Pay Check

Does Michael Dell’s salary compute? Is Dick Cheney’s bonus defensible? Are Herb Kelleher’s stock options on course? We analyze the earnings of twenty Texas CEOs: Who’s underpaid, who’s overpaid, and who’s on the money?

October 1998By Comments

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I’VE BEEN IN THE EXECUTIVE COMPENSATION business for 39 years. For the first 28 years I designed incentive plans for CEOs and other senior executives around the world; for the past 11 I’ve critiqued such plans as a university professor and as the author of six books and hundreds of articles on executive pay. And in all that time, I’ve rarely come across a corporate chief as undeserving of his pay as Lester M. Alberthal, Jr., who is about to retire as the CEO of Plano-based Electronic Data Systems. Alberthal fits the mold of a classic pay abuser. Although his performance was just plain terrible most of the time, EDS’s board lavished upon him vast sums of money: a total compensation package worth more than $13.8 million in 1997. Yet you’d have to search long and hard during Alberthal’s nearly twelve years as CEO to find an instance when EDS outperformed the Standard & Poor’s 500 Index, a listing of five hundred stocks that is the premier gauge of the stock market. Actually, there is one instance that springs to mind, and that was August 7, 1998, the day after EDS announced his retirement. That day the company’s stock price jumped 14 percent, adding $2.5 billion to the total market value of the stock. It’s not often that a CEO can determine just how much impact he personally is having on his company’s stock price, but for Alberthal, August 7 was one for the books.

Fortunately, not every head of a corporation is a pay abuser, as I discovered when I analyzed the compensation of twenty Texas CEOs. In fact, although the state is often described with superlatives, the men who run its best-known companies are wimpy when it comes to executive pay. In 1997 the typical Texas CEO delivered a shareholder return (stock price appreciation and reinvested dividends) in periods of three, two, and one fiscal years that was essentially average when compared to the return delivered by CEOs around the country. Nonetheless, he earned a base salary that was 7 percent below the market, a combination of base salary and annual bonus that was 17 percent below the market, and total compensation (salary, bonus, miscellaneous compensation, and long-term incentives, including the estimated present value of stock-option grants) that was 30 percent below the market.

How did I arrive at these and other conclusions? What exactly is “the market”? To assess whether a CEO is paid too little, too much, or just enough, you can’t simply tote up the average pay of other CEOs and then compare it to his. In a study I completed a few months ago, I found that the average total compensation for 279 CEOs across the country was $8.7 million. But the range varied wildly, from $100,000 for Warren Buffett of Berkshire Hathaway to $152 million for Sanford I. Weill of Travelers Group. So, for each CEO, I adjusted for three factors:

COMPANY SIZE Other things being equal, CEOs of large companies are paid more than CEOs of small companies. In determining company size, I gave equal weight to the company’s 1997 revenues and to its year-end permanent capital in the business—that is, the sum of long-term debt and shareholders’ equity.

COMPANY PERFORMANCE There are, of course, numerous ways to look at company performance, but I focused on the one thing shareholders look at the most: total shareholder return. At the end of the day, that’s what shareholders care the most about, much more than growth in earnings per share and return on equity. Because a company can look good or bad at any given time, I measured total shareholder return for the 1997 fiscal year, the 1996 and 1997 fiscal years combined, and for the 1995, 1996, and 1997 fiscal years combined. Then I constructed an overall performance score for the company by giving three times the weight to the three-year period and two times the weight to the two-year period.

TYPE OF INDUSTRY Surprisingly, the industry in which a CEO works has little bearing on his pay if differences in company size and performance are taken into account. I found that only one industry paid differently than other industries: the utility industry, which pays its CEOs significantly less than nonregulated companies pay their CEOs. (By contrast, the Baby Bells, though they are still highly regulated, do not require their CEOs to wear compensation hair shirts. They pay them competitively, thank you very much.)

After weighing these factors, I considered the many elements that make up a CEO’s pay package. Leaving aside broad-based fringe benefits like pension plans and medical insurance, they can be boiled down to base salary, annual bonus, and long-term incentives. While the first two are self-explanatory, the third, alas, is not. Long-term incentives are designed to induce a CEO to focus on the company’s performance over time. They come in three basic flavors:

STOCK OPTIONS Options are far and away the most popular long-term incentive. The CEO is given the right, but not the obligation, to buy a number of shares of his company’s stock for a fixed period of time at a fixed price. If the stock price rises, he makes out—but if it doesn’t, he doesn’t lose because he doesn’t have to exercise the option.

