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CEOs Aren't People; They are Assets

CVS is working on acquiring Aetna. It’s a big, big deal. It’s a $69Billion deal. Aetna’s invested in a software system whose manufacturers may make as much as $500Million as a result of the transaction. That is a whole lot of money. But it's a reasonably good ROI on an asset that the company believe is instrumental in its current success.

Aetna made an investment to acquire and continue development of this software package more than five years ago. The annual cost to maintain and upgrade software and hardware was more than $18Million. The goal was simple. Invest enough and smart enough, to bring value to investors that exceed the cost of the investment.

The payout to the software manufacturer is less than 1% of the value of the transaction (0.72% to be precise). In the past five years, Aetna's Market Cap has grown by about 400%, to around $58Billion. The transaction would add about $11Billion to that.

If I went to a Fortune 100 company and told them that I had a magic system that would, with absolute success, create $50 Billion in shareholder value for only $500Million, most shareholders would vote to fund the system. In hindsight, seems like a pretty good investment.

The system mentioned above is actually Aetna CEO Mark Bertolini.

If I went to the same investors and told them that I had a CEO candidate who needs to be paid an average of $100Million a year, for the next five years, they would probably balk. They would likely protest even after being shown how that CEO would build more than $50Billion in value for them.

Of course, the above scenario simplifies things. No CEO is solely responsible for an increase in Market Cap. It takes far more than one person (a software system is just as unlikely to drive this kind of value). No CEO, at the time of hire, can be quantified in a way that provides a near certain probability of success. The market is also a huge driver of company value. Government policies also help or hinder value.

The most significant difference between human and system investment is in what “feels” reasonable. An investment in hardware or software never feels excessive so long as the return justifies the cost. An investment in a person, or even many people, has a more unpredictable, emotional and visceral feeling. That is one of the reasons compensation is such a touchy topic.

Is $500Million a lot of money? Yes, of course. Is it "too much" to pay a CEO that has helped build enormous value? Yes, of course. And… No, not even close.

Would Mr. Bertolini feel any differently if he had made $450Million? Probably not.

Would he feel different if he had made "only" $250Million? Probably not.

But, if you had capped his upside potential to a lower number, shareholders may have never seen the currently projected returns. It is impossible to predict accurately.

In the end, executive compensation is designed to drive and support a range of reasonable possibilities. Sometimes fantastic or terrible things happen that drive value far higher or lower than imagined. When a person is paid "too much" during a successful transaction, they get a ton of attention. When a system costs a similar amount, few will blink an eye. It is in the rare ginormous transactions like the CVS – Aetna deal that we must always remember that every CEO is as much an asset as they are a person. If that asset delivers returns that make shareholders happy, the cost is nearly never "too much," even when it is.

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