Tuesday, April 18, 2006

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


  • At 6:40 PM, April 18, 2006, Blogger Unknown said…

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  • At 6:41 PM, April 18, 2006, Blogger Unknown said…

    A lot of employees created value for Exxon over the same period. Are they also compensated for past performance or is it like the NBA where the best of the best get compensated handsomely (much of which is probably economic rent) and everybody else while everbody else receives the perfectly competitive market wage?

  • At 8:18 AM, April 19, 2006, Blogger Brandon Fuller said…

    Some random thoughts: Given the course of history since 1992, is it really so surprising that the market value of a major oil company increased? Taking a cue from Jeff S--Is Exxon's performance "clearly" attributable to Raymond's guidance?

    Even if it is…sure, top performers like Raymond get lots of compensation, but lots of mediocre-to-bad CEOs get massive compensation packages as well. Executive compensation appears to have very little to do with relative performance. I think Chris gets at the real driver behind executive compensation in the last question. CEOs often appoint corporate board members, who in turn set executive compensation packages. Large chunks of executive compensation often get buried in the fine print (if it appears at all) of corporate accounting statements, such that shareholders have very imperfect information about just how much the Big Tuna takes out of corporate earnings.

    This is not, as retiring Treasury Secretary John Snow suggests, the invisible hand at work (efficient markets require good information). The implicit nod between executives and boards is more like what Paul Krugman calls the invisible handshake. When shareholders can't see that the CEO gets something like 10% of corporate income, they can't see the action they miss due to excessive executive pay, and they therefore can't penalize the company for shady dealings.

  • At 11:32 AM, April 19, 2006, Blogger Chris Buzzard said…

    Here is an interesting post from an International Corporate Governance blog maintained by a former Wal-Mart VP. This post offers tips for committee members making executive compensation decisions.

  • At 6:32 PM, April 19, 2006, Blogger Chris Buzzard said…

    Last night (Tuesday 4/18), Lee Raymond gave a 90-minute talk at Columbia University in which he defended the compensation package the board awarded him.

    What do you think about his defense of the retirement package?

    Notice, he says, "When the company does well, the shareholders and employees should do well, and when the company does poorly, then the shareholders and employees should do poorly. The facts are that when prices of oil collapsed, the incentive program went down, substantially."

    He indirectly makes an interesting point. Exxon performed exceptionally during his tenure, but so did the rest of the oil industry. How much of Exxon's success was due to his guidance and how much to favorable industry conditions? Perhaps he should be compensated based on his ability to help ExxonMobil outperform its industry. How did Exxon's chief competitors perform during that time frame? I calculated a 13.4% annual return for Chevron investors and a 18.0% return for BP investors (Exxon's return was 13.9%).

    What do you think, is absolute or relative performance the most relevant measure of a CEO's ability?

  • At 11:30 PM, April 19, 2006, Blogger Ian said…

    Hi Chris.
    in your analysis, you neglected to account for how much he was being paid during his tenure when you calculated his percentage. I'm sure if you include that it would be higher than the 2% you claim.

  • At 3:22 PM, April 20, 2006, Blogger Chris Buzzard said…

    Actually, it is a little less than 2%. The NY Times article says ExxonMobil’s 2005 net income was $36.13 billion (verified by Google Finance and SEC filings). During his 13-year tenure, Raymond received a total of $686 million in compensation (including all of his annual compensation and retirement package, again from the NY Times article). Therefore, the ratio of his total compensation over 13 years divided by 2005 profits is: 0.686/36.13 = 0.0190 = 1.90%.

    Taken a step further, perhaps we should compare his total compensation over the 13 years with the investors’ change in wealth over the same period. Exxon’s market value was $76 billion at the end of 1992 and $339 billion at the end of 2005 (an increase of $263 billion). Raymond’s $686 million of total compensation is only 0.26% of the increase in shareholder wealth over that time.


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