Was 2008 a turning point for CEO salaries?

In its annual analysis of CEO pay, released today, the Associated Press discovered that two CEOs, Chesapeake Energy (CHK)'s Aubrey McClendon and Motorola (MOT)'s Sanjay Jha, received over $100 million in 2008. In spite of these record paydays, however, median CEO income dropped 7 percent from the previous year.

2008 demonstrated a fundamental problem with executive compensation: in the standard model that has evolved over the last few years, executive base salaries tend to be comparatively low, but are bolstered by cash and stock bonus packages that are, in concept at least, tied to performance. The idea is that by linking personal rewards to the company's growth, bonus-based executive compensation will encourage decisions that help drive the stock up in value.There are two fundamental shortcomings in this compensation method. The first is that by tying the personal rewards of executives to stock performance, bonuses have encouraged many CEOs, particularly in the financial services sector, to seek massive, unsustainable growth, as opposed to slow, responsible development. In the short term, this has given them some fantastic paydays; in the long term, it has left many companies overextended or, worse yet, entangled in exceedingly risky investments.

The second shortcoming is that by building an executive compensation structure dependent upon huge bonuses, many companies have fostered the belief that bonuses are not tied to performance at all. In this construct, executives who regularly receive large bonuses feel entitled to them, and see bonus reduction as a form of pay cut. Of course, this begs the question what kind of financial genius would count on an as-yet-undetermined yearly bonus package for most of his or her financial needs.

The ultimate problem is that if bonuses are no longer tied to performance, and boards of directors are convinced that huge retention bonuses are necessary to keep the best talent, then CEOs and their companies become enmeshed in a payment structure that is no longer connected to any measurable metric. At this point, CEOs receive bonuses because, well, that's what CEOs do; similarly, boards of directors pay bonuses because, um, under-compensated CEOs will jump ship to companies that are more generous.

While part of the executive compensation scandal of the past few months has been based on the sheer amount of money given to executives, the relative silence on this matter over the decade before suggests that as long as the charade didn't involve taxpayers, the participants were content to see it continue. The best example is probably the John Thain debacle: in a spectacular unhinging of pay and performance, Thain lavishly rewarded his employees on the eve of the company's destruction. Even as many on Wall Street lauded Thain for his loyalty to his team, the average person saw this as a lead pirate robbing the federal government and distributing the proceeds to his gang of thieves.

On the bright side, the median base salary of an S&P 500 CEO rose 3 percent, to over $1 million in 2008. This suggests that business might be moving, albeit slowly, to a more reasonable compensation structure. Large base salaries encourage executive loyalty, and push CEOs to concentrate on long-term company performance. After all, if their company continues to do well, then they will continue to draw a large paycheck; if their short-term focus causes it to fail, then they will have to find another company that can match their salary needs.

Unfortunately, the bump in base salaries may simply be a band aid to cover a drop in stock options and other compensation. The median bonus dropped by 27 percent, and, according to the AP, 90 percent of the $1.2 billion in stock options that CEOs received in 2008 was "under water," meaning prices were too low to yield a profit.

As the well-worn refrain goes, every disaster carries with it an opportunity. In a climate that increasingly views Wall Street ethics as a contradiction in terms, the current recession offers an opportunity for boardrooms to remake themselves into responsible stewards of company assets. Alternately, many CEOs could simply view this as a challenge to find ever-more-creative ways to strip value from their companies. Here's hoping that CEOs will join their boards in pursuing the former path!
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