the previous five years.
Representatives for all of the companies
challenged the idea that return on capital was the best way to measure
Chi Hea Cho, a spokeswoman for
Salesforce.com, said that because its business model was based on
recurring revenue, return on invested capital was not the right way to
measure performance. “We have created a thoughtful executive
compensation structure based on total shareholder return, which aligns
executives’ interests directly with those of our stockholders, and
over the last five years, Salesforce has delivered returns of 111
percent, more than double the S.&P. 500 index.”
Paul Caminiti, a spokesman for the
Vector Group, said in a statement: “From 2010 to 2015, Vector’s common
stock produced total annualized returns of 21.6 percent, as compared
to 12.6 percent for the Standard & Poor’s 500 over the same five-year
A Vertex spokeswoman, Heather Nichols,
said in a statement that successful earlier-stage biotech companies
were measured largely on research productivity and shareholder
returns. “Over the last five years,” she said, “Vertex has delivered
three breakthrough medicines to people with serious diseases and a 259
percent total shareholder return.”
The analysis also identified more than
70 companies whose chief executives were delivering outsize returns on
capital for fair or even undersize pay.
This group included
MasterCard, overseen by Ajaypal Banga, which had a 40 percent
premium compared with its peers, and the TJX
Companies, the retailer run by Carol Meyrowitz, with a 36 percent
excess return on capital.
Philip Morris International, a tobacco company headed by André
Calantzopoulos, generated excess return on capital of almost 30
percent compared with its peers.
Gary Lutin, a former investment banker,
said it was crucial for investors to assess whether their companies
were generating more wealth for management than for shareholders. As
overseer of the Shareholder Forum, an independent creator of programs
to provide information investors need to make astute decisions, he has
convened a workshop to focus investor attention on
basic measures of
that generate long-term shareholder
“Both investors and corporate directors
need to measure performance based on the profits a company generates
from its competitively successful production of goods and services,”
Mr. Lutin said. “That’s the only real foundation there is for
investment value, and for national prosperity.”
A version of this article appears in print on June 19, 2016, on page
BU1 of the New York edition with the headline: Gauging the Value of a
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