Touching the Elephant

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Expert Perspective by Grahall’s OmniMedia Editorial Board

expert perspective telescopeIn his September 15, 2009 article “Majority of Americans find Wall Street pay unreasonable”, Reuters journalist Steve Eder shares the results of a phone poll of 1,000 adults by Ipsos Public Affairs between September 11 and September 14, indicating that “ 60 percent of Americans are concerned or angry about excessive pay…”. Further on in the article, Eder writes that “ …56 percent of respondents in the poll said bankers fared better than other people during the financial crisis.”  This in spite of that fact that “more than 30,000 people lost their jobs in the finance industry since the start of 2008 according to Challenger, Gray & Christmas, an outplacement company”.  Frankly, we doubt that a poll of the 30,000 folks who lost their financial services jobs would show that they felt bankers had fared better.

The parable of the blind men and the elephant has long been used to highlight the fact that one’s perception of reality depends on one’s experience and point of view. We see a resemblance between the situation today surrounding executive compensation and this parable. The important question when considering the results of the Ipsos study is what information did the 1,000 adults in the study have regarding Wall Street pay? Did they have enough information to draw a conclusion? And was that information accurate, complete and unbiased? For the study authors to then extrapolate the results of this 1,000 person survey to be the opinion the “majority of Americans” seems a bit far reaching, especially since 1,000 people is only .00033% of the US population. Then again if the sample was random and the questions were not leading, it could be a credible sample of sufficient size. Knowing the margin of error would help us to know if extrapolating 1,000 responses to 307 million is a reasonable thing to do.

That being said, we agree it is likely that many Americans believe banking executives are overpaid. In fact, many Americans might believe that executives are overpaid in most industries (the exception to this probably being American executives). We also expect that this belief probably arose based on the stories hyped in the media and on Capitol Hill; stories lingering as a vestige of the initial financial services bailout last fall. But is it reasonable to point a finger of blame at all financial services companies, or all of Wall Street firms or even all of banks, based on the media stories surrounding a very small group of companies with very high pay and/or egregious practices?

Let’s look take a step back from the hype around executive compensation and look at it from a different perspective, diving deeper into real data and offering candid and telling insight into the state of executive compensation in the USA. Grahall has recently completed proprietary and authoritative research into executive compensation in publicly traded companies and has uncovered some unexpected information which we preview in this article. (The complete results of this research will soon be available here on our website.)

In order to properly set the stage, let us share with you the background and methodology used in this Grahall study. The study compares 2008 pay (reported in 2009) to that in 2007 and looks at 1,000 publicly traded companies across all industries. This focus on 1,000 publicly listed organizations yields a much more robust and factual understanding than most studies of the changing world of executive rewards. It also eliminates much of the distortion in data normally quoted by pundits and the news services. 

SIDEBAR: The average Bank CEO in our sample made $687,000 in total direct compensation. The next four bank executives below the CEO averaged total direct compensation of $311,000. This is remarkable only in that of the 20 plus industries we studied, banking executives were lowest paid. In fact, on average, bank executives’ earnings were just 40% of the average of the other industries combined. Some might argue that if Banks had recruited higher caliber executives who would have demanded higher pay the subprime mortgage disaster might have been avoided. We doubt it, but it’s hard to tell.

We favorably contrast our approach to the method most often used, which analyzes a certain segment of the population of publicly traded companies (for example, the Fortune 500, the banking industry, etc.) and extrapolates the data from that restricted sample to the entire group.  

In addition to the absolute and relative amount of pay, the change in pay from year to year is surprisingly dramatic. For example, when we looked at all executives across all industries we found an 18% variation in the increase in base pay (average of the 10th decile to the 90th decile). The variation in total cash compensation was nearly 100% (when looking at the average of the 10th decile to the 90th decile). Finally, the variation in total direct compensation was approximately 150% from the average of the top decile to the average of the bottom decile.

The methodology we used to create deciles is simple. We created three databases each using the 1,000 companies on our sample. Each database had a separate ranking criterion: 1) change in base pay, 2) change in total cash compensation, and 3) change in total direct compensation. For each database we divided the companies into 10 equal groups of 100 companies each. Last we determined the averages for each of the 10 groups in each of the three databases.

Looking at base pay first, the top 100 companies in our study increased pay for executives by 18% from 2007 to 2008, while the bottom 100 companies held pay flat for that year, giving no increase. Some of this “flatness” may be due to the $1,000,000 pay cap; however, most of the salaries (over 85%) were less than $1,000,000, so there remained room for increase within the Section 162(m) requirements.

More dramatic differences are seen when we look at total cash compensation. Here executives in the top 100 companies saw annual pay increase by 53% (yes, fifty-three percent), while executives in the bottom 100 companies had annual pay DECREASE by 44%. That variation is almost 100 percentage points between the top and bottom of our study group.

Most dramatic were the differences seen in total direct compensation (TDC). Here executives in the top 100 companies saw TDC increase by 96% (YES, THAT’S NINETY-SIX PERCENT,) while executives in the bottom 100 companies saw TDC drop by 50% – a nearly 150 percentage point variation between the top and bottom companies on our study.

Can we extrapolate these findings for 1,000 companies to all 10,000 publically traded companies? Since 1,000 companies represent about 10% of all publically traded companies, it is a statistically relevant sample size. And what do these dramatic statistics tell us about the state of executive compensation? Fundamentally, they tell us that the picture of executive pay at every company cannot be painted by the same broad brush. There are very real and very significant differences in pay and pay changes year to year across industries, across companies, and even across companies in the same industry.

We have heard that some experts studied the average increase in executive pay and found an increase for 2008 over 2007 of only .5% — essentially flat. Their conclusion? Since the stock market was down 40% over that same period, pay is not tied to performance (or at least not to stock market performance). Based on our research this is nonsense. We would ask how many times these “researchers” touched the elephant?

We see that in many companies Directors have been differentiating pay from year to year, but one has to look at the bigger picture to ascertain that. It is hard work by the Directors to differentiate pay, but it is their job. It is also hard work to uncover the true shape of the pay changes on a year-to-year basis, but it’s worth it. The alternative choice is that we may have more legislation based on impressions and popularism.

Contact Grahall’s OmniMedia Editorial Board at edie.kingston@grahall.com

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