You’re fired... thanks!
Over the past decades we have witnessed a huge rise in chief executive exit packages which, at current levels, seem outrageous especially in specific cases where the CEO’s performance was poor. It is worth highlighting some facts which are taken into account when structuring these packages – facts which are often left out of headlines but which are very important for the ultimate shareholder.
The basis for many exit packages is severance and other bonuses promised to the incoming CEO. To get a feel for the average CEO compensation package (including salary and stock options), in 2011 this was approximately 209 times greater than the average employee’s pay. In 1965, this multiple was approximately 18 times.
Huge payouts have become the norm as top-tier multi-billion dollar companies seek to keep up with their competitors. If a company wants an above-average CEO – a person who can maintain or create a competitive edge for the company and all its stakeholders – then such packages will have to be paid. Otherwise the same company will pay for it another way.
Severance is a useful tool while negotiating hiring contracts, as it allows a company to offer a CEO less in annual salary; while providing the CEO with a carrot to improve the company’s performance through a performance-based bonus. An exit package also protects the CEO, to a certain degree, from unfair dismissal.
In principle, this offering is specifically designed to align, as much as practically possible, the CEO’s interests to those of shareholders, but not necessarily those of stakeholders like employees, suppliers and the surrounding community.
The logic is simple: the larger the profits, the more value created for shareholders and the bigger the CEO’s bonus. On the other hand, it is the partial reverse of this which irritates shareholders – if a company’s profits decline as a direct result of poor CEO performance, shareholders value deteriorates, however, the respective CEO often gets a wonderful golden parachute.
This is where the crux of the matter lies – the incidence of chief executives being fired should increase tenfold if this is based entirely on poor performance, yet company directors have two main dilemmas. Firing a chief executive may create a lengthy and disorganised handover which could cost the company more than what could be paid out in an exit package. Directors find it is much easier to be generous and keep bridges intact.
The peak of large CEO compensation packages came in 2002 and later rapidly declined after Enron and WorldCom. The market feels that in certain areas, such as the banking sector, huge unjustified compensation packages are paid out, which very often are not reflective of the company’s underlying performance – it is a frequent psychological style that questions are asked when results fall short of expectations and not when profits are rolling in.
If one takes a closer look at what the real implications are for top management as a result of underperformance, it can be noted that a ripple effect does exist. It may not be as large as shareholders expect it to be, but in order to access that, one would need to be well informed and unbiased. In one of the more recent banking dramas, the Libor scandal, Barclays lost a few top posts as a direct result and this may be only the start of the firing line.
It is important, yet also difficult, for board members to appoint chief executives who are growth drivers of shareholder value and that such people are attracted with a remuneration package (which would also include an exit plan) which achieves the right balance between reward and shareholder value.
There will obviously be times when the desired outcome is not achieved and the option chosen to deal with such circumstance may be tricky. The situation a board must try to avoid is having a CEO who is content with being fired knowing what the exit package is worth.
Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the author’s objective and independent opinion. It is based on public information and should not be viewed as investment advice in any manner. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
Mr Micallef is an executive director at Curmi and Partners Ltd.