As promised (though a day late), I combed through the Policy Analysis paper “Executive Pay: Regulation v. Market Competition” that I bashed in my last post. Here are three of the greatest hits from the paper’s attempt to justify CEO pay:

The authors write, "In a recent Watson Wyatt survey of board members of major corporations and institutional investors, we found that board members believe that the pay-for-performance model directly contributes to improved corporate performance (2)."

I would hope so, given that they set the pay - but this belief is part of the problem, not a justification for CEO pay.

In a table attempting to prove that there is “pay-for-performance,” the paper notes that CEOs for “Companies Creating Low Returns” earned $8.8 million in 2005 and $5.5 million in 2006 (3). The authors have lived in a pay-for-recommending large CEO pay (normally called being an executive compensation consultant) bubble for so long that rather than think – huh, that is a lot of money for what we are calling “low returns" - they instead argue that  the 38% drop, to a paltry $5.5 million, shows that pay-for-performance works. Sad, really.

Then, in a circular logic finale, the paper states: “Any employer who underpays an employee relative to the market risks losing that employee and the value he or she brings to the company. Boards try to ensure continuity of management, but they face a constant threat of losing a CEO if more lucrative opportunities arise” (4). Notice that the authors use the ridiculous levels of CEO pay that currently exist in most companies, they refer to this as “the market" for CEO pay, to justify continuing to pay CEOs ridiculous amounts.

The National Center for Policy Analysis released a press release today on a paper released by executive compensation consultant Watson Wyatt Worldwide. In case you didn't know, executive compensation consultants are basically paid large amounts of money to justify paying CEOs and other managers even larger amounts of money. Here is the bulk of the release:

The current executive pay system -- the "pay-for-performance" model -- is working effectively.  In other words, say Ira Kay and Steven Van Putten of executive compensation consultants Watson Wyatt Worldwide, pay levels track corporate performance. 

Their study, which analyzed the relationship between the total return to shareholders generated by companies and the related stock option compensation for executives in the largest 1,088 companies in the United States in 2006, found that executives in companies that performed well were rewarded for that better performance

Other findings:

• While executive compensation packages of 10 seem exorbitant, CEO pay is a very small part of the overall cost structure of companies.
• Total CEO pay in 2004 was just 0.09 percent of sales, 0.06 percent of market capitalization and 1.3 percent of net income of companies.
• In 2006, CEOs in high-earning companies earned far more realizable pay -- the actual cash bonus paid the in-the-money value of stock options and the real value of restricted stock, plus the payout from performance plans -- than CEOs at companies with low earnings; the former also earned 3 times as much in realizable long-term incentives (LTI).

I will tear apart the findings in-depth tomorrow, but for now notice that their findings completely lack context - so what that the pay of one individual (the CEO) is a "small part of the overall cost structure" of the 1,088 LARGEST companies in the U.S. One would hope that an individual paycheck is not straining billion dollar companies, even if that paycheck is unjustifiably big.

Also, they point to the fact that high-earning CEOs outperform lower-earning CEOs; unfortunately, that says nothing about the absolute pay levels of either group.

Much posturing has occurred about changing CEO pay over the past couple years, but will a financial collapse combined with a gigantic taxpayer bailout be enough to finally force the issue? Here's what the Wall Street Journal has to say:

The American Federation of State, County and Municipal Employees has submitted 36 proposals, 32 of which address pay practices. AFSCME wants 10 companies to require executives to hold a majority of their stock and stock options until two years after retirement or termination. The union is also asking three firms to adopt "bonus banking," in which a portion of executives' annual bonuses would be withheld for three years, then recalculated based on updated corporate results.

The resolutions -- new for the union this year -- respond "to the financial crisis that, in part, derived from the perverse incentive structure of CEO pay," says Richard Ferlauto, AFSCME's head of corporate governance and pension investment.

Governance experts say the executive-pay proposals are more targeted and ambitious than those submitted in recent years. Last year, for instance, activists focused mainly on winning an annual advisory vote for shareholders on executive pay. That issue has receded because Congress is expected to consider such a requirement. Some shareholders also may mount campaigns against re-election of directors, particularly those on compensation or audit committees.

