What's a CEO Really Worth?
I realize the title asks a silly question. It's not a silly question for lack of importance, but trying to define what the "right" amount to pay a chief executive officer is mind-bending at best.
With the political landscape currently dominated by Republican presidential candidates promising not to raise taxes on those making a gobs of money while Occupy Wall Street protesters shout about the massive wealth inequality in the U.S., it seems like a question we can't help but try to address.
How do we begin to tackle this question, then? Warren Buffett is rarely a bad place to start, and when it comes to investing in a publicly traded stock, Buffett has always advocated treating it the same as if you were buying the entire company.
So let's say I suddenly found myself with $200 billion in my bank account -- more than enough to buy Coca-Cola (NYS: KO) . How might I think about executive compensation then?
Why pay doesn't matter
Now that I'm the sole owner of Coca-Cola -- and keeping in mind that I have no interest in running the company myself -- my biggest concern has to be making sure there is someone running the company who I believe will not only do a good job but also, maybe more importantly, is someone who I can trust.
How much should I pay that person? In 2010, current CEO Muhtar Kent had combined compensation of $24.8 million. To my old self (that is, before becoming a magic-made billionaire), that would seem like an awful lot of money.
But think about it this way: Kent's compensation was 0.2% of Coca-Cola's $11.8 billion profit.
Let that sink in for a moment. As sole owner of Coca-Cola, I've got roughly $12 billion in annual profits at stake, and the man who I'm holding responsible for making sure that that profit not only stays healthy, but grows, is being paid a fraction of a percent of the profit.
I don't know about you, but when I think about it that way, $25 million in comp for the CEO seems like a bargain.
In fact, if Coca-Cola were 100% owned by me, I'd be very willing to pay more -- maybe considerably more. Rather than being primarily concerned with how much I'm paying the CEO, I'd be far more concerned with the extent to which he's passionate about what he does, whether he has relevant experience and knowledge to make him successful, and, once again, whether this is a person I can trust.
In short, in the search for a CEO for my company, I'd look for the right person first, and we could discuss pay later.
But wait. Why pay does matter
Though it was fun being a billionaire for a minute, let's return to reality.
For those of us who aren't billionaires who are buying entire companies, we're almost always in the position of looking at an executive's established pay to determine whether it makes sense rather than being able to unilaterally set that pay. For us, the pay package for a CEO can be extremely meaningful.
Many public company CEOs don't have egregious pay plans. Low annual pay is often a signpost of a manager who's passionate about the business. Oftentimes this is also an executive who was a founder and owns a significant stake in the company, and therefore is rewarded financially when all the owners are. Amazon.com's (NAS: AMZN) Jeff Bezos made $1.7 million last year, Google's (NAS: GOOG) Eric Schmidt made $313,219 in 2010 before handing over the CEO reins, and Berkshire Hathaway (NYS: BRK.A) (NYS: BRK.B) compensated Warren Buffett $524,946 -- and all but $175,000 of that was paying for the Oracle of Omaha's security detail.
In other words, if what we really want is the right CEO -- as outlined with Coca-Cola above -- a below-average pay package can often be a signal that we're on the right track.
And what of a kingly pay scheme? I would argue that while it doesn't necessarily mean that we don't have a talented manager, it calls into question whether he or she is a passionate, trustworthy operator, or simply a greedy mercenary who will run the business in a way that works best for his or her personal bottom line.
In 2007, Goldman Sachs (NYS: GS) CEO Lloyd Blankfein was paid an impressive $70.3 million. But it gets better. Of the five named executive officers in Goldman Sachs' proxy that year, the least compensated member was Chief Administrative Office Edward Forst, who made $49.1 million. In total, the five named executive officers grabbed $322 million that year -- or a full 2.8% of Goldman's net income.
I'm guessing many would agree if I suggested that those massive payouts have been reflected in Goldman's culture.
A big pay package is not a sure sign of a manager you can't trust. However, thinking back to my moments as a billionaire above, if I'm the owner and the CEO I'm about to hire is pushing me hard for an overly generous compensation arrangement, it's going to leave me wondering whether this is a manager who's bent on helping me build and grow my company, or simply looking for a cushy corner office and a way to get rich.
Over the next few weeks, I'm going to take a closer look at some of the highest- and least-compensated CEOs in the S&P 500 and see if we can track down some executives who we can love, and maybe a few who we'll love to hate.
In the meantime, you can keep a closer eye on any of the stocks listed above by clicking the "+" and adding them to your Foolish watchlist. Don't have a watchlist yet? Start one up for free by clicking here.
At the time this article was published The Motley Fool owns shares of Berkshire Hathaway, Google, and Coca-Cola. Motley Fool newsletter services have recommended buying shares of Amazon.com, Google, Berkshire Hathaway, and Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.
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