RESTRICTED STOCK Here the CEO is given a number shares. To earn them, he need do nothing more than breathe while he is on his company’s payroll for, say, five years.

PERFORMANCE PLANS A few companies offer their CEO large sums of cash for meeting predetermined performance goals. Or, instead of cash, the CEO is given a number of shares, though in contrast to restricted stock grants, his performance must meet certain expectations before he is permitted to take possession of the shares.

Sounds simple, right? Not so fast. Whenever you attempt to calculate total compensation, there always arises the thorny issue of how to value stock options. My preference is to answer the following question: If the CEO, on the date the option is granted, were free to sell it to an outside party, what might that outside party pay for the privilege of having a long-term call on the stock? CEOs like to tell you that it is impossible to value an option on the date it is granted because it’s impossible to know what the future holds for the stock price. Indeed, they would have you believe that the option is worthless on the date it is granted, because the price the CEO has to pay to exercise the option is equal to the market price of the stock on the date of the grant. Therefore, the CEO points out, there is no gain at the time of the grant, and since there is no gain—voilà!—the option must be worth nothing. But if options are worth nothing, why is it that CEOs would crawl through fire to get them? The fact is, an option can be valued at the time of its grant, though different analysts have different methods of doing it. I use a modified version of the Black-Scholes Option Pricing Model, which was formulated by economists Fischer Black and Nobel prize—winner Myron Scholes and carries the seal of approval of the Financial Accounting Standards Board (the regulatory body for accounting in the U.S.) and the Securities and Exchange Commission.

All that said, I’ve assigned one of four labels to each of the twenty CEOs on these pages:

WORTH IT BIG TIME CEOs in this category generally are excellent performers. Some earn substandard amounts of pay, making them incredible buys. Others play the pay game so fairly that you have to give them credit. A few performed so magnificently that I overlooked the fact that they earned far more than the norm.

WORTH IT A CEO in this category will have more or less normal performance and more or less normal pay. However, a CEO who turned in a substandard performance and received substandard pay could also fit here. It may seem counterintuitive to view a low-performing, low-paid CEO as worth it, but if someone didn’t perform below the average, the average wouldn’t be the average.

NOT WORTH IT Here we have a CEO who typically combines substandard performance with pay that, though perhaps not out of sight, is too high in relation to his company’s size, performance, and type of industry.

NOT WORTH IT BIG TIME CEOs in this category are lousy performers who insist on being paid as if they were terrific performers. This utter disconnect between pay and performance is what gives them this bottom-rung ranking.

Lester M. Alberthal, Jr.

Electronic Data Systems — Plano
Base salary $850,000
Salary plus bonus $850,000
Total compensation $13,844,000

WE LEARN FROM PHYSICS that there is matter and that there is antimatter. Well, Alberthal is the anti–Michael Dell. From December 1986, when Alberthal became CEO, to December 31, 1997, the end of EDS’s last full fiscal year, he beat the S&P 500 Index. However, as the time period shrinks, his performance flags. If you look only at the past seven years, Alberthal underperformed the S&P 500. If you look at even narrower time periods—six years, then five years, then four years, and so forth—his performance becomes positively awful. In 1997 he eked out only a 3.2 percent total shareholder return, about one tenth of the S&P 500’s return of 33.4 percent, yet the EDS board rewarded him with $12.9 million in free shares of stock. From December 31, 1997, to August 6, 1998, shareholders actually lost 15.9 percent of their investment (compared with a 13.3 percent positive return for the S&P 500). Still, when Alberthal leaves, he walks away with a retirement package worth $38.6 million. EDS defended Alberthal’s astounding retirement pay by pointing to his long career at the company and the agreement he signed stating that he would never work for a competitor. A better deal for shareholders would have been to double his severance pay provided he was successful in getting the company’s primary competitor to hire him as its CEO.


David A. Arledge

Coastal — Houston
Base salary $723,000
Salary plus bonus $1,123,000
Total compensation $2,072,000

ARLEDGE’S PERFORMANCE has been above par since taking over Coastal in October 1995: Shareholders received an 88 percent total return between September 30, 1995, and December 31, 1997, versus 73.8 percent for the S&P 500. Granted, he slipped fractionally below the S&P 500 during the one-year period ending December 31, 1997. But his pay was 21 percent below the market in salary, 50 percent below the market in salary and bonus, and 78 percent below in total compensation.


