Michael Eisner is my hero. Shareholders have realized more than $46 billion in gains during his tenure. Shares purchased for $100 when he joined Disney in September 1984 are worth $2,500 today.
Though countless others have contributed to Disney's successes, Eisner's fingerprints permeate virtually every key business and operating decision the company has made over the past 13 years. He is the poster boy for shareholder wealth creation.
Eisner is also the poster boy for high CEO pay, earning $1 billion since joining Disney in 1984. In less than 13 years Eisner has taken home $9.8 million in salaries, $69.4 million in bonuses, and has exercised options for $267.4 million. In addition, based on the current stock price of about $84.50, Eisner has 158,000 restricted shares worth $13.4 million, and holds 16 million stock options with a current exercisable value of $642.3 million.
Add it up: Eisner has become the first CEO in a publicly traded company to make more than a billion dollars. And more is on the way: If Disney stock appreciates 15 percent per year for the next 10 years (a paltry return compared to the 28 percent annual return Disney shareholders have earned since 1984), his 1996 stock option grant alone will be worth $2.1 billion.
Underlying Eisner's record-breaking pay is a straightforward compensation plan basically unchanged since he joined the company. It has three basic components: a base salary, an annual bonus and stock options.
The base salary has been fixed at a relatively modest $750,000 per year. Until this year, his annual bonus has equated 2 percent of net income over a fixed return-on-equity (ROE) threshold. In addition, he received option grants in 1984, 1989, and 1996, each giving Eisner about 1.5 percent of Disney's stock-price appreciation.
Although the magnitude of Eisner's pay has fueled the ongoing controversy over executive compensation, Disney's performance is the envy of Corporate America, and his pay is the envy of corporate CEOs.
While it is impossible to prove that Disney's pay strategy has been the driver of its success, Disney offers many lessons for aspiring-billionaire CEOs at other companies:
Keep it simple. Incentive plans are too often based on a plethora of confusing or conflicting performance measures, arrayed in complicated matrices or tables or formulas. Managers will either be completely ineffective (the "deer-in-the-headlights" syndrome), or will focus on the measure that is easiest rather than what is best. In contrast, Eisner's contract defines and rewards clear performance objectives: create value for shareholders by increasing share price and by increasing net income over a capital cost (the ROE threshold).
Keep it bottom-line oriented. Performance measures such as strategic milestones, market share, and customer satisfaction might be just fine for lower-level managers, but not for the CEO whose job it is to define the strategy and decide whether market share or customer satisfaction is too high or too low. As with Eisner, the CEO should be rewarded on an "imbalanced scorecard" focused on the corporate-wide bottom line.
Keep it consistent. Compensation committees and HR staffs can't resist the temptation to adjust or fine-tune salary levels, bonus targets, performance measures, performance standards, and option-grant criteria. And yet, each adjustment diminishes long-run incentives: Why invest today for uncertain rewards tomorrow? Although Eisner's bonus contract was changed in 1996 (not, I believe, for the better), his contract and incentives have been remarkably stable for more than a decade.
Use external performance standards. The quickest way to destroy bonus incentives is to set performance standards based on budgets or prior-year performance. CEOs should have incentives to maximize performance without wasting time sandbagging the budget process or worrying about how this year's performance will affect next year's standard. Eisner's bonus formula, based on a fixed ROE performance standard, avoids this common but important problem.
Emphasize sharing rates. When Disney profits increase by $1, Eisner gets 2 percent. When Disney shareholders realize $1 in appreciation, Eisner gets about 1.5 percent. Simple and compelling. The downside is that the magnitudes become huge following spectacular performance: In order to maintain his historical sharing rate, Eisner received options worth nearly $200 million in 1996. But, we all should have such problems...
Not all of the lessons from Disney are worth emulating. Consider, for example, the recent experiment on "retention dis-incentives" with Michael Ovitz.
Ovitz received a base salary of $1 million for five years, whether or not he stayed with the company. He received a one-time $10 million "severance" bonus plus a $7.5 million annual bonus for five years if fired, but "discretionary bonus" (which Eisner set at zero the first year) if he stayed employed.
In addition, Ovitz received 3 million options fully exercisable over five years if fired, compared to 5 million non-fully exercisable options if he stayed (these 3 million options, incidentally, are worth over $80 million if exercised today). Given this contract, it isn't really surprising that he was able to get fired after only 14 months. But there are still important lessons: executives respond to incentives, and it is crucial to get the details right.
Eisner's plan isn't perfect. His 1996 options grant, awarded with three years remaining on the prior grant, effectively and unjustifiably doubles his sharing rate for stock-price appreciation.
On the bonus front, while ROE-based performance thresholds are poor substitutes to thresholds based on Disney's cost of capital. Still, for CEOs and shareholders alike, a Disney-type plan may be the quickest ticket into Fantasyland.
Kevin J. Murphy is professor of finance and economics at the University of Southern California's Marshall School of Business.
For reprint and licensing requests for this article, CLICK HERE.