It's good that Johnson & Johnson (JNJ) feels worried enough to send a letter to its shareholders defending CEO William Weldon's $28.7 million pay packet, because it creates an opportunity to learn exactly why chief executives continue to be rewarded even when they fail. Weldon's compensation structure, for example, is rigged to make sure he is always paid more than the average pay of executives at similar companies.
J&J's letter points out that Weldon took a pay cut last year:
In light of the Company's mixed performance in 2010, the Board exercised discretion and reduced the total planned compensation for the Company's Chairman/CEO, Mr. Weldon, by 12% for 2010 from 2009. In doing so, the Board significantly reduced Mr. Weldon's bonus award for 2010 by 45% from 2009 (Mr. Weldon's 2010 bonus award represented an award of 66% of what was originally targeted for him for 2010 at the beginning of the performance year) and slightly reduced all forms of Mr. Weldon's long-term incentive compensation awards for 2010, including Stock Options, Restricted Share Units ("RSUs") and Certificates of Long-term Performance ("CLPs"), from 2009.That all sounds reasonable until you add it up, at which point you discover that all those "12%," "45%," and "66%" cuts figure out to a mere 7 percent reduction in total annual compensation.
J&J's defense came after Institutional Shareholder Services, a shareholder watchdog group, recommended that shareholders vote against ratifying Weldon's pay packet at their upcoming annual meeting:
Shareholders are concerned when CEO pay levels continue to be high despite flat returns and financial metrics, and significant ongoing challenges to a company's reputation and industry leadership--as has been the case at JNJ due to product recalls and manufacturing issues.That letter followed a year in which the company experienced 11 drug recalls costing $900 million, sales were down, the stock was down, and its consumer healthcare unit was placed under FDA supervision.
Shareholders ought also to be concerned about the underlying basis of Weldon's pay, which always gives him more money than the average executive he competes against. Weldon's compensation is fiendishly complicated -- it takes the company 37 pages to describe it in an annual SEC filing. But an important part states that Weldon and his team will always get paid like the children of Lake Wobegon -- above average:
The Company's target pay philosophy positions total compensation for its executive officers between the 50th and 75th percentiles of the Executive Peer Group.That peer group contains plenty of companies that don't make drugs, or that are far larger than J&J, such as PepsiCo, IBM, General Electric, Boeing, Hewlett-Packard and Procter & Gamble.
Large companies often have a self-inflating policy of wanting to compensate their CEOs at rates above those of their peers in order to retain executive talent. (What board would dare admit it aimed to pay its CEO less than his peers?) Thus the "median" pay always moves upward each year, and Weldon's moves up ahead of it. It's a similar situation at Merck (MRK), where CEO pay also went up in 2010.