A great debate is wracking America - Equality of Opportunity vs. Equality of Outcome - and there is a rather unlikely group of people that, quite oddly, generally has become the ardent champion of Equality of Outcome, namely, the practitioners of America's highest-paid occupation, CEOs.
Now the rhetoric of your average chief executive officer is pure Equality of Opportunity. "Pay me well if I perform," he declaims, "and if I don't, throw me out." But rhetoric is one thing and actions are another. For my research shows CEOs don't take easily to the notion that when their performance falls they ought to earn less than their better-performing peers. No, when that happens, your normal red-blooded American CEO immediately sets in train actions that will shortly restore his compensation to its former glory, or better yet, to more than its former glory.
When their performance begins to decline, CEOs typically resort to one of two stratagems or, sometimes, to both stratagems at once. One stratagem is to increase the size of their stock option grants so they can earn the same as before, but with a lot lower performance. The second stratagem is to call in one favorite executive compensation consultant and to design an entirely new long-term incentive plan. The new plan is added on top of everything else the CEO has been receiving, with the result that pay almost always rises.
A prime illustration of many CEOs' closet fondness for the Equity of Outcome camp involves Pfizer Inc., which is based in Manhattan and is one of America's largest pharmaceutical companies.
For part of 1966, I worked for Pfizer, and the person who hired me, Edmund T. Pratt Jr., went on in 1972 to become the company's CEO. Even though I quit the company (to become a consultant), Ed and I maintained a cordial business relationship. In fact, I became the company's compensation consultant and remained so for the next 15 years, until I retired from that profession.
Ed didn't believe in getting too fancy when it came to structuring executive pay programs. Ed's idea of the perfect executive compensation package was to pay a solid base salary and to give the person a reasonably sized stock option grant each year. If the company prospered, and the stock price rose, the executive would become fairly wealthy. But if the company didn't prosper, and the stock price either remained flat or dropped, the executive earned very little compared to his peers at other companies. Ed wouldn't dream of having an executive bonus program at Pfizer. And when it came to the exotic new forms of long-term incentive compensation that consultants like me were dreaming up, he just laughed.
But when he wasn't laughing, Ed Pratt was performing. I would like to have measured his performance during his almost 20-year tenure as CEO, but data limitations forced me to concentrate on the last 16 years of his tenure - between Feb. 28, 1975 and Feb. 28, 1991 (at which time he relinquished his title as CEO). What I did here was to measure Pfizer's shareholder return performance (i.e., stock price appreciation plus reinvested dividends), first between February 1975, and February 1991, then, reducing the length of the period by dropping the earliest year, between February 1976, and February 1991, then between February 1977 and February 1991, and so on through the period between February 1990 and February 1991. In all, I measured Pfizer's performance in 16 different time windows. In each case, I compared the resulting level of performance to that of the companies comprising the Standard & Poor's 500 Stock Index (of which Pfizer itself it a member). Taking all 16 windows together, I found that, on average, Ed Pratt performed at the 73rd percentile of the distribution. In other words, only 27% of the CEOs making up the S&P 500 companies outperformed him. On top of that, Ed finished his long career with an awesome sprint. For the three periods, February 1988 through February 1991, Pfizer ranked at, respectively, the 88th, 91st and 97th percentiles of the S&P 500 company distribution.
To provide a perspective on the slowdown at Pfizer, consider that in Ed Pratt's last year as CEO, a total return to shareholders was 84%. But in the 31/3 years William Steere has been CEO, the total return to shareholders has been 30%.
Now if your stock growth starts to slow up, as it decidedly has at Pfizer, you have two choices as CEO. You can be philosophical about the matter and simply take your lumps. You're going to make less money, but performance being what it is, you ought to make less money. I believe strongly that if Ed Pratt were still CEO, he would have opted for this choice.
But if you're not a philosopher, but rather a doer, you can spring into action. Ideally, that action would take the form of Herculean efforts to turn your company around and get the stock price going again. But if you're not too good at that sort of action, you can take a different sort of action - redesign your pay package so that even if the stock price doesn't get going again, you do.
