In Defense of CEO Packages

By Carlos Portocarrero

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I can’t believe I’m doing this, but I’ve been hearing a lot about how people are so upset when they see CEOs of companies that haven’t done well (or done really badly) get these incredible severance packages worth millions of dollars. I too felt this way and part of me still does, but now that I have a better understanding of why they get these packages, I think a little differently. Don’t get me wrong, I still think it’s outrageous, but at least now I know how it works and can have a knowledgeable discussion about it.

Here’s the problem: you can’t hire a “good” CEO without sweetening the pot. The problem is that CEO salaries are inflated across the board (in my opinion) to the point that, in order to be competitive and attract top candidates, you’ll need to throw in some clauses that make your offer a good one.

If you’re a sports fan, you’re familiar with this problem. Once big-time players become free agents, they can field offers from different teams, pit them against each other, and watch as the offers become more and more inflated. That doesn’t make it OK, it just puts the whole issue into context.

Take the cases of Alex Rodriguez and Darren Dreifort. ARod is widely considered the best baseball player in the game, and he’s paid like it. He was already getting paid a ridiculous sum, but this year he opted out of his existing contract (10 years, $252 million) to re-sign a much more lucrative one (10 year, $275 million). Why would he opt out of his current, ridiculous contract? Because he could—it was an option in his contract that was negotiated in there. Why? Because he’s so good that New York had to give him whatever he wanted to get him to come to New York.

The story of Darren Dreifort went slightly differently. He was an OK pitcher with a great arm, pitching in Los Angeles—a pitching friendly ball park. He had an OK season but the Dodgers thought he was about to break through and become a star. So they signed the 29-year-old pitcher to a five year, $55 million contract. He would pitch about 200 more innings over the course of three years before retiring. They wound up paying him around six million dollars per win. The kicker? He didn’t even play for two of those years. He retired from baseball and, due to the guaranteed nature of baseball contracts (much like CEO packages), he got to keep all his money.

The Lesson?

Buyer beware, I guess. If you want to rail on someone when these kinds of things happen with CEOs, blame management for choosing the person and giving them what they want. Sometimes it’s a terrible decision, other times it’s just bad luck (Dreifort was a hard worker but injuries derailed his career). If companies want to play with the big boys, they’ll have to throw in some pretty sweet deals (including golden parachutes) to get the big-name CEOs to come work for them.

On the flip side, management could pick qualified candidates that don’t necessarily have those needs or that kind of leverage. The baseball analogy works here too: teams that don’t want to pay those crazy contracts can do a few things to skirt them. They can dip into their farm system and promote from within, they can hire a candidate that might not have the name recognition but is just as capable too. It’s another common problem—management (and stockholders) often want a sexy name as their CEO: “Oh he used to be the CEO over at Goldman Sachs!” Take a look at the Tampa Bay Devil Rays: they have one of the lowest payrolls and they’re in the World Series thanks to young players, great drafting, and a good manager. The Oakland Athletics do it year in and year out.

Next time you see a CEO get a crazy package and you’re going to start to get upset, don’t forget that it isn’t their fault—they just asked for stuff and were given it. We all wish we could get that kind of a deal.

2 Responses to “In Defense of CEO Packages”

  • Lazy Man and Money Says:

    Ever stop to think who gives them that high salary that they ask for? It’s the board members of that company. You know who makes up the board of most companies… other CEOs!

    This is like Arod getting his contract not from the owners, but from a vote of other players. Other players are clear to be voting up Arod if they know that it Arod may vote for them in the future… or if they can use that in their own negotiations in the future (i.e. “If I vote Arod up to $40 million a year, it’s easier for me to justify $18 million for myself, even though my performance was not as good.”)

  • The Writer’s Coin » Blog Archive » Chairmen of the Boards Says:

    […] couple of days ago The Writer wrote a piece called In Defense of CEO Packages. Over the last few years, we’ve certainly seen quite a few examples of outrageous pay (name, […]

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