Gordon M. Bethune

Continental Airlines — Houston
Base salary $756,000
Salary plus bonus $1,693,000
Total compensation $3,007,000

TALK ABOUT A TURNAROUND. In Bethune’s nearly four years as CEO, Continental has garnered rave reviews from passengers and shareholders, two groups that are hard to satisfy at the same time. Between November 31, 1994, and December 31, 1997, Bethune delivered a 483 percent shareholder return, more than four times the 120.5 percent return of the S&P 500. Yet he is modestly paid, with a salary that is 5 percent below the market, a combination of salary and bonus that is 36 percent below the market, and total pay that is 75 percent below.


E. R. Brooks

Central and South West — Dallas
Base salary $700,000
Salary plus bonus $1,150,000
Total compensation $1,441,000

ON A SCALE OF 0 TO 100, WITH 0 representing the worst-performing company in terms of shareholder return and 100 the best-performing, Central and South West doesn’t fare well at all. Indeed, its shareholder return in the three-, two-, and one-year time periods was quite poor, rating only 16, 14, and 25, respectively. The only consolation was that Brooks’s total pay put him at 37 percent below the average for already low-paid utility company CEOs.


Richard B. Cheney

Halliburton — Dallas
Base salary $1,100,000
Salary plus bonus $3,080,000
Total compensation $5,674,000

THE FORMER U.S. SECRETARY of Defense has been a fine performer during his short tenure at the energy services company, which began in October 1995. Between September 30, 1995, and December 31, 1997, total shareholder return was 170.2 percent, or more than twice the return of the S&P 500. His salary put him 32 percent above the market, and his salary and bonus put him slightly higher than that, but he didn’t receive much in the way of stock options or other long-term incentives. As a result, his total pay put him 42 percent below the market.


Robert L. Crandall

AMR — Fort Worth
Base salary $767,000
Salary plus bonus $1,767,000
Total compensation $7,111,000

CRANDALL WAS, TO MY WAY of thinking, a genuine American hero. His presumed daily prayer—in which he asked, among other things, “Lead us not into temptation”—was answered; either that or his ever-present Vantage cigarettes overwhelmed his greed glands. Over the years, he has turned aside his board’s desire to give him pay raises, bonuses, and sundry long-term incentives. He knew that if AMR was going to return to profitability, he would have to get a handle on the company’s burgeoning labor costs, particularly the labor costs for his pilots. And he figured that the way to do that was to lead by example. A long time passed, and progress was measured in inches rather than miles, but today AMR is a healthy company, in no small measure a result of Crandall’s sacrifices. His total pay in 1997 was much higher than it had been in quite a few years. Even so, he ended up being underpaid by 38 percent. He has since retired, and he will be sorely missed—at least by me.


Michael S. Dell

Dell Computer — Round Rock
Base salary $788,000
Salary plus bonus $2,788,000
Total compensation $33,756,000

BETWEEN JUNE 23, 1988, THE day after Dell Computer went public, and January 31, 1998, its founder and CEO beat the S&P 500 by 33 times. If we extend the performance period to July 31, 1998, he beat the S&P 500 by 63 times. That’s better than any of the companies in the S&P 500 and almost twice as good as the number two performer, WorldCom. Face it: Michael Dell is farther out on the curve of performance than Isaac Newton was on the curve of intelligence. Until just a couple of years ago, he was content to pay himself almost nothing, à la Warren Buffett and Bill Gates. But then he decided that he ought to be paid like a working-stiff CEO. In fact, he went the working stiffs one better by taking such large option grants that his total pay in 1997 positioned him at 42 percent above the market. It would be nice if he eased off a bit, but with his performance, his shareholders presumably wouldn’t mind if he began disappearing into the company’s treasury for weeks at a time.


Thomas J. Engibous

Texas Instruments — Dallas
Base salary $646,000
Salary plus bonus $2,146,000
Total compensation $5,365,000

FROM MAY 31, 1996—JUST before Engibous became CEO—and December 31, 1997, TI’s total shareholder return was 62.8 percent versus 49.5 percent for the S&P 500 during the same period. But Engibous’ pay lags the market substantially: 29 percent below the market in salary, 8 percent below in salary and bonus, and 45 percent below in total pay.


