Sally is 56 years old. She works as a waitress with a base salary of $4.75 an hour. Last year, she made $7,810.

Lou is 56 years old. He is a successful executive with a large corporation. His base salary is $1.5 million, which translates to an hourly rate of $721.15.

Sally receives bonuses for exemplary performance. Her bonuses are gratuities left by customers appreciative of her service. In a good year, her tips total more than her salary. Last year she made $11,372 in tips.

Lou also receives bonuses for meritorious performance. The amounts of his bonuses are determined by his board of directors, most of whom, by happy coincidence, are also successful executives whose boards of directors likewise award them bonuses. In a good year, Lou’s bonuses also exceed his base salary. Last year, for example, Lou’s bonuses totaled $4.5 million.

Alas, that’s where the similarity ends. Sally has no health care, no life insurance, no retirement plan. She exercises no stock options and will receive no pension.

Lou, on the other hand, is the beneficiary of a current trend in corporate compensation—long-term incentive packages consisting primarily of stock. Stock options as performance incentives have become popular for two reasons. First, they theoretically tie the fortunes of management to the fortunes of the company; if the company’s stock depreciates, the value of the options declines or may have no value whatever. Second, incentives are tax deductible, whereas straight salary in excess of $1 million is not.

Companies have caught on quickly to the benefits of deductibility. The top 365
U.S. firms avoided paying $514 million in taxes last year by shifting the bulk of executive compensation to incentive pay.

Lou benefited as well. Last year, he was granted options totaling 2.2 million shares. Every time the stock goes up $1, Lou is, therefore, $2.2 million dollars richer—on paper at least. But Lou has good reason not to exercise his stock options just yet. If the company’s

stock appreciates annually at the rate of 10 percent, the projected value of his stock at the end of the option period will be—are you ready?—$353,089,000!

Those 2.2 million shares join other blocks of stock Lou already holds with a value of $95 million. Oh, and he also received unspecified compensation identified in the company’s annual report only as “other,” valued at $102,600 (apparently an amount too insignificant to itemize).

But the best comes after Lou stops working. At age 60, after only 10 years of service with the company, Lou will receive an annual lifetime pension of $1,140,000. He will also be awarded a 10-year consulting contract with a diurnal consulting fee based on his daily salary rate at the time of retirement. Plus expenses, of course. During that decade, as a consulting retiree, he will be provided a suite of offices and may avail himself of company cars, corporate aircraft, and financial planning services.

Sally looks forward to social security and perhaps an occasional free burger. Lou, of course, is Mr. Louis V. Gerstner, Jr., chairman of the board and chief executive officer of IBM. To say Mr. Gerstner had a good year would be disparagement. As a member of the nation’s elite aristocracy of top executives, Mr. Gerstner, like his peers, has become a favored destination of runaway executive compensation: remuneration that far eclipses the nation’s economic growth, inflation rate, and certainly the average worker’s compensation.

From 1980 to 1995, CEO pay rose a breathtaking 499 percent. Company profits, by contrast, rose only 145 percent. Inflation, although comparatively modest at 85 percent, still outpaced the average worker’s wages, which increased only 70 percent.

But, apparently, a fivefold increase in executive pay was judged too modest by the nation’s boards of directors, because in 1996 the average salary and bonus package offered to America’s CEOs jumped an additional 39 percent. That’s without stock options. If you add long-term performance incentives, the increase soars to 54 percent.

To put that in perspective, had a minimum-wage worker like Sally paced the increases in CEO pay, she would have made $39,050 in 1995—without tips; $60,137 in
1996.

The Case for Lou

It’s hard to argue with the fact that Sally just can’t run a world-class corporation. And Mr. Gerstner has a compelling case of accomplishment he can present as justification for what mere mortals may view as excessive. In spite of inheriting an $8 billion loss from his predecessor John Akers, Gerstner has piloted IBM to 14 straight quarters of revenue growth. The company’s market valuation—considered the ultimate measure of performance—grew by $23 billion in 1997. IBM’s stock price surpassed an all-time high, rising 38 percent last year, and the stock split for the first time in 20 years. Mr. Gerstner, it can be argued, made a lot of money for a lot of people.

Last year, under Gerstner’s leadership, IBM earned $6.1 billion on revenues of $78.5 billion; both up from the year before. Service revenues rose 28 percent to $19.3 billion with another $42 billion already booked for 1998 and beyond. Hardware sales pushed beyond $36 billion, up 4 percent in constant currency. Along the way, IBM quadrupled the capacity of hard-disk drives; conquered the use of copper in silicon environments, thus dramatically increasing the capacity and speed of semiconductors; and, for the fifth straight year, led all companies in U.S. patents with 1,724—a wealth of discoveries that are the foundation for the company’s future success.

And this, perhaps the most mind-boggling achievement of all: IBM unveiled a continuous speech recognition device for Mandarin Chinese!

That, by any measure, is a Lexus-full of leadership and rightfully deserves to be compensated.

And, to Mr. Gerstner’s credit, he has yet to cash in his stock options, effectively letting his fortune ride on the future performance of his company.

The Case for Sanity

Nonetheless, what constitutes rightful compensation is a matter of perspective and timing.

Excess in good times is easily and frequently overlooked. Such munificence, however, occurs not only in good times but in lean times as well, when it is hard to understand and harder to justify.

While hundreds of thousands of people were laid off in 1996, the CEOs of 30 companies with the largest layoffs saw their compensation increase by 67.3 percent. Indeed, when Mr. Gerstner jettisoned 36,000 people in 1994, his compensation suffered not one bit. In fact, firing (or, in corporate parlance, downsizing, rightsizing, destaffing, transitioning, and involuntarily separating) people is almost always viewed on Wall Street as an astute cost-cutting measure and is rewarded by an increase in stock value. Thus, CEOs, who are normally large stockholders, regularly profit from depriving others of their incomes.

And then there is lavish compensation that is simply undeserved. When Michael Ovitz left Disney after just 14 months as the number two man behind Michael Eisner, he collected a tidy $90 million for his mouse-ish exertions. (Eisner himself recently exercised stock options at a profit of $565 million—that in addition to the $202 million he cashed out in 1992. He is estimated to have amassed over $1 billion since coming to Disney.)

Gilbert Amelio haplessly managed Apple for 17 months as it precipitously dropped in market share, profits, and stock price. He walked away with $7 million.

Or consider Stephen Case, formerly of America Online, who earned $33.5 million between 1994 and 1996, while his company lost millions and its stock price plunged.

And let’s not forget former IBM chairman John Akers. After presiding over a three-year, $15 billion slide, massive layoffs, and a 100-point drop in stock value, what was Chairman Akers handed as he was being pushed out the door to make room for Mr. Gerstner? Not counting stock options, Akers’ separation package came to $6,846,781.

But my favorite is Lawrence Cross, the CEO of a company you’ve probably never heard of unless you financed a mobile home recently—Green Tree Financial Corporation. That “green tree” must grow nothing but money, because last year Mr. Cross picked a cool $102.5 million in salary and bonuses. Sally, who incidentally happens to live in a mobile home, would have to work 7,500 years to earn the equivalent (give or take a century of OT). You just have to wonder: Couldn’t Green Tree Financial find itself a competent manager for, say, a miserly $10 million?

If you’re wondering just how much incentive one person can need, you’re asking a fair question.

With compensation ballooning into the hundreds of millions, will a couple of million more even show up on the radar screen as an incentive? Besides, if success guarantees $350 million and failure, say, $100 million, failure still has too sweet a sting.

So, how much is enough? Adam Smith fans will make the “it’s-what-the-free- market-bears” argument. I put that argument to Sally, and she responded with a weary, knowing chuckle as she poured me more coffee. She thought about it a minute, then leaned heavily on the counter and offered a variation on an old admonition: “Be compensated simply, so that others may simply be compensated.”

No, this isn’t about free markets, it’s about interlocking boards of directors, institutional one-upmanship, and the limitless horizon of mutual self-interest. It’s about CEOs who approve one another’s pay packages and control enough voting shares to make them stick despite stockholders’ objections. Whether compensation falls under the guise of salary, bonus, or incentive, the royal perks continue to flow and, like water, find the path of least resistance into the waiting bowls of top management.

So, what’s the lesson here? A friend of mine who recently found himself out of work offered this bottom-line assessment: “I’ve been rich and I’ve been poor, I’ve been up and I’ve been down, and rich and up is better than poor and down.”

Just ask Lou and Sally.

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