It's the cash flow, baby: the solution to excessive CEO comp ... as well as the basis of my personal investment strategy.

AuthorSutton, Gary
PositionSUTTON'S LAWS

AN ANGRY institutional shareholder voted against my reelection to a board last month. I squeaked back in, but this shows how explosive CEO compensation has become. And there is a solution.

But first, let's analyze this incident.

In this particular company the growth was slowing. We needed a CEO to broaden the business, adding things beyond our experiences. This is a mid-cap outfit and we successfully recruited the president of a large-cap business, a guy who had precisely the background needed.

We matched his prior salary and options and made good on his lost options in the move. Nothing more. This resulted in a base salary of a half-million dollars. That's about median for comparable outfits. His option grants were aggressive for us, but he wouldn't come for less than what he already had, so we anted up.

After he joined, his options for the first full year went underwater as he struggled against the sluggish growth he inherited. He personally went into the open market and bought our shares, investing more than he took home in salary. I liked that, and joined him by investing more than my compensation as a director.

Five quarters later sales are growing faster, earnings are accelerating, and cash flow has bounced way up.

Well, all this is fine and dandy until you issue the 10-K. If you use the Black-Scholes method to value stock options, and if your stock has recently dropped, making it more volatile, that somehow jacks up the imputed value of the grants. Go figure. And so his compensation was reported as something in excess of $20 million. (Well, that would be excessive, if it were real.)

So even professional investors don't look deep enough.

Okay, now, it's inarguable that lots of CEO compensation is abusive and threatens the entire idea of a public stock market. But, in this case, we made the best deal we could and had no other candidates interested who were half as qualified. Besides, those who howl about CEOs' salaries, without regard to the results delivered, should understand that those who flip over into private equity often make multiples of their prior compensation.

And get this. I'm cheap. As a CEO through three decades of businesses in printing, software, aerospace, burglar alarms, and data storage, I never paid myself more than $120,000 (and saved the SEC documents to prove that). Three times I went without salary when embarrassed by results. I never made a nickel on cheap options. My shareholders all had to profit before I saw...

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