The Executive Compensation Controversy - Fondazione Rodolfo ...

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THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISTable 4.4Incentives for Banking and Non-Banking CEOs, by Continent and SectorEUROPEUNITED STATESESTIMATED PAY-PERFORMANCE ELASTICITIESBanksNon-BanksTARPBanksOtherBanksNon-BanksShareholder Return .382*** .056*** .677*** .532*** .002Sales Growth .156 .078*** .611** .463*** .417***∆(Return on Assets) 1.747** .677*** 5.637 4.32*** .446***Europe ExcludingUK and GermanyShareholder Return .486*** .036 — — —Sales Growth .146 -.061 — — —∆(Return on Assets) 4.74 .715*** — — —AVERAGE COMPOSITION OF2003-2006 COMPENSATIONBase Salary 44% 51% 27% 28% 28%Bonuses 30% 20% 28% 28% 25%Equity-Based 20% 21% 39% 34% 41%Note: Data are based on same-CEO first-differences from 2003-2008. Pay-Performance elasticities are calculated from aregression of ∆Ln(CEO Pay) on one or all three performance measures; regressions include year dummies and (for nonbanks)additional controls for industry. For the purposes of these regressions, (Stock Return) t is defined asLn(1+Shareholder Return) for period t; ∆ROA is defined as the year-over-year change in ROA (defined as net incomebefore extraordinary items plus interest divided by average assets over the year); and sales growth is defined as∆Ln(Sales) t . Monetary data are converted to 2008-constant US dollars, adjusted for inflation, and then converted toEuros using the 2008 year-end exchange rate (€1 = $1.3919).*,**,*** indicates that the pay-performance elasticity is significantly different from zero at the 10%, 5% and 1% levels,respectively.had more wealth to lose than their non-banking counterparts (median 2006 wealth incompany stock of €13.4 million in banks compared to only €4.1 million in non-banks), butindeed they lost more (62% compared to 44%). Overall, the results for European bankingCEOs are similar to the results for those for USA bankers receiving government bailouts, andare inconsistent with the idea that banking executives faced rewards for success but no realpenalties for failure.In Table 3.7, we showed that – with the exception of Germany and the UK – there is noevidence that bonuses for European CEOs is related to stock-price performance. Table 4.4provides a similar analysis for the banking and non-banking subsamples. As shown in theTable, the elasticity of cash compensation to shareholder value is positive and significant forbanking CEOs; the estimated elasticity of .382 suggests that cash compensation increases by-111-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISTable 4.5Comparison of 2006 and 2008 Year-End Values for Stock Options for USA CEOs ofTARP and non-TARP RecipientsTARPRecipientsNon-TARPBanksOther Non-TARPCompaniesNumber of CEOs 35 29 675Percentage of Options in the Money2006 Fiscal Year-End 92.2% 82.3% 91.3%2008 Fiscal Year-End 18.0% 43.5% 37.7%Average Value of Options (€000s)2006 Fiscal Year-End €21,998.1 €9,096.9 €20,469.12008 Fiscal Year-End €1,189.7 €2,588.4 €5,487.5Change in Value of Options -€20,808.4(-94.6%)-€6,508.5(-71.5%)-€14,981.6(-73.2%)Median Value of Options (€000s)2006 Fiscal Year-End €7,080.5 €4,206.0 €8,218.82008 Fiscal Year-End €156.1 €740.9 €1,323.2Change in Value of Options -€6,924.4(-97.8%)-€3,465.1(-82.4%)-€6,895.6(-83.9%)Notes:Sample includes executives in S&P 500, S&P MidCap 400, and S&P Small Cap 600 Firms who held thetitle of Chief Executive Officer in both 2006 and 2008. Option and stock data from S&P’s ExecuCompdatabase. TARP recipients include companies receiving money from the TARP as of March 2010. Non-TARP banks defined as companies with SIC codes between 6020 and 6299 and include commercial banks,savings institutions, mortgage banks, and security and commodity brokers, but exclude investment advisors(SIC 6282). Average value for options based on year-end parameters and prices. Average value equals therestricted shares held at the end of the fiscal year multiplied by the year-end stock price.about 4% for each 10% increase in shareholder returns. The pay-performance elasticity forbanking CEOs remains large and significant even after excluding German and British firms(while the estimated elasticity outside of banking is insignificant after excluding these firms).Therefore, while we concluded in Section 3.2.3 that there was an absence of alignmentbetween European CEOs and shareholders, the analyses in Table 4.3 and Table 4.4 suggestone sector with better alignment: banking. In particular, compared to non-banking CEOs,European banking CEOs have more wealth invested in company stock, faced larger penaltiesfor poor performance, and have bonus plans that are more sensitive to company stock-priceperformance.Table 4.5 provides additional comparisons of banking and non-banking CEOs based ondata available only in the USA. The top panel shows that over 90% of the stock options heldby CEOs of TARP recipients were “in the money” (that is, had a stock price above theexercise price) at the end of the 2006 fiscal year, and that these stock options had an average-112-
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1. INTRODUCTION 12. A PRIMER ON EXE
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