Turning Lead Into Gold: How CEOs' "Performance Incentives" Are Screwing Everybody

This piece originally appeared in the Providence Journal.

Back in the Middle Ages, shadowy figures known as alchemists claimed that they could turn lead into gold. We have alchemists today who don’t have to fake such miracles. We call them CEOs.

Our contemporary power-suited alchemists can turn sinking sales, falling profits, even global economic collapse into personal mega-million-dollar windfalls. They have discovered, in effect, the secret to perpetual income growth.

Want in on that secret? Want to be able to make every bump that comes your way just another springboard to grand fortune, just like CEOs? Here’s what you need to do.

First: Get yourself a job as a top executive at a Fortune 500 company. Second: Announce your total commitment to "pay for performance" and urge your corporate board to pack your pay deal with "performance incentives."

Now the fun begins. In your first year as a typical big-time CEO, you’ll receive a token million or so in straight salary. Your real rewards will come in those performance incentives, neat little gimmicks such as stock options. These options give you the right to buy, at some future date, shares of your company’s stock at the current share price.

Let’s say that your firm’s stock is currently selling at $10 a share. You get options to buy a million shares, a few years down the road, at that $10 price. If your firm’s share price should jump to $20 over those few years, you can buy the million shares at $10 and turn around and sell them at $20. Your personal profit: $10 million.

But let’s suppose your shares don’t appreciate. Let’s suppose your firm’s share price, after a year, has dropped to $5. Your options have essentially become worthless. You can’t make any money, after all, buying stock at $10 a share and selling at $5.

Time for some alchemy. In your second year, with your firm’s shares sputtering at $5, your board of directors ever so thoughtfully hands you still another "performance incentive" to right the corporate ship: options to buy a million more shares — at the current $5 share price. If this share price, over the next year, should move back to $10, you stand to make $5 million — without improving, by one iota, the share value your company held when you were originally came on as CEO.

Wait, things can get even more magical: It’s year three of your CEO tenure. Your share price has fallen yet again, to $2. Now you really need an incentive to perform. So your board supplies one: new options to buy not one million, but two million shares — all at the current $2 share price.

Ah, now you really have an incentive to "perform." You rush to fatten your company’s bottom line by any means necessary. You outsource jobs. You squeeze consumers. You play games with credit-default swaps. Maybe you even cook the books.

Your share price, after all this hard work, rises to $10. You now stand to make $5 million on your year two options and $16 million more on year three, $21 million in all. And those shareholders who owned your firm’s stock three years ago, when that stock traded at $10? They haven’t made a dime.

As the chief executive, in short, you made $21 million for accomplishing nothing. Pure alchemy.

This scenario, we document in a new Institute for Policy Studies report, is playing out — with a vengeance — once again this year. Take American Express CEO Kenneth Chenault.

Last January, Chenault pocketed options to buy nearly 1.2 million shares at a moment when American Express stock was trading at a bargain basement price of $16.71. Thanks to the bailout generosity of U.S. taxpayers, American Express shares have risen steadily in 2009, trading at around $32 in recent weeks. That’s still only half what the credit-card giant’s shares were worth at their peak in 2007. But Chenault still stands to make, from his 2009 options alone, nearly $18 million.