The Evils of Evergreen Contracts

The "miracle of compound interest" helped put Bell, Calif., in the doghouse.
August 5, 2010 AT 3:00 AM
Girard Miller
By Girard Miller  |  columnist
Girard Miller is the Public Money columnist for GOVERNING and a senior strategist at the PFM Group.

Just after the news broke about California's latest pay plunder, I attended a municipal professional conference where tongues were wagging and eyes were rolling about the Bell, California, salary scandal. When somebody asked me for some of the background, my comments included these observations:

• The city manager had reportedly served there for 17 years.

• His employment contract apparently provided for automatic 12 percent pay raises.

• It was reported to be a multi-year evergreen contract that renewed itself annually.

Whereupon, my colleague said to me: "Well that proves that Einstein was right! It was the miracle of compound interest."

She had a point. If you compound a $100,000 salary at 12 percent annually for 17 years, the result is a salary of $687,000. Now, the $787,000 city manager's entry salary when he was originally hired was less than $100,000, according to news reports. So there is still a hundred grand missing in this explanation that my simple math does not cover. But (without seeing the actual contracts) my suspicion is that a good part of the ultimate explanation for the exorbitant salary was a result of ever-renewing "evergreen" contracts. (Note: The Los Angeles Times reported August 4 that the manager's salary was increased 47 percent in 2006).

Evergreen contracts have been around for many years. School superintendents love them. In many cases, it keeps their compensation out of the public eye. Some city managers aspire to have them because of the volatile political world in which they live. But they have an evil underside, which the national soul-searching over the Bell scandal has revealed. It's just too easy for complacency to set in, and for salaries to escalate on autopilot. And when the pay escalation exceeds the inflation rate, the differences can be huge. Using the example I cited above, the result of compounding at the average inflation rate of 3 percent over the last 17 years would be an increase of pay from $100,000 to $165,000. That's a far cry from the $687,000 you'd get if a 12 percent escalator were left untouched over that same period.

Now that's an extreme example, and I've never met anybody in the public or private sector that had a 12 percent pay escalator in a multi-year deal. But it shows us why constant vigilance is necessary when compensation matters are involved.

My advice to every mayor, councilmember, county commissioner, and school board member in America is that you should refuse to accept evergreen contracts and demand that those now in place be amended to expire without auto-renewal — unless the compensation increase is limited to the CPI, and the salary is verified regularly to be within prevailing pay standards as I outlined them in my companion column. That includes testing the market for the "replacement cost" of the tenured incumbents. The professional associations should discourage evergreen deals in their ethical guidance. And while you're at it, give consideration to the accompanying variable-compensation incentives and prevailing-pay guidelines I've suggested, as well. Nobody likes to go through the uncomfortable process of contract renewals with a chief executive, but it's a necessary part of running a representative democracy and protecting the public's interests.