One of the cool parts about my job is figuring out ways to use digital data and research across a variety of industries. I recently read some financial analysis on seekingalpha.com regarding how CEO pay relates to company performance. Ballooning executive salaries and compensation have certainly been a topic of conversation and debate since the financial meltdown in 2008. I want to see if I could replicate the methodology used to answer the question: “Is the CEO overpaid?”
Methodology 1 – Use public information to create a compensation ratio
Most employers are not going to disclose the median salaries publicly or to their employees. Fortunately, there is one source of average compensation at a given company through Glassdoor.com. In order to figure out the methodology, I need a test case. I will look at the last publicly traded company I worked for, Digital River, Inc. (NASDAQ: DRIV). Disclaimer: I’m not trying to pick on anyone at Digital River, it’s simply a test case to validate a methodology.
In 2012, the CEO’s* total compensation was $6.65 million. According to Glassdoor, the median compensation for a Digital River employee in the US was approximately $73,300. Having worked at Digital River, I can say a median salary of $73K seems high. I would like to validate the integrity of the data against another source. If we validate this median against Bloomberg data in the Software Publishing industry (Oracle, Salesforce.com, Autodesk) we see the median in that industry is $74,693. The Glassdoor data seems valid, and based on this data the CEO at Digital River made over 90 times the annual salary of the average employee in 2012.
Is that good or bad? In looking at the previously mentioned Bloomberg report, the average ratio for a CEO of a company on the S&P 500 is 204 times that of the average employee, with the top end being 1,795 times greater. Clearly the Digital River CEO is not in that category, but then again Digital River is not in the S&P 500. I’m not sure I have enough information to make a judgment, but the methodology seems valid. We need more data to form a point of view.
Methodology 2 – Look at trends and stock price
In a publicly traded company, the stock price is the telltale sign of success. Investors will buy stock in a company if they feel the stock price will increase. If they feel there is not positive momentum, they will sell and move their money elsewhere. As the person ultimately accountable to the Board of Directors and the shareholders, the CEO’s compensation should be directly tied to the company’s performance. Unfortunately, this is not always the case.
The below chart shows a comparison between the CEO’s annual compensation package and the stock price. You can see that over the last 7 years the executive compensation increased by nearly 80%, while the stock price fell by over 50%. This methodology also appears to be valid, and paints a grim picture for the CEO. When investors see this, it can appear the CEO is being rewarded for failure and investor confidence can be shaken. Based on these two methodologies, it does appear the CEO compensation is out of line compared to performance and median pay.
*Note: Digital River CEO Joel Ronning stepped down at the end of 2012.