Who decides how much a CEO makes?

/ Source: msnbc.com

With public companies putting the finishing touches on their annual reports, shareholders will soon learn the details of the latest round of CEO pay packages. Which has Arthur in Maine wondering: just how does a company decide how much to pay the CEO?

How is CEO compensation determined? Especially with a CEO that had nothing to do with the formation of the company in which he is employed.
Art H. -- Waterville, Maine

CEOs of public corporations get paid based on the recommendations of the board of directors. The pay package can include salary, bonus, stock options, and deferred compensation, along with use of the “company” jet to fly to the “company” villa in Tuscany or Aspen and a limo to drive you to an expense account lunch. Some CEO deals even require the company to pay their income taxes.

The justification many CEOs (and their boards) give for lavish pay is that the very presence of the CEO increases the value of the company (and the company’s stock), so the top executives should get a nice slice of that gain. (Funny, though: few offer to give the money back when the stock goes down.)

There not a lot of evidence that CEOs with pay packages larded with goodies do a better job than those with more modest paychecks. One study found that companies that allow personal use of corporate aircraft, for example, tend to underperform the stock market by about 4 percent a year, over the 10 years covered by the study. (Considering that the total return of the S&P 500 index averaged about 10 percent a year over the past eight decades, that's not small change.)

So how do these packages get approved? Corporate boards usually include a subset of the board called the compensation committee. The problem is that many corporate directors (so-called “inside” directors) report to the CEO. So their judgment is not exactly impartial. (“Hey, boss: remember that raise I asked you for? One reason I need it is because I’m staying late working on your generous pay package for next year.”)

When it comes to “outside” directors (people who work for other companies), some CEO pack their boards with friends and cronies. So the board’s final decision is not always, well – above board. The Sarbannes-Oxley law took some steps to set rules on this, requiring certain new reporting procedures and holding directors personally liable if shareholders squawk.

You can read the details in the annual SEC filings that typically start rolling in over the next few months. These disclosures often make great reading -- if you have the patience to slog through the legal mumbo jumbo.

The problem is that not all the little goodies stuffed into these pay packages have to be disclosed. So the Securities & Exchange Commission recently proposed rules that would make it easier for shareholders to find out just how much of a company’s profits are being diverted to top executives. (So far, so good.)

Unfortunately, there is little in the proposed rules that would empower shareholders to do anything when they believe a CEO is overpaid. When it comes time to vote for new corporate directors, the candidates almost always run unopposed. Challenging those incumbents is expensive, and your average outraged shareholder doesn’t have the time or money to take on the company’s hand-picked candidates. Rare examples of challenges are usually funded by large shareholders like disgruntled money managers or well-funded corporate “raiders.” So disclosure of outsized pay, by itself, will do little to strengthen the link between CEO pay and performance.

I am looking for a financial advisor. Who would you recommend, if any one firm? I would like to purchase a home and I am going to be receiving an inheritance, so I would like to find someone very soon.
Nancy S. -- Canadensis, PA

This is a lot like finding a doctor. Just because they work for a good firm, went to a name school, have the right certificates on the wall, doesn’t mean they’re right for you. One of the most important factors is chemistry: you’ve got to like the person and – most importantly – trust them.

Most people find a new advisor by word of mouth from a friend or relative. If that’s not possible, give a few firms a call. Big firms may offer wider selection of services, smaller firms may give you more personal attention. Either way, arrange to meet with at least three different advisors before choosing one. Ask them any and all questions you may have – no matter how “dumb” those questions may seem to you. You’ll learn a lot about the person – before you hire them – by the answers you get. If all you get is a lot of jargon or, worse, “you don’t need to worry about that,” thank them for their time and go on to the next one.

At these first meetings, ask for specific advice and then compare what several advisors say. There’s nothing like getting multiple opinions – for free – before you get started. And these get-to-know-you sessions are absolutely free. Make sure you ask about fees with the first call. If you say you’re looking for a financial advisor, and someone tries to charge you for the first meeting, cross them off the list.

Make sure you take the time to understand how you’ll be charged for the advisors services. What you’re trying to avoid is a broker posing as a “financial advisor”  -- which is what most brokers pout on their business cards these days. Brokers gets paid a commission on the investments they sell you, so they have an incentive to steer to funds or stocks that make money for them – regardless of whether they make money for you. You’re looking for either a “fee based” advisor (who charges an hourly fee for occasional meetings) or an advisory account where you’re charged a percentage of the balance – regardless of where it's invested.

With a fee based on the size of the account, the advisor makes more if your assets grow, so your interests are better aligned. You may be surprised to see how much fees vary, but you don’t necessarily want to go with the low bidder. Expect to pay 1 to 1.5 percent for an advisory account – less if you're investing in mutual funds. Expect to pay lower fees if your money is mostly in bonds, a little higher if it’s in stocks, which takes more time to actively manage. But by all means ask about any and all fees for the investments you're asked to consider. And don't hesitate to try to negotiate a lower fee: not everyone pays sticker price.

Avoid rushing the process: it can take time to feel comfortable with an advisor. You can get some initial advice, say, about buying a house from your interviews with potential candidates. But you don’t have to rush your inheritance into a set of investments right away. In fact, you may change your mind a number of times as you get used to your new financial life. That’s not a bad thing.

Until then, you can keep your money in a safe, liquid investment like a money market fund or in short term bonds. If you open a "temporary" account with one of the big firms, make sure you won't owe any fees when you close it. And expect to get the hard sell to sign up for more products -- like credit cards or second mortgages. If you don't like the way you're being treated, pick up and leave. People open and close investment accounts all the time.

If you haven’t handled investment decisions before, it may take a while to find out just how comfortable you are with risk: that’s to be expected. As you get started, you may want to put only a piece of your money into riskier investment likes stocks. That’s a lot better than jumping in too quickly to a level of risk you’re not comfortable with.

So take your time, find someone you trust (and like) and you’ll soon be on your way.