Is Your CEO Dollar Worth It?
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Everyone obsesses over CEO pay in the financial media. People want to vent their inner jealousies of not making a seven figure salary. I kinda wish I could make $3 million per year myself; working a couple of years and then retiring. According to Alyce Lomax’s article “Doing the Math on CEO Pay” the median pay of U.S. workers stands at $39,000 per year compared to the average total CEO compensation package of $9.6 million.
Being a contrarian investor as well as a writer, I decided to look at CEO pay from a pragmatic standpoint for this article. A shareholder owns the business and its assets. As an owner I want my manager, the CEO, to do two things: expand free cash flow generation and offer above average shareholder return.
The questions an owner/stockholder should ask: How much free cash flow does each dollar of the CEO salary generate? And, does my investment return outpace the S&P 500 including dividends?
This article examines the cash paid to CEOs of three companies: Kroger (NYSE: KR), JPMorgan ), and McDonald's ) between 2009 and 2011.
Kroger, a supermarket and convenience store conglomerate, paid their CEO, David B. Dillon, $8.5 million in cash between 2009 and 2011. During that time, Kroger’s free cash flow increased $166 million. If you take $166 million and divide it by $8.5 million you arrive at $20 in free cash flow growth for every dollar spent on this CEO’s salary. During this same time period Kroger's stock lost 4% compared to the S&P 500 total return of 44%.
While I am pleased this company managed to pull off some free cash flow growth; the subpar return of the stock price gives me reason for concern. Kroger feels the heat from Wal-Mart and Wall Street knows it.
Profitability bombs over the past three years including goodwill write downs, pension costs and closure of 34 stores. Kroger likes to acquire other companies and some of those acquisitions didn’t work out like the goodwill impairment of Ralph’s in 2009. Pension related costs amounted to $953 million in 2011.
Mr. Dillon’s salary needs a review for adjustment downward.
When one talks about CEO pay, JPMorgan’s CEO Jamie Dimon generally comes up. JPMorgan, for those who don’t know, is a financial services conglomerate involved in investment banking, private equity, treasury and security services, asset management, retail banking and card services.
Over the past three years, cash payment to James Dimon amounted to $13 million. During that time JPMorgan’s free cash flow dropped $27 billion -- from $122.8 billion to $96 billion. This translates into a $2,000 decrease in free cash flow for every dollar spent in CEO salary. Their stock price also lagged during the last three full fiscal years, returning just 9% versus the S&P 500 total return of 44% according to YCharts.
JPMorgan’s cash flow problems were especially prevalent in 2010 when it turned a negative operating cash flow of $3.7 billion due to a $72 billion purchase of trading assets. Securities losses amounted to $3 billion in 2010 and $1.5 billion in 2011.
Mr. Dimon’s salary needs adjusted downward not given the 50% increase in base salary he received in 2011.
James Skinner, the former CEO of global restaurant chain McDonald’s, received $19.3 million in cash from 2009-2011 while McDonald’s free cash flow increased $622 million. This works out to $26 per every $1 spent on his salary. McDonald’s total stock price return (73%) actually beat the S&P total return (44%).
Global expansion and the desire for a cheap dining experience during difficult times provided catalysts for free cash flow growth. McDonalds’ store count increased by 1,000 during this time.
James Skinner retired in the earlier part of 2012. The new McDonald’s CEO Donald Thompson faces challenges such as unfavorable currency translations and softening overseas demand.
James Skinner earned his paycheck.
From a pragmatic standpoint, growing free cash flow at an acceptable rate justifies the salary of a CEO. Shrinking free cash flow should equal a lower salary for the CEO or downsizing. A downward adjustment for the CEO salaries of Kroger and JPMorgan should be implemented until fundamentals improve. Raises should be in order for CEOs of companies like McDonald’s that can improve free cash flow and give back market beating returns on their stock price.
stockdissector a position in McDonald's. The Motley Fool owns shares of JPMorgan Chase & Co. and McDonald's. Motley Fool newsletter services recommend McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.