Corporate bonuses help lick inflation -- for those in the executive suite
Inflation snaps at the coat sleeves of executives with the same vigor that it uses on the salary earner's heels. But executives may be insulated with layers of bonuses and fringe benefits while wage earners wear shredded shirts.
Executives can patch up inflation-tattered salaries in ways their employees cannot. According to former Labor Secretary John Dunlop, now at the Harvard Business School, the number of Fortune 500 companies paying top-level bonuses to executives has jumped from 60 to 80 percent since 1976. Wage earners are not so fortunate. Mr. Dunlop says incentive plans such as "piece rates" -- in which an employee is paid by the number of projects completed, not by the hour -- are used by only 30 percent of industrial companies.
During the 1960s, when the stock market was fairly sensitive to corporate and executive performance, the most common type of bonus was the stock option. when the stock market flattened out in the '70s, boards of directors found that stock prices were not gauging corporate or management track records accurately. Bonuses became more and more closely tied to short-term profit rates.
In recent years executives have been widely criticized for boosting profit rates in order to receive higher bonuses that emphasize short-run profit margins rather than long-range growth. Contributing to this trend is the fact that bonuses grow more important to an executive as he rises in rank (and decisionmaking responsibility).
According to a study by Sibson & Co., a management consulting firm, in companies with over $5 billion in sales, bonuses are 54 percent of the chief executive officer's (CEO's) total pay. The chief operating officer (CEO) gets 42 percent of salary in bonuses and the top financial officer, only 27 percent.
Just because an executive receives a bonus does not mean his salary will increase faster than his subordinate's. After comparing the after-tax spending power of their salaries with previous years, executives are beginning to feel they have not been faring especially well.
"Executive salaries tend to drift backward in periods of high inflation," says Donald Simpson, partner of Hay Associates, a Philadelphia-based management consulting firm. "It is only in the last two or three years that increases in executive pay have been consistent with salary increases below the executive level." The hardest pressed are middle managers, who receive neither the cost-of-living adjustments of unionized employees nor the large bonuses of top executives.
Furthermore, the size of a bonus depends largely on corporate profit rates. An executive's salary could fall even if his company's poor performance were caused by conditions beyond his control, such as a recession. Or, in the case of the auto industry, executives received lower salaries because of severe foreign competition. The chairmen of American Motors, Ford, and General Motors saw their 1980 incomes drop 37 percent, 55 percent, and 57 percent, respectively.
To cut the link between reward and profit margins, and to weld compensation more securely to long-range performance, many companies are now using long-term income plans (LTI). These allow executives to set quantifiable, internal measures of performance, and to gauge their productivity.
For example, a better indicator of executive performance than stock prices is a company's change in market position. If it is capturing an increasing portion of industry sales (at the expense of competitors), it is performing well. Or the board of directors may set specific goals for increases in earnings per share over a sustained period, perhaps three years. The executives must steer the company through a steady-growth course and meet those goals to receive benefits from LTI plans. Both of these performance measures emphasize stability and long-range planning more than stock prices do.
LTI is becoming fashionable executive attire. Ninety-two percent of the Fortune 500 companies have some provision for long-term income, according to the Sibson & Co. study.
"If senior management compensation is increasing at a faster rate than that of lower-level management or unionized employees, it is not so much because the CEO's salary rate or bonuses have been greater, but because of the inclusion of long-term income plans," says Ronald Geottinger, Sibson & Co.'s president. "The net effect has been an increase in the amount of cash paid to senior management."
In 1980, 23 of the 25 highest-paid executives received over 50 percent of their total pay in long-term income. Capping the list was Robert A. Charpie, president of Cabot Corporation, who earned $3.33 million. Long-term income accounted for 76 percent of his compensation. Edward M. Gibbs, executive vice-president of NL Industries and the second-highest-paid executive, earned 91 percent of his total $3.225 million compensation in LTI. No. 3 on the list, C. C. Garvin Jr., chairman of Exxon, received 70 percent of his $3.06 million salary in LTI.
Are executives insulated from inflation? Yes. And no. It varies with the company and with the executive. And more and more it varies with the achievement of long-range goals.
Clifford Mitman, vice-president of the management consulting firm Towers, Perrin, Forster & Crosby, observes that "the CEOs that are doing the best in salary are the ones that are making their companies do the best in the marketplace."