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by WealthEffect Staff


Top jobs and the amazing technicolor dreamcoat
  Estimating the cost of executive compensation  
  Analyzing the Board of Directors  

Henry II cut right to the chase in The Lion in Winter when he noted, "God, but I do love being king." Those who rise to the rank of CEO enjoy significant power and great wealth. If they worry about where their next paycheck is coming from, it's only because it's coming from so many different angles.

CEOs and other top executives are paid salary, bonuses, "other annual compensation," restricted stock awards, company options, long-term incentive payments (LTIP), and "all other compensation." The compensation of the top five execs during a company's most recent three years is presented in the "Summary Compensation Table" in the proxy statement.


To estimate the cost of executive comp, first add up all the dollar figures listed for the last three years. Then, add up the options granted over that period and convert these to a dollar value by multiplying the option total by the value per option (available in the notes to the annual report; if unavailable, assume a value of $15/option). Add both dollar figures together and ask yourself whether you made the right career choice.

Once you have determined how much is being paid, you can then consider when how much is too much. By comparing the company's pretax income for the three years to the total compensation of the top five executives, you get a reasonable idea.

As a rule of thumb, the company's pretax income should be at least twenty times the compensation for the top five managers. The ratio will generally be lower for smaller companies (less income / more growth potential) than for larger companies. Regardless, when the number gets below ten (more than 10% of earnings going to the top five employees), serious questions should be raised in an investor's mind.

The proxy statement also provides details to help you judge the independence of the board of directors — remember, the board is beholden to the stockholders, not to the management. The first consideration is whether the CEO is also the chairman of the board. This is usually the case and it usually impairs the independence of the board. After all, when the top manager answers to a board which, in large part, answers to him, the concept of independence takes on an Alice in Wonderland quality. You'll be hard-pressed to find changes at the corner office, even of significantly under-performing companies, unless the CEO isn't also the chairman of the board. The recent upheaval at Compaq was initiated by Ben Rosen, a very independent chairman.


The proxy also includes a background summary of the various members of the board of directors. Determine how many board members have ties to the company, either directly as executives or indirectly as former employees, consultants or lawyers. These inside members should represent a minority, preferably a small minority, of the board.

Next, compute how many outside directors own more than $2 million in company stock. Finally, consider the qualifications of the outside directors — do they come from senior positions in successful companies or is their background in academia and government?

Your hope is to find a board of directors largely made up of independent, highly qualified individuals with a vested interest in the success of the company, people who are willing and able to act in the best interests of the stockholders.

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