Here’s $400 Million for the Memories

Last week, the 2005 retirement package for former ExxonMobil CEO Lee Raymond became public. The retirement package, valued at about $400 million, includes cash, stock, options, country club fees, use of corporate jets, company car, and company driver. In total, Raymond received more than $686 million in compensation between 1993 and 2005. Now, shareholders, consumer groups, and corporate governance experts are asking how much executive compensation is too much.

There are two central theories regarding worker compensation. If there are large numbers of workers and firms, and perfect information about performance, then wages in a market economy reflect the marginal value of each worker. If this were the case, then Raymond, by his presence, must have increased Exxon's value by at least $686 million.

However, if there are small numbers of individuals under consideration, then a "principal-agent" problem arises. Exxon's board wants to encourage its CEO to increase shareholder value, so it must provide a substantial reward for performance. Regardless of whether Raymond himself is worth that amount of money, the promise of the gigantic reward is enough to encourage him to manage the company wisely.

So, which one fits Raymond’s case? Well, Exxon’s market value has risen to $375 billion, making it the largest American corporation, and profits have risen from $4.8 billion to $36.1 billion since 1992 when he took over as CEO. Exxon shareholders have enjoyed 13% returns under Raymond’s tenure, and the $686 million Raymond received over 13 years constitutes less than 2% of Exxon’s net income for 2005 alone. Clearly, Exxon and its shareholders benefited greatly under Raymond’s guidance.

However, no CEO, no matter how brilliant, has a marginal value of $400 million when he's retired. Therefore, the $400 million retirement package must be a reward for past performance. In other words, it is a signal to future CEOs of potential rewards. If they perform as Raymond did, they too will be reaping the benefits long after they've left the company.

1. According to Mark Cooper, research director at the Consumer Federation of America, “He (Raymond) served his stockholders well and the American public poorly.” Whom should a company and its CEO serve--stockholders or society?

2. Is it possible to measure the marginal value of a CEO in the same way one measures the marginal value of a line worker? How?

3. Executive compensation is often determined by corporate boards, who themselves are often friends and colleagues of the CEOs they are overseeing. How likely are they to be impartial in setting compensation packages? What mechanisms could be used to increase their impartiality?

Topics: Executive compensation, Principal-agent relationship