European CEOs make half the pay

By Michael Brush

Forgive European CEOs if they suffer from a bit of paycheck envy.

They're not doing bad, mind you. Many still get to use the word "million" when tallying up their compensation. But compared to their American counterparts, whose total pay increased an average 27% last year, they're practically destitute.

Consider:

• The average pay for the top executive at the 200 largest U.S. companies last year was $11.3 million, according to Pearl Meyer & Partners, the compensation division of Clark Consulting. That's more than 2.5 times the average $4.3 million earned by the top executive at 100 companies in the London Stock Exchange's FTSE 100 Index ($GB:UKX), according to Independent Remuneration Solutions, a British compensation consultant.

• It's the same story at midsized companies. Bosses at U.S. businesses with annual sales of about $500 million earned $2.16 million last year. CEOs at similar-size companies in the UK, France and Germany earned $1.2 million, about half as much, according to Towers Perrin, another compensation consulting firm. In Japan, the typical CEO at this size company made $543,000.

You see even more striking contrasts when you examine individual companies in the same sector.

Deutsche Telekom (DT, news, msgs) Chairman and Chief Executive Kai-Uwe Ricke got $3.3 million in salary and bonus last year, and he accrued $400,000 in incentive pay. His counterpart at AT&T (T, news, msgs), Edward Whitacre, had a pay package worth more than $38 million. That included $9.2 million in salary and bonus, $4.7 million in long-term incentive payouts and $24.8 million worth of long-term incentive grants.

Ricke got paid one-tenth as much as Whitacre even though Ricke manages a bigger company; Deutsche Telekom has annual revenue of around $75 billion, while AT&T's is $50 billion.

U.K.-based GlaxoSmithKline (GSK, news, msgs) paid CEO Jean-Pierre Garnier in salary and bonus of $6.4 million in 2005, using exchange rates from last week to convert his salary to dollars from pounds. When you add in "other" pay and options, his total pay package was worth around $9.4 million, according to Hemscott Group, a UK-based company that tracks European pay levels.

In contrast, Henry McKinnell, chairman and CEO of Pfizer (PFE, news, msgs), had a pay package worth more than $17 million last year. He got a salary and bonus worth $6 million. He realized options gains worth $6.2 million and received long-term incentive payouts of $5.5 million. The two companies are similar in size: GlaxoSmithKline had annual sales of $41 billion last year while Pfizer's was $51 billion.

Just what accounts for these huge differences in pay for CEOs on the two continents? After all, you can't write off higher pay for U.S. CEOs as the price of better talent -– especially if you expect that talent to produce better results.

GlaxoSmithKline's Garnier earns significantly less than Pfizer's CEO. But over the past five years GlaxoSmithKline shares are flat while Pfizer shares are down more than 40%. Shares of both AT&T and Deutsche Telekom are down significantly in the past five years but Deutsche Telekom shares are down less.

So if it's not pay for performance, what explains the difference? Here's a breakdown.

Rewarding risk

In the United States, there's a deeper history of granting large equity stakes to CEOs at young companies to entice them to work hard. That kind of thinking has spilled over into pay policies at mature companies, says Russell Miller, a pay consultant with Korn/Ferry International.

The emphasis on incentive pay in the United States shows up clearly in the numbers.

"Variable pay," things like options and incentive pay, accounts for 62% of pay for U.S. CEOs at mid-size companies, according to Towers Perrin. But it makes up just 35% of CEO pay for similar-size companies in the UK and 41% in France. In contrast, base pay made up only 27% of the pay for U.S. CEOs while it accounted for 43% in the UK and 40% in France.

Consider the example of BP (BP, news, msgs) Chief Executive Lord Edmund John Phillip Browne. He made $6 million last year in salary and bonus pay and he was awarded $20 million worth of restricted stock, the first such award in at least three years.

Now look at how much more the chief executives at U.S.-based Occidental Petroleum (OXY, news, msgs) and Valero Energy (VLO, news, msgs) made, even though their companies are much smaller.

Occidental Petroleum Chief Executive Ray Irani got a salary and bonus worth $4.94 million last year, less than Browne's salary and bonus. But Irani more than made up for it with grants of options and restricted stock to the tune of $49 million. He also realized $37.5 million by cashing in options. And he got $10.5 million in long-term incentive payouts. His total pay package: $84 million.

Though Irani earned more than three times what Brown made, Occidental Petroleum has annual revenue of $16.4 billion, just 6% of the $261 billion in annual revenue at BP.

Likewise, former Valero Energy Chief Executive William Greehey last year had a salary and bonus worth $4.9 million, again less than Browne. But Greehey realized $55.2 million by cashing in options, and he got $29.2 million in long-term incentive payouts. His company has $87.3 billion in annual sales, one-third BP's sales.

Some argue it makes sense that U.S. CEOs have greater potential rewards, because they accept the risk of having a big chunk of their pay linked to options. "If you pay people more in the form of risky options, then you have to compensate them more for holding a riskier portfolio," says Martin Conyon, a management professor at the Wharton School of the University of Pennsylvania.

This may hold true in theory. But options packages at many U.S. companies are structured in ways that pay off many CEOs handsomely even though they do a lousy job.

At least in the case of Occidental Petroleum and Valero, shareholders have been rewarded handsomely along with the CEOs of those two companies. In the past two years, shares of Occidental Petroleum and Valero are up 114.8% and 252%, respectively, while BP shares are up 29.8%.

Involved shareholders

European CEO salaries also get a lot more scrutiny from shareholders, says Bob McCormick of the U.S. pay consulting firm Glass Lewis.

In the U.K., shareholders get to vote on pay proposals. Companies don't actually have to adhere to shareholder wishes, since the votes are non-binding. But it's a "slap in the face" if there is a big vote against a remuneration report -- which can make companies leery of straying too far away from their peers in terms of pay, McCormick says.

To the victor, the spoils

Other pay analysts chalk up the huge pay packages in the United States to a winner-take-all mentality in a culture that doesn't frown on celebrities, sports stars and CEOs getting most of the marbles.

"The U.S. values individualism and individual achievement," says Mel Fugate, a professor at the Southern Methodist University's Cox School of Business. "So anybody who can obtain the coveted CEO post 'deserves' to get the spoils. There is much more tolerance for income inequality in the U.S. than in Europe."

In contrast, management at European companies tends to be more team oriented, with top managers sharing more of the responsibilities and the rewards, Fugate says.

The pay differences across the Atlantic can make for awkward moments at European multinationals when the head of the U.S. division of a company makes more than the CEO back home in Europe, says Towers Perrin's James Matthews.

But European CEOs put up with it because they know they need to pay U.S. managers more if they want to stay competitive. "If you are going to be in Europe, you will get paid according to the local market," says Miller at Korn/Ferry International. "If they like where they are, they are not going to move."

At the time of publication, Michael Brush did not own or control shares of companies mentioned in this column. Brush is an award-winning New York-based financial writer who has covered business and investing for The New York Times, Money magazine and the Economist Group. Brush studied at Columbia Business School in the Knight-Bagehot Fellowship program. He is the author of "Lessons From the Front Line," a book offering insights on investing and the markets based on the experiences of professional money managers.