But I wouldn't hold my breath. As the same article notes:

But several firms are fighting back, claiming that the proposals are vague and misleading. At least seven companies, including Bank of America Corp. and PNC Financial Services Group Inc., have asked the Securities and Exchange Commission to block shareholder votes on the resolutions. The SEC so far has ruled in favor of at least one such request, from SunTrust Banks Inc.

In an all too familiar story, Dell Inc. stock is down more than 50% over the last year, but two departing executives are getting richer.

Mike Cannon, leaving after less than two years as president of Dell's global operations, is receiving a staggering $10 million in cash while outgoing chief marketing officer Mark Jarvisis is receiving $1.25 million.

According to Dell's SEC filing, Cannon will receive a $5 million payout on or before Feb. 20 as well as two payments of $2.5 million due in April and July, respectively. Dell will also continue to pay for Cannon's home-security system until Feb. 1, 2011.

Jarvis will receive $625,000, what would have been his salary this year, plus a $625,000 bonus.

Chesapeake Energy Corporation just awarded its CEO $75 million in addition to the nearly $3 million it paid him in 2008.

Chesapeake's board of directors said the payment to Aubrey McClendon was for his "extraordinary contribution to the joint venture transactions that were consummated by the company during 2008 and increased the company's intrinsic value by at least $10 billion."

"Intrinsic value" is an interesting way of ignoring the fact that Chesapeake stock fell 60% in value last year - a very bad year even in this market.

Bank of America CEO Kenneth Lewis has recommended to his board of directors that senior executives, including himself, do not receive bonuses this year.

In a memo, Lewis writes, “This was a difficult decision because we have worked hard and made progress on many projects that will create value for our company in future years. Nonetheless we are a pay-for-performance company.”

Before you feel too bad for Lewis, remember that he earned nearly $25 million last year - so he shouldn't have to give up cable despite the pay cut.

In case you thought the United States was unique in how richly it pays its CEOs, take comfort in these figures from Canada's Financial Post:

The [Canadian Centre for Policy Alternatives] released figures yesterday showing that individual total compensation packages in 2007 for the top 100 CEOs at publicly listed Canadian companies increased an average of 22% to $10.4-million as the economy thundered along. This compared with a pay hike of 3.2% to $40,237 for the average Canadian worker during 2007.

That gap has been growing amid increased competition for companies to attract strong leadership. In 2007, Canada's top 50 CEOs earned 398 times more than the average worker, compared with 85 times in 1995. Mr. MacKenzie said between 1998 and 2007 the average compensation of top CEOs increased by 147%, adjusted for inflation. This compared with a 3% decline in inflation-adjusted weekly wages for average Canadians and a 6% rise for those on the minimum wage.

Robert H. Frank at Cornell argues in The New York Times that Congress should not limit executive pay:

So why not limit executive pay? The problem is that although every company wants a talented chief executive, there are only so many to go around. Relative salaries guide job choices. If salaries were capped at, say, $2 million annually, the most talented candidates would have less reason to seek the positions that make best use of their talents.

More troubling, if C.E.O. pay were capped and pay for other jobs was not, the most talented potential managers would be more likely to become lawyers or hedge fund operators. Can anyone think that would be a good thing?

In large companies, even small differences in managerial talent can make an enormous difference. Consider a company with $10 billion in annual earnings that has narrowed its C.E.O. search to two finalists. If one would make just a handful of better decisions each year than the other, the company’s annual earnings might easily be 3 percent — or $30 million — higher under the better candidate’s leadership. That same candidate couldn’t possibly make as much difference at a company with only $10 million in earnings.

That’s why companies where executive decisions have the greatest impact tend to outbid others in hiring the ablest managers.

One reason for these trends is that companies themselves have become bigger. As the New York University economists Xavier Gabaix and Augustin Landier argue in a 2006 paper, C.E.O. pay in a competitive market should vary in direct proportion to the market capitalization of the company. They found that C.E.O. compensation at large companies grew sixfold between 1980 and 2003, the same as the market-cap growth of these businesses.

Beyond growth in company size, executive mobility has also increased. In past decades, about the only way to become a C.E.O. was to have spent one’s entire career with the company. With only a handful of plausible internal candidates, pay was essentially a matter of bilateral negotiation between the board and the chosen. Increasingly, however, hiring committees believe that a talented executive from one industry can also deliver top performance in another.

This new spot market for talent has affected executive salaries in much the same way that free agency affected the salaries of professional athletes.