Tuesday, April 18, 2006

CEO Compensation- Again.....and again...

My partner was right. This topic just doesn't quit. This morning, CNBC coordinated with the Wall Street Journal to target the CEO of UnitedHealth Group, Bill McGuire. Dr. McGuire has commited the sin of having a board of directors who have now paid him options totalling in excess of $1.5 billion.

According to just the price charts alone, the company's stock has risen some 300% in the past five years, and has a current market value of $67.4 billion. By my reckoning, the company's market value was in the neighborhood of $20B five years ago, to account for the total return in the interim. Thus, it appears that Dr. McGuire led the firm to increase shareholder wealth by roughly a factor of 48 times the value of the options granted to him for said performance.

Not a bad deal for the shareholders, actually.

On CNBC this morning, they asserted that various UNG investors who had been interviewed held a range of opinions. Some, like me, felt McGuire had earned his compensation, and were happy to have had the opportunity to pay him for the performance. Others were outraged.

What was of more interest, though, was some of what the 'executive compensation' expert, invited on the program for this segment, had to report. Among founder-led firms, such as Dell and Microsoft, there is no single policy. Gates gets no stock, nor options. Michael Dell, on the other hand, receives options from his board.

I think this alone is very insightful. There simply is no "right" answer. But everyone agreed that the board was responsible and accountable for the compensation situation. The "expert" then went on to babble about more disclosure of options granted, rescinded, etc. It sounded like maybe the SEC has something afoot here.

Taking all this together, plus my earlier posts, I think the situation boils down to this.

1. Boards have created this mess by having retired CEOs, most of whom were probably overcompensated in their time, continue the tradition of overpaying the CEOs of the firms on whose boards they sit for similarly mediocre performance, i.e., it is a learned trait.

2. CEOs who consistently create superior returns for their shareholders deserve extraordinary compensation for their extraordinary performance.

3. CEOs who do not consistently create superior returns deserve modest fixed compensation. Their bonus compensation should definitely depend upon the superior shareholder returns they cause to occur. No superior returns, no wealthy CEOs.

4. Change takes time. Americans aren't particularly good at being patient. But, if one would give market forces a chance, and not rush to legislation, this "problem" of CEO (over)compensation should be self-correcting in not too long a time. I have suggested how this might happen here.

It reminds me of the mess that our politicians have created with Federal election campaign finance "reform." The more they have tinkered with it, the worse the problem has become. Had they simply opted for full disclosure of campaign financing to begin with, the whole matter would probably have been self-correcting there, too.

Sometimes, you have to let markets, even "information" markets, take a little time to work. But they do. Rushing them usually creates unintended consequences of significant proportions.

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