A few Congressional leaders have nothing better to do than pursue the decision by corporations to “pay” hard-working executives for their contributions to their respective companies. The latest brouhaha involves the retired chairman of Exxon Mobil, Lee Raymond, and his “excessive” pension payment of $98.4 million. This compensation was on top of a $69.7 million compensation package for 2005.

What the press reports, but fails to explain, is that when an executive such as Raymond makes a substantial amount of money in one year, only a minor amount of this “compensation” comes out of company funds. According to a Wall Street Journal article that reported these payment statistics, most of Raymond’s 2005 compensation was made up of restricted-stock awards and the exercise of options. In other words, compensating Raymond, in large part, has not come at the expense of company profits.

Very often CEO compensation is broken down into salary, bonus, and grants. For the sake of argument, since we don’t know the exact breakout of payments to Raymond, here’s a sample of how a CEO could have been compensated at Raymond’s level for 2005:

‐ Salary: $2.5 million
‐ Bonus: $10 million (based on good company performance that year)
‐ Grants of Restricted Stock and Stock Options: $57.2 million

On this last point, options are typically granted from time to time at an exercise price equal to the market price of the stock on the date of the grant. At some point (often after 10 years), the options must be exercised, or they will be forfeited. At the time of exercise, any gain in the shares above the exercise price is taxable to the CEO as ordinary income, whether or not the shares are sold. As a practical matter, given the large amount of tax due at this point, most executives sell shares in order to pay the tax. To the extent shares are retained, the basis in these shares is the market price of the shares when the options were exercised. Thus, in this example, the balance of the $69.7 million of “compensation” (or $57.2 million) is this gain on the exercise of options. And Uncle Sam gets his share (something over $20 million) right away. If a CEO lives in a high-tax state such as California, the income-tax bill on such earnings will run in excess of $25 million.

But here’s what’s most important: In this example, the company paid the CEO a total of $12.5 million — not $69.7 million. The $57.2 million difference is a gain in the value of the shares earned by this CEO’s stewardship of the company. Importantly, the rest of the company’s shareholders (including, but not limited to, your pension plan and your mother’s trust fund) realized the same proportionate gain.

Although it makes for sensational news to report the “abusive” income realized by CEOs, they only benefit if (and to the extent that) the shareholders gain. Would shareholders want lesser incentives offered to company executives? We think not.

The government’s selective intrusion into the private sector to judge what a fair compensation package should be ignores the incentive basis that drives corporate success. Seldom if ever do we see these accusatory politicians complaining about the compensation packages of their avowed constituents in the movie industry, where agents negotiate $30-plus million payments for well-known actors and actresses for three or so months of work. Similar outlier compensation packages are agreed upon with regularity in professional sports. Yet we have little evidence that such compensation adds productivity or value to the private sector. Or how about the recent 54 percent pay increase legislators awarded themselves in Pennsylvania? Where was the value-added performance in this case? More, we didn’t hear a peep from our federal bureaucrats about these guys getting excessive pay.

Once we let the political camel’s nose under the free-market tent, we may find that everybody’s compensation — except, of course, that of the politicians — will have to be approved by a “fairness” committee created by the federal bureaucrats.

– Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc., and principal of Victoria Capital Management, Inc. Robert F. Clarke is Group CEO of SunGard.