Street Talk: CEO Paychecks: How They Are Determined

A "pay-for-hay" performance culture is embedded in the industry's DNA.
Feb 01, 2007
Volume 20, Issue 2

Brian O'Connell
In the September 2006 issue I wrote about the ticklish issue of CEO pay and how shareholder groups, especially the powerful pension and other institutional groups, are growing sick and tired of CEO overpayment and underperformance.

I'm revisiting the subject after news last month that Home Depot paid outgoing chief executive officer Robert L. Nardelli $210 million in cash and stock options on his way out the door. Included in that little gift basket was a $20 million severance package and retirement benefits valued at $32 million. Yet Nardelli had presided over a period where Home Depot had lost significant ground to its chief competitor Lowe's, and had seen its stock price languish. When Nardelli took the reins at Home Depot, on December 5, 2000, shares of the company closed at $40.75. On his last day on the job, six years later, the stock closed at $40.16. During the same time period, Lowe's saw its stock price rise 210%.

All Pay, No Hay
Now we're seeing almost similar situations being played out in the life sciences world, where executives are gobbling up big paychecks while leaving meager scraps for company investors.

Don't get me wrong. A good CEO can make all the difference in the world on a company's stock price. The problem is that performance goes both ways. In last September's column, I pointed to a well-received University of Florida study that showed how a benchmark group of securities analysts usually predict a firm's future performance based not only on its track record but also on how favorably the analysts view the company, which is influenced largely by how charismatic they consider its chief executive officer.

As I said, negative perceptions of a CEO are especially dominant in the life sciences field. If you read the column, you might remember how former long-time Pfizer CEO Henry "Hank" McKinnell left the company significantly poorer straight across the board.

McKinnell's retirement package would make even the most jaded Wall Street investment banker blush—he was given the option of a lump sum of $83 million or an annual pension of $6.5 million. Company shareholders had to wonder if the world had turned upside down. After all, McKinnell's tenure was a Chicago Cubs-like period of underachievement where Pfizer's stock fell 40%. As one trader said of the McKinnell golden parachute, "It's the equivalent of paying a .220 hitter $10 million a year."


Over at Merck, the company's top executives had structured a noble plan to ensure that executive pay would be tied to the company's stock performance. Good idea, bad execution.

In the past five years, the company has lost roughly 40% in stock value. Still, Merck execs made out okay. In fact, former CEO Raymond Gilmartin earned $54 million during that five-year period, including almost $38 million in cashout payments from company stock options. When he stepped down as CEO, Gilmartin received a generous pension of $784,000 annually. What's more, he continued to receive those generous stock options, although somebody needs to explain to me why a former CEO deserves even one stock option.

The question then is: how did Gilmartin earn all of this dough when the company had supposedly crafted a system where executive pay was tied to company stock performance? Merck said in a statement in 2006, after Gilmartin had left the company:

"(We) believe that executive officer compensation for 2005 was consistent with the level of accomplishment and appropriately reflects company performance." But the metrics used to jump to that conclusion have not been released by Merck, so investors have no idea what formula is being used to calculate executive pay-for-performance.

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