Consider, for openers, that Ed Pratt received an option on $2.4 million of Pfizer stock in 1990 - his last full year as CEO. (His option grants in the three preceding years were on $2.8 million, $1.7 million and $1.8 million of stock.) Now here comes Mr. Steere, and what happens in 1991, his first year as CEO: He gets an option of $5.2 million of stock, or more than double the size of the option Ed Pratt received just one year earlier. Then a year later, in 1992, he gets an even bigger option, this time $7.5 million of stock, or about triple the size of Ed Pratt's option grant his last year as CEO.
Consider here that to make $4 million on his last stock option grant over the option's 10-year term, Ed Pratt would have had to increase Pfizer's stock price by 167%, or at a rate of 10.3% per year - about the same rate stocks generally have appreciated since World War II. But with an option of $7.5 million of stock, you can make $4 million by increasing that stock price by only 53%, or a paltry 4.4% per year. A shareholder could make more than that by buying government bonds.
Apparently, Mr. Steere didn't trust that his now-engorged option grants would do the trick for him, for in 1993, he managed to introduce two new long-term incentive plans.
Remember that when Ed Pratt was running things, and running things well, he made do with a single long-term incentive plan, namely, stock option grants. Now that Mr. Steere is running things, and on the evidence, running things in a below-average manner, not only have the size of the option grants grown metastatically but the company now has three long-term incentive plans, two plans introduced by Mr. Steere and an option plan that was in existence during Mr. Pratt's tenure.
The first of the new plans started by Mr. Steere is a restricted stock plan, and this sort of plan is a dandy for a CEO who has trouble batting out of the infield. With restricted stock, you don't have to worry about getting the stock price up, as you do with a stock option.
No, with restricted stock, you make money even if the stock price falls, and you get the dividends thrown in to boot. For restricted stock is just a fancy name for giving the executive the shares for free. And all he has to do to earn those free shares is to sit around for a few years and look pretty; no performance is required. Well, in 1993, Mr. Steere was given 10,390 free shares, and those shares had a value of $600,000 on the day they were granted.
As if this were not enough, Mr. Steere engineered a second new long-term incentive plan.
Under this plan, he has, for all practical purposes, the opportunity to earn 25,000 more free shares each and every year, although these shares, unlike the restricted shares, do require that he do something.
According to the company's latest proxy statement, Mr. Steere must meet twin goals involving total shareholder return and earnings per share growth, both involving a comparison of Pfizer's performance to the performance of a peer group of companies, and over periods ranging from two years to five years.
Unfortunately, the proxy is utterly silent on how much total shareholder return and earnings per share growth performance is required, so it is impossible to say whether the performance goals are tough or a joke.
In any event, if Mr. Steere achieves all of his performance goals, he can earn another 25,000 shares free each and every year.
At the $69 closing price of Pfizer stock on Dec. 31, 1993, that 25,000-share opportunity was worth an added $1.7 million per year.
Now Mr. Steere did cut back on the size of his option grants. Recall here that he received an option on $5.2 million of stock in 1991 and an option on $7.5 million of stock in 1992. For 1993, he received an option on only $4.7 million of stock. Still, that option was about double the option Ed Pratt received in his last year as CEO.
By our estimate, the decrease in the size of Mr. Steere's 1993 option grant, as compared to his 1992 grant, was worth about $650,000, or about the value of Mr. Steere's 1993 restricted stock grant. That makes him about even. But that third new long-term incentive plan tilts the scales in his favor by a net of about $1.7 million per year.
With his larger option grants, and his new restricted stock grants and his new performance share grants, Mr. Steere is poised to earn what Ed Pratt did, and with a lot less performance than him, or alternatively, to earn a lot more than Ed Pratt did, but with not better performance. Nice work if you can get it
My just-completed study of the 1993 pay of the CEOs of the 200 most highly capitalized companies in the country served up the same conclusion that I have been finding ever since I began these studies six years ago, namely, there is hardly any relationship between what a CEO earns and his company's performance. With CEOs like William Steere taking actions to guarantee themselves Equality of Outcome, you now know why.