October 26, 2006
Secret Compensation?
Posted by Lisa Fairfax

Today the New York Times ran an article on the highest paid CEO.  A man whose name you may not know, Barry Diller, was this year's winner of that honor.  According to one study, which took into account the total value of all his stock options, Diller's estimated compensation last year was $295 million.  Another study, which considered only on the value of the stock options grated in 2005, Diller's comensation was a more modest $85 million.  Regardless of the approach you favor, Diller comes out on top.

The article disturbed me.  Not because of the total amount, though it was mind-boggling.  And not even because both studies suggested that Diller's salary was not deserved.  Indeed, based on company performance, both studies contend that Diller was overpaid and than the new grants in stock options were unnessary to align his interests with shareholders.  Diller of course disputes this and says that he has created value for the company.  He apparently even declined to draw a salary in some years, and agreed to cut his salary in half last year.

But therein lies the problem for me.  Diller's "salary" was $726,115 last year.  A blip on the radar screen when you compare that to his option grants.  So of course he could afford to forego his salary.  Indeed, despite the cut in salary, he nevertheless received a bonus and stock options.  And those things, of course, drove his salary up. 

Of course people have discussed (and discussed) the best way to address the executive compensation issue.  My reference to "secret compensation" refers to an article by Iman Anabtawi which, in part, refers to the notion that stock options represent a form of hidden compensation or a "secret."  And it is a pretty big secret. 

And you instinctively think that if people learn about the secret, it should have an impact.  Certainly, those who viewed the problem with executive compensation in terms of its secrecy focused on disclosure as a way to resolve it.  The idea being that forcing executives to reveal that they made $295 million as opposed to about $726,000 would shame them or their boards into reducing the amounts.   Apparently this has not worked.  Some may say we just need better disclosure.  Others point out (and this fits in with some tournament theory work), that the disclosure may be feeding the drive in salary as CEOs and companies feel they must stay competitive with their peers.  Disclosure also gives compensation committees and experts at least anecdotal support for setting high salaries in the first place. 

The possibility that disclosure may be ineffective supports Lucian Bebchuk's work regarding managerial power and the notion that boards have been captured by the CEO and because of that capture cannot be considered independent when making compensation decisions.  This seems to be plausible in the case of Diller who effectively controls 56% of the voting rights at his company.

I am not yet picking sides in the compensation debate, because I think secrecy does matter.  Yet thinking about Diller and the competing theories regarding executive compensation makes me more open to the notion of cutting back all executive stock awards--options and restricted stock combined--on the theory that these awards are secretive (at least in part) and hence allow executives to get paid more than they would be comfortable telling the public, but also on the theory that if most compensation was in fact "salary," boards may feel that there is some upper limit to the amount of cash they could give an executive in any given year--and hence feel uncomfortable, for example, paying someone $85 million in cash.  Which does not seem to be the case with regard to stock awards.

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