Don D. Jordan

Houston Industries — Houston
Base salary $1,000,000
Salary plus bonus $2,080,000
Total compensation $9,058,000

AS I MENTIONED EARLIER, most utility companies pinch pennies with their CEOs, but Houston Industries is different. It pays Don Jordan generously—so generously that, even after adjusting for company size and performance, his total pay package in 1997 put him 221 percent over the market, higher in percentage terms than any other Texas CEO in this article and wildly out of sync with the rest of the industry; the CEO of San Francisco–based PG&E, a utility that has more than twice the revenues of Houston Industries, earns only $2.7 million. In terms of shareholder return, Jordan’s fares a bit better than his rivals’—26.6 percent in 1997 versus an average of 22.9 percent for other public utility chiefs in my study—but performs poorly compared with CEOs generally.


Herbert D. Kelleher

Southwest Airlines — Dallas
Base salary $395,000
Salary plus bonus $567,000
Total compensation $651,000

WHAT IS IT WITH THESE AIRLINE guys? They must be surveying one another and ignoring what passes for decent compensation in other industries. AMR’s Crandall was low to the ground in terms of pay, as is Continental’s Bethune, but Kelleher beats them both. His salary puts him 46 percent below the market. The combination of his salary and bonus puts him 67 percent below. And his total pay is—are you ready for this?—90 percent below. He is paid so little that his passengers ought to pass the hat for him at the end of every flight. Southwest’s performance in earlier years suffered along with the rest of the industry, but in 1997 it was exemplary. Kelleher delivered total shareholder returns of 68.2 percent, more than double the 33.4 percent performance of the S&P 500.


Kenneth L. Lay

Enron — Houston
Base salary $1,200,000
Salary plus bonus $1,675,000
Total compensation $13,701,000

LAY’S SHAREHOLDER RETURN performance during the three-, two-, and one-year time periods is in the same league as that of EDS’s Alberthal, and in case you missed the point, that’s not a good thing. In 1997, for example, Lay delivered a return of negative 1.4 percent versus 33.4 percent for the S&P 500—yet his ultralarge option grants catapulted him to a total pay package that was 65 percent above the market. During Lay’s long tenure as CEO, which stretches back to November 1985, Enron’s shareholder return was not much different from what an investor could have received by putting his funds in the S&P 500. And during at least some periods, Lay actually delivered superior returns. But starting in early 1992, Enron’s returns began to slip below the overall market, and more recently they’ve slipped badly. Meanwhile, Lay’s pay package has been growing and growing. (In fairness, Enron’s shareholder returns for the first seven months of 1998 surpassed the S&P 500—a possibly hopeful sign, although seven months is an extremely short period.)


Bill M. Lindig

Sysco — Houston
Base salary $660,000
Salary plus bonus $1,221,000
Total compensation: $1,913,000

THE FINDING HERE IS LOW pay and low performance. Lindig, who got his job in January 1995, earned 22 percent less in base salary in the company’s 1997 fiscal year (which ended June 30, 1997), 32 percent less in salary and bonus, and 72 percent less in total compensation. But between December 31, 1994, and June 30, 1997, he delivered shareholder returns of only 47.6 percent, less than half the 103.9 percent return of the S&P 500 during that period. However, he seems to have found the “go” button on his desk, because between June 30, 1997, and July 31, 1998, he slightly outperformed the S&P 500.


John Mackey

Whole Foods Market — Austin
Base salary $170,000
Salary plus bonus $263,000
Total compensation $322,000

IF HOUSTON INDUSTRIES’ Don Jordan is, relatively speaking, the most overpaid CEO featured in this article, Mackey is the most underpaid. His pitifully low salary is 66 percent below the market, and his salary and bonus is 78 percent below the market. Worse, he gets stock options that are so teeny-weeny that his total pay is 92 percent below the market. That much money wouldn’t buy Michael Dell for more than a few days. Of course, Mackey is no Dell when it comes to performance, though he isn’t any slouch either. On a scale of 0 to 100, his shareholder return during the three-, two-, and one-year time periods rated 58, 93, and 61, respectively.


L. Lowry Mays

Clear Channel Communications — San Antonio
Base salary $726,000
Salary plus bonus $2,726,000
Total compensation $3,649,000

HIS SHAREHOLDER RETURN in three-, two-, and one-year time periods rated 99, 99, and 97, respectively. You really can’t top that. Although his cash compensation positioned him 54 percent above the market, his total pay left him under the market by 51 percent, principally because his stock-option grants were puny.


Erle Nye

Texas Utilities — Dallas
Base salary $760,000
Salary plus bonus $1,085,000
Total compensation $1,753,000

WHEN IT COMES TO DETERMINING how competitive its CEO’s pay is, I’d wager that Houston Industries has never bothered to call up Texas Utilities to find out how much Nye is being paid. The answer would be “not much.” Nye’s total pay puts him 38 percent below the market. However, though he earns far less than Don Jordan, his performance is also substantially lower. During the three-, two-, and one-year time periods, his shareholder return rated 19, 15, and 19, respectively.


Eckhard Pfeiffer

Compaq — Houston
Base salary $1,250,000
Salary plus bonus $4,500,000
Total compensation $30,220,000

AN EXCELLENT PERFORMER, Pfeiffer’s total shareholder return has been fine and getting even finer. In the three-, two-, and one-year time periods, Compaq rated 83, 95, and 90, respectively. But his pay is a thing of wonder. His salary is 19 percent above the market, his salary and bonus is 34 percent above, and his total pay is 88 percent above, the latter figure a result of stock-option grants with an estimated present value of $24.2 million. What’s going on here is obvious: Compaq’s board has looked at the return numbers and rewarded Pfeiffer with a ton of compensation. Most companies don’t pay for performance these days, but that doesn’t mean it’s wrong when one does.


Bruce E. Ranck

Browning-Ferris Industries — Houston
Base salary $600,000
Salary plus bonus $727,000
Total compensation $1,205,000

HE GOT HIS JOB IN OCTOBER 1995, and during the two years ending September 30, 1997 (the end of BFI’s most recent full fiscal year for which data are available), he delivered total shareholder returns of 31.2 percent versus 69 percent for the S&P 500. No matter how you slice it, that’s underperformance. But he seems to be a quick study, for in the one-year period ending September 30, 1997, he outperformed the S&P 500 by 55.7 percent to 40.4 percent. Meanwhile, his salary is 26 percent below the market, his salary and bonus combined is 57 percent below the market, and his total pay is 81 percent below.


Lee R. Raymond

Exxon — Irving
Base salary $1,750,000
Salary plus bonus $3,250,000
Total compensation $18,182,000

HIS PERFORMANCE HAS BEEN blah but so has his pay. During the three-, two-, and one-year time periods, Exxon’s total shareholder returns rated 47, 48, and 42, respectively. Yet Raymond’s total pay is also just below average—12 percent below, to be exact. How can someone earning $18.2 million ever be considered even a little bit underpaid? You have to remember that the number one factor driving CEO pay is company size, and Exxon is the biggest thing going. By all rights, he could be making even more.


Robert L. Waltrip

Service Corporation International — Houston
Base salary $879,000
Salary plus bonus $3,212,000
Total compensation $20,346,000

IF ANYONE SHOULD KNOW that you can’t take it with you, it’s Waltrip, who runs the largest assemblage of funeral homes in the country. Yet his total pay in 1997 put him 192 percent over the market for a company of SCI’s size and performance. Speaking of performance, Waltrip has been a bit, well, moribund: His shareholder return rates a solid 63 in the three-year period, but it slips in the two-year period to 52 and in the one-year period to 46. For this kind of pay, he has to do better than that.


Edward E. Whitacre, Jr.

SBC Communications San Antonio
Base salary $975,000
Salary plus bonus $4,275,000
Total compensation $21,619,000

IN AMERICA, IF YOU RUN A company with huge revenues, and better yet, with huge and growing revenues, you get to earn a ton of money, even if you aren’t the best of performers. I’ve mentioned that the Baby Bells, though highly regulated, do not extract any pay sacrifices from their CEOs. And here comes Whitacre to prove my point: In 1997 he hauled away a total pay package that puts him 74 percent above the market. But during the three-year and two-year periods ending December 31, 1997, Whitacre’s shareholder returns rated only 37 and 29, respectively, though he moved to an above-median 61 for the one-year period.


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