Overpaid CEO? Here's how to find out

Is the chief of a company collecting a treasure he doesn't deserve? Here's how to peek at his paycheck -- and a standard to guide you.

By Michael Brush

Few injustices tick off our readers like corporate bosses who make too much money while their shareholders go bust.

One of my columns on the subject, "The 5 most outrageously overpaid CEOs," brought in a torrent of mail.

"No one person is worth several hundred times what the average worker makes," wrote one reader. Another likened juicy CEO pay packages to "legal theft from the shareholders."
But many readers had a more practical bent. "Thanks for your article! Not because we love to hate these guys, but because it gives us another tool to check before we invest," wrote one reader.

Whether you're simply interested in checking what your employer pays its chief or you're using executive pay as a variable in your investing strategy, there's a fairly easy way to discover what a CEO makes. Below, I'll give you a step-by-step guide in how to use that tool.

Who's watching the boss? Here's why investors should care: Corporate governance experts say that when boards dole out excessive pay to top execs, it is a sure sign that those boards aren't working hard enough for shareholders.

"The decision of what to pay a top executive is one of the best indicators of what a board is doing and thinking," says Ric Marshall, chief analyst at The Corporate Library, an independent research firm that provides corporate governance analysis. "A board that can't say no to top executives, or feels executives should be entitled to some level of compensation that is far above the median, is an ineffective board."

A recent study by Moody's Investors Service confirms Marshall's analysis. The study, called CEO Compensation and Credit Risk, found that excessive pay packages are linked to credit-default risk and credit-ratings downgrades.

Out-of-line bonuses and options grants were more telling than excessive base salaries, says Chris Mann, an author of the Moody's study. This makes sense, because highly paid CEOs tend to get most of their pay in the form of bonuses and options. So that's where you're likely to see the excesses, too.

A CEO with too much influence over a company's board has little incentive to work hard or make smart decisions, because he or she will be raking in millions regardless of how the company performs, concludes the Moody's study.

Do your own detective work As an investor, how do you gauge whether a board is overpaying a CEO? A complete analysis seems tough, since boards compensate execs with a dizzying array of base salaries, bonuses, options, severance packages and retirement plans. And then there are the perks, such as access to the company jet for personal use, or payments to cover pet grooming.

The good news is that you can get at a lot of basic information on a CEO's pay package by checking a single document companies file with the U.S. Securities and Exchange Commission. This is the proxy statement -- which is meant to update shareholders on the state of a company prior to its annual meeting.

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Finding the proxy is easy. Just go to the "company search" page at the SEC Web site, type in your company's name or ticker, and look for the Def 14A form -- the code name for the proxy.
Once you've opened the proxy, find the section titled "executive compensation." Here, you'll find a table laying out the pay packages for the five highest paid execs for the past three years.
As an example, let's take a look at the proxy for Cendant (CD, news, msgs). Cendant is a travel and real-estate services company whose Chief Executive Henry Silverman regularly comes under attack for getting paid too much as the shares of his company lag the market. Over the past two years, Cendant shares are up 10%, compared to gains of 20% for the S&P 500 ($INX). The stock price is roughly where it was in 1998.

On page 21 of the company's most recent proxy statement, filed on March 2, 2005, you'll find a table with all the major components of Silverman's pay package: base salary, bonus, options, restricted stock grants and "other" compensation.

You'll see that Silverman earned a base salary of more than $3 million each of the past three years, bonuses in the $7.8 million-to-$15.2 million range and "other" compensation -- like retirement plan and insurance payments -- of anywhere from $3.3 million to $5 million each year.

How much is too much? It seems like a lot, but how do you know for sure?

There are no hard and fast rules. But one way to size up a pay package is to compare it to what others in the industry got. Silverman received total direct compensation of $23.9 million last year, compared to a median of $4 million at 12 similar companies, says Institutional Shareholder Services, which advises institutional investors on proxy voting and corporate governance matters.

Since individual investors don't have access to industry averages, here's a basic rule of thumb. The Corporate Library gets suspicious whenever CEO pay packages are more than 20% above the median for similar size companies. "We have found that companies that pay more than 20% above the median are consistently the ones that end up in scandal, in an investigation or in bankruptcy," says Marshall.

To help you make the calculation, see the box below for a breakdown of the median level of pay -- including base pay, bonus, restricted stock grants, options and "other" pay -- at companies based on their market capitalization, thanks to Moody's.

Median CEO pay levels at U.S. companies, by market capitalization
Company market cap
Total Compensation
Bonus
Options
$250 million to $1 billion
$1,843,000
$254,300
$717,000
$1 billion to $3 billion
$3,133,000
$550,000
$1,419,000
$3 billion to $5 billion
$5,372,000
$850,000
$2,345,000
$5 billion to $10 billion
$6,199,000
$1,030,000
$3,155,000
$10 billion +
$9,389,000
$987,000
$6,176,000

Source: Moody's Investors Services

To be fair to Cendant, the board at that company has trimmed Silverman's pay package and taken steps to better link pay to performance. But ISS still thinks the package is excessive because pay-for-performance hurdles are too low, and his pay too high. "Over the past year, Cendant underperformed both its index and its peers. Yet, the company's CEO is one of the highest paid in terms of salary and in terms of bonus," says ISS. Cendant declined comment.
Watch the perks Though they don't cost as much as lavish bonuses and pay packages, excessive perks are another red flag. Perks are typically, but not always, summarized in a footnote to "other compensation" in the proxy.

The Corporate Library, for example, chides American Express (AXP, news, msgs), Cendant and Honeywell International (HON, news, msgs) for giving their CEOs from $100,000 to $200,000 a year to subsidize personal use of corporate aircraft. At Dominion Resources (D, news, msgs), Chief Executive Thomas Capps recently got $385,510 in tax reimbursements.

Sometimes, companies slip top execs nice perks but you can't find them in the proxy statement. The Corporate Library, for example, takes Colgate Palmolive (CL, news, msgs) to task for releasing its "Above and Beyond" perk plan as part of a quarterly statement in November 2004, even though most investors expect to find such information in the proxy. The plan offers 800 executives anywhere from $2,000 to $11,500 a year to spend on personal services including housekeeping, fitness center membership dues (plus the cost of personal trainers and running shoes), tickets for entertainment events, club membership, and even pet grooming.

Chief Executive Reuben Mark said that Colgate is frugal when it comes to perks -- forgoing extravagances like corporate aircraft or subsidized housing for top brass. He says the Above and Beyond plan was part of an overhaul of company perks that reduced spending on such goodies by over 50%. The $2,000 to $11,500 annual Above and Beyond payments to 800 execs is too small to warrant a mention in the company's proxy statement, says Mark.

Other companies mentioned in this column declined to comment.

Advance detective work Corporate-governance experts also like to dig into the details of severance packages and retirement plans -- often a back door way for boards to hand CEOs sweet reimbursement packages.

For severance packages, generally anything more than three times annual compensation is out of line, says Patrick McGurn, special counsel for Institutional Shareholder Services. Institutional Shareholder Services also dings companies if they offer top brass severance packages even when they are terminated for poor performance.
Special Coverage

MSN Money exposes bloated CEO salaries and compromised corporate ethics. Read about what impact it has on your finances and join the discussion in our message board. Click here to go to our special coverage.

It's a lot harder to figure out what's going on with executive retirement packages like deferred compensation or supplemental benefit payout programs. Some details are in the proxy statements, but they are "extremely sketchy," says McGurn. "It takes someone with a lifetime of experience to estimate what the potential payouts would be. We were hoping to get some rules from the SEC to force greater clarity, but we haven't seen them yet."
McGurn would also like to see the SEC force companies to provide what he calls the "holy cow" numbers. That's a simple set of figures that would make it easy for investors to understand the sometimes stunning total pay and benefits package. "We are not seeing a lot of companies provide that on a voluntary basis," laments McGurn. "We would love to see the SEC require it."
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column.