A Cut Above - and Below

Which local CEOs deliver the best bang for their bucks? [From the May/June issue of Nashville Post magazine]

The executive compensation debate these days might be focused on sexy names like Goldman Sachs – which has paid its employees more than $21 billion in bonuses year to date – but a broader question has vexed many an investor and board member for decades now: Is our CEO delivering performance worth his pay?

To answer that question for the leaders of the 30 Nashville-area companies listed on the New York Stock Exchange or Nasdaq, we took an approach that went beyond straight-up comparisons of stock returns or proxy-listed pay packages. We sought to equalize the valuations awarded different industries by comparing each company's price-to-book ratio to its peers'. We also didn't compare local CEOs' compensation packages head to head – not very useful when the companies involved are large retailer Dollar General and small drug developer Cumberland Pharmaceuticals.

Instead, we calculated CEO pay slices, the ratio of the boss' pay as a percentage of the total of the company's top five.

The CEO pay slice has been correlated with a number of performance measures: Earlier this year, researchers led by Harvard Law School professor Lucian Bebchuk wrote that firms with a higher CEO pay slice are generally less profitable relative to their assets, make worse acquisition decisions and "generate lower value for their investors."

Of course, not every company with a high CEO pay slice will perform more poorly, but Bebchuk, Martijn Cremers of Yale Management School and Urs Peyer of INSEAD noted that CEOs who have captured an unusually large share of executive-suite pay could more easily strong-arm the board and their direct reports in ways that may not always be productive.

"The ability of some CEOs to capture an especially high slice might reflect undue power and influence over the company's decision-making," they wrote. "As long as the latter factor plays a significant role, the CEO pay slice partly reflects governance problems."

To arrive at our ranking, we divided companies' relative price-to-book ratios by their CEO pay slices so that companies whose CEOs create more value for investors at a lower relative compensation level were doubly rewarded. We assigned a 75 percent value to the average of our calculations and built a grade scale from there.

Landing atop our list was Emdeon, which went public last August. CEO George Lazenby earned our only A+ in part because of his relatively modest $1.6 million pay package – given that he runs a $1 billion business – and Emdeon's 30 percent premium over its peers. Interestingly, the next three companies on the list all operate in the senior-living space.

On the flip side, restaurant chains O'Charley's and J. Alexander's make up the bottom two in large part because their shares are still recovering from the beatings they took in 2008. (View the ranking here.)

Our calculations also produced some interesting correlations along the lines of the Bebchuk group's research.

• Only two of the 10 companies with the highest CEO pay slices trade at higher price-to-book ratios than their industries'.

• Of the eight companies investors said were worth comparatively more than their competitors at year end, five have CEO pay slices at or below 30 percent.

• Eleven companies sported year-end price-to-book values that were below half their industries'. Of those, only HealthStream – where CEO Bobby Frist takes home a paltry $240,000 a year – scores better than a D.

One thing to consider: Getting into investors' good graces can lift our grades quickly. Based on the much-improved prices of their shares in mid-April, Louisiana-Pacific and Tennessee Commerce both would have earned solid Cs rather than the Ds they sported at the end of 2009.

Beats having to give the CEO a pay cut.