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Part II: Symposium 45 Executive Compensation in Public Corporations Michael B. Dorff IN 2005, Occidental Petroleum paid its chief executive officer (CEO), Ray Irani, more than $63 million in salary, bonuses, stock options, and other forms of compensation. That means that Mr. Irani took in more than $170,000 per day that year. Therefore, he earned more on a Sunday spent playing golf than most families in the United States see in a year, whether he shot a good game or not. Mr. Irani was not unique, though his pay was at the high end of the range. KB Home, Lehman Brothers, Lennar, Merrill Lynch, Morgan Stanley, Toll Brothers, and Valero Energy, among others, all paid their respective CEOs at least $30 million that year. And 2005 was hardly a banner year. In 2001, Oracle’s founder and CEO Larry Ellison exercised stock options for a profit of over $700 million. That is nearly $2 million for Mr. Irani’s hypothetical Sunday golf outing, making Mr. Irani look vastly underpaid by comparison. Of course, Mr. Ellison had earned those options over more than one year. Mr. Irani has managed to accumulate a fair amount of wealth himself, some $440 million in Occidental stock alone. Compensation packages like these led one commentator to describe excessive CEO pay as the “mad-cow disease of American boardrooms.”1 What do public company CEOs do to deserve the kind of wealth that will make even their grandchildren rich? Mr. Irani may be very capable at his job; I certainly have no reason to suspect otherwise. But is he worth $170,000 a day? That represents over $7,000/hour, even if he never sleeps. Why do public corporations pay their chief executive officers so much? Scholars like me who study corporations have come up with three major explanations, if we exclude variations on a theme. These explanations all center on power: the power of self-interest, the power of group conformity , and the power of markets. How CEO Compensation Is Determined To understand these theories we first need to ask why executive compensation in public corporations is different from other high-paying jobs. After all, few people complain when a rock star, professional athlete, 1. John A. Byrne, et al., “How to Fix Corporate Governance,” Business Week, May 6, 2002, p. 71. Jewish Choices, Jewish Voices: MONEY 46 or entrepreneur earns a fortune; why shouldn’t the stewards of our largest corporations also be well rewarded? Paying CEOs of public corporations is different because it is less clear that there is a true market in CEO compensation. Markets require selfinterested buyers and sellers on both sides of the bargaining table. When a sports team hires an athlete, the team’s owner wants to pay as little as possible, because every dollar the owner pays the athlete comes out of the owner’s pocket. With public corporations, in contrast, the “owner” consists of hundreds of thousands of shareholders, most of whom own an insignificant percentage of the company. The power and authority to run the company, including the power to spend the shareholders’ money in hiring a management team, vests in the board of directors. The directors usually own some stock in the company, but rarely enough to amount to more than a tiny fraction of a percent of the corporation. As a result, those who run the company do not own it, and the money the corporation pays to its officers does not come out of the directors’ pockets. Theoretically, the directors are chosen and elected by the shareholders, so they should represent the shareholders’ concerns and try to minimize the amounts they pay to officers. The practical reality, though, is very different . Unlike most democratic political elections, corporate elections for board slots are seldom opposed. Instead, exactly as many candidates run as there are slots to fill. The scarcity of opponents has nothing to do with the desirability of being a director—to the contrary, directorships represent wonderful opportunities, as I will explain later—and everything to do with electoral mechanics. Specifically, shareholders vote for directors at an annual shareholders ’ meeting. Because most shareholders own only a few thousand dollars worth of stock, they seldom see fit to attend in person, even if the meeting happens to take place near their home. Instead, shareholders vote by means of a proxy form. The proxy form authorizes someone else to vote the stockholder’s shares at the meeting, in accordance with the stockholder’s instructions...

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