Tim Cook, CEO of Apple, recently announced that he
received $4.25 million in salary and bonus for the fiscal year ended Sept. 28. Now, Tim doesn't exactly need to be shopping the discount rack at the Dollar Tree, but the compensation actually does seem a little low given that he is CEO of one of the most visible and valuable companies in the world. After all, it is reported that Oracle CEO Larry Ellison made $96 million in 2012. So what gives?
First, most people know that CEOs are not compensated in the same way as most employees. Whereas the average employee receives most of their money from salary and then possibly a small bonus, the proportions are generally flipped for executives. The majority of their compensation comes from profit-sharing or bonuses that are based on the stock price or some other metric of performance for the company. In this way, it's somewhat easy to obfuscate their real earnings by saying that a CEOs salary was fairly low by comparison.
If you look at the fine print, Tim Cook received Apple stock valued at $376 million in 2011 when he signed on as CEO. $376 million! Not a bad signing bonus if you ask me (I'll bet they threw in a free iPad too). It's difficult to say how much that stock is worth now, but as the price has only increased, it is probably worth $450 million or so. So Tim Cook clearly has a huge interest in making the financial decisions that will guarantee the greatest value to Apple shareholders. Makes sense, right?
Maybe not. Apple has been criticized in the past for hoarding cash, being forced to finally issue a dividend in mid-2012 which has continued into 2013. What does a dividend do to the stock price? With a price that is the net present value of expected future cash flows (in an efficient market), issuing a dividend means there is less cash to distribute later, which means that the price goes down. Since Tim actually owns the stock (and presumably receives the dividend along with all other shareholders), he may be personally indifferent. However, many executives are given a bonus tied to stock price that does not take dividends into account. In this way, CEOs are incentivized to not distribute dividends even when it is the right move for the business.
What about recent news that Carl Icahn wants Apple to have buy back as much as $150 billion worth of stock? When stock buybacks occur, there are fewer shares publicly traded. These shares are still vying for the same overall profit, however, which means the overall pie is bigger. When the pie is bigger, the share price goes up. Assume a CEO is compensated based on share price and his or her company is sitting on spare cash. Instituting a stock buyback immediately increases his or her compensation without actually adding value in any way to the company. Sounds like a sweet deal for the opportunist executive.
Not only are the incentives for executives skewed towards certain financial decisions that may or may not be in the best interest of the company, but the magnitude of the incentives are nearly impossible to discern. A very common compensation tool is deferred compensation, whereby an executive is still paid for years after leaving the company. This can further hide the real compensation of a CEO and provide the executive with a lower tax bill. Benefits such as use of corporate jets, dinners, etc. make things even more complicated. Taken as a whole, executive compensation has been made deliberately difficult to comprehend for one simple reason: companies want executives to be attracted to their company due to the high compensation, but don't want the negative publicity that comes from paying these executives so much more than their average employee. If there was a legal and moral way that Apple could pay Tim Cook $100 million a year and report that paid him $1 million, I'm sure it would do just that (and that's not an Apple-specific criticism; most other companies would do the same).
So next time you see numbers about how much money a CEO made, think twice about it. Aligning compensation with incentives in a transparent way is much more complicated than it first appears, yet attracting and retaining top executive talent is (arguably) the most important role of the board of directors of a company. Only companies that do it well will continue to thrive under new leadership.
