My Big Fat C.E.O. Paycheck

NY Times
April 3, 2005
EXECUTIVE PAY
My Big Fat C.E.O. Paycheck
By CLAUDIA H. DEUTSCH

THE spectacle of once-respected corporate titans doing perp walks - Martha Stewart, Bernard J. Ebbers, Richard M. Scrushy, the list seems endless - has pretty well tarnished the title of chief executive. But it has done little, it seems, to scratch the gilt from the corner office.

In fact, the boss enjoyed a hefty raise last year. The chief executives at 179 large companies that had filed proxies by last Tuesday - and had not changed leaders since last year - were paid about $9.84 million, on average, up 12 percent from 2003, according to Pearl Meyer & Partners, the compensation consultants.

Surely, chief executives must have done something spectacular to justify all that, right? Well, that's not so clear. The link between rising pay and performance remained muddy - at best.

Profits and stock prices are up, but at many companies they seem to reflect an improving economy rather than managerial expertise. Regardless, the better numbers set off sizable incentive payouts for bosses.

With investors still smarting from the bursting of the tech bubble, the swift rebound in executive pay is touching some nerves. "The disconnect between pay and performance keeps getting worse," said Christianna Wood, senior investment officer for global equity at Calpers, the California pension fund. "Investors were really mad when pay did not come down during the three-year bear market, and we are not happy now, when companies reward executives when the stock goes up $2."

Even when companies reported modest increases in executive pay, it was often because they shifted from stock options, which are listed as compensation as soon as they are doled out, to outright stock grants to be paid - and accounted for - down the road.

Of course, corporations have been wrestling for decades with ways to link pay to performance, with little success. In the 1980's, they tried tying cash bonuses to rising sales or earnings, only to find that the payouts encouraged executives to make decisions that yielded short-term results - and, often, longer-term disasters.

In the 1990's, companies tried stock options, figuring that they would be the best way to tie the executives' fortunes to those of shareholders. Instead, they prompted some managers to time decisions to pump up the stock just when their options vested. Bonuses and options at Tyco and Enron, for example, did little to prevent widespread accounting frauds at either company.

The secret to linking pay to performance remains elusive. Net income at Eli Lilly fell 29 percent and its return to shareholders dropped 17 percent last year, but its chief executive, Sidney Taurel, saw his pay go up 41 percent, to $12.5 million.

Similarly, Sanmina-SCI, the electronics contract manufacturer, has lost money in each of the last three years, and its shareholders' total return fell 27 percent last year, but the pay of its chief executive, Jure Sola, jumped to $15 million from $1.2 million in 2003.

SOME paychecks remained robust even if at first blush they looked reduced. Net income at Merck fell 15 percent last year, and total shareholder return dropped 28 percent. The summary compensation tables in the proxy show the pay of the chief executive, Raymond V. Gilmartin, dropping 39 percent, to $5.9 million from $9.6 million.

But Mr. Gilmartin may find it easy to recoup the perceived loss. He got far fewer options last year, but he is participating in a new long-term performance plan that will give him $2.7 million worth of shares next year if he meets earnings targets - and double that amount if he exceeds them by a set amount. He gets the shares even if the stock price does not rise by a dime. And the payments won't show up until the 2007 proxy.

Conversely, Apple Computer had a stellar 2004, yet Steven P. Jobs, its chief executive, was paid exactly $1 for his efforts. Why? Apple paid him in advance - in 2003, it gave him $75 million worth of stock.

Shareholders are not giving up on tying pay to performance. But now they seem less focused on how executives are paid and more concerned about exactly what they do to earn it.

"It's easy to manipulate stock price. It's even easier to manipulate earnings," said Paul Hodgson, a senior research associate at the Corporate Library, an investment research firm specializing in corporate governance. He, like others, is pressing companies to set pay based on measures that are harder to fudge, like return on capital employed.

Directors, meanwhile, are spending more time scrutinizing auditor reports and management strategies, looking for just such fudging. And for that, they've been rewarded. Pearl Meyer's data show that average total compensation of directors at 200 large companies probably topped $200,000, up from an average of $176,000 the previous year.

"Directors are meeting more often, so their meeting fees are up," said Jannice L. Koors, a Pearl Meyer managing director, "and there's clearly a sense that the liability they face, both personally and professionally, has increased, and thus warrants more pay."

Inflated pay for deflated performance has become ever more rankling to shareholders, many of whom are still scrambling to recoup the losses they suffered after the stock market imploded in 2000.

Few begrudge Daniel A. Carp, the chief executive of a newly revitalized Eastman Kodak, his $2,172,988 bonus this year, which brought his total compensation to about $4.4 million. But they are likely to squawk about the rich pay package - $7 million in salary and bonus, 5 million options and nearly $27 million worth of restricted stock - that Blockbuster awarded to John F. Antioco, its chief executive. After all, Blockbuster lost $1.25 billion last year.

Pay inflation will not end soon because companies are afraid to lose talent, said Ira Kay, who runs the executive pay practice at the consulting firm Watson Wyatt Worldwide.

Still, companies are rethinking the