Stock Picking by the CEO's Paycheck

The numbers are eye-popping. Millions, sometimes tens of millions — even hundreds of million of dollars in salary, stock and benefits — are paid to chief executives of American corporations.

At first blush, that kind of money may look excessive, but you'll find plenty of people who say it isn't.  So if you are a shareholder and you hear the CEO of a company whose stock you own was paid $40 million dollars last year, should you care if it's fair?

If it isn't, it should raise questions about the company board of directors, the ones who decided the pay. Have they approved a plan that has the CEO's or the company's best interests in mind?  If it favors the CEO, the board isn't working in the best interests of you, the shareholder.

But how can you tell?

Determining whether CEO pay is justifiable isn't as easy as looking at how much money you made, or lost, in the stock of the company that CEO runs, according to a panel of experts we spoke with.

There are a lot of different variables that go into a CEO's salary, so you need to know what the board wanted the CEO to do, whether he or she delivered, and whether it was better or worse than his or her peers.

Because of rules introduced by the Securities and Exchange Commission last year, that information is easier to find than it once was, meaning investors can decide for themselves if they think a CEO's pay is reasonable.

Information about an executive's pay can be found in a company's proxy statement, in the Compensation Discussion and Analysis (CD&A) section. If you do not have a hard copy of the proxy, you can go to the SEC's web site and look for a company's DEF 14A form, which is another name for the proxy.

To help you navigate the technical language and pages and pages of descriptions that make up these CD&As, we asked five people from different walks of the corporate and investing world to tell us five things they focus on in the CD&A to determine whether or not an executive's pay is fair.  

Aligning Pay With Company Performance

Denny Hightower, former CEO of Europe Online Networks, and a former Disney executive, said looking at how a CEO's pay aligns with company performance is very important.

Hightower is currently a director, and member of the compensation committee for the pizza delivery chain Domino's. He has also chaired the compensation committee at Gillette, and served on the boards of TJX Companies, and Northwest Airlines.

"If I were looking at it as an outside investor, I think I would be very attuned to how the cash and equity portions of the pay align first and foremost with company performance," said Hightower.  To do this,  he said to look at what the company said it was going to do that year, and how well it did it.  This will show investors if the strategy was executed.  Then move down the chain to the CEO.  The CD&A should contain information about the specific targets the board set for the CEO in the past year.

Hightower said when investors are looking at these targets, they should try to determine if they were easy or "stretch" goals for the executive.  Third, see if the peer group the board's chosen to compare the CEO's pay to is appropriate.  The board, he said, should be keeping the peer group fresh and appropriate. 

Fourth, Hightower notes it's important to keep in mind the length of a CEO's tenure when trying to figure out if his or her pay was appropriate. 

"To get the right person, there will be sign-on bonuses, equity awards and other incentives for a new CEO that are not performance driven, so know where the CEO is in the spectrum," he said.

Finally, Hightower notes the incentives a board does put in place for a CEO should be those that reward the executive for making decisions that are good for the company, its customers and the communities in which it firm operates.

CONTINUED: Measure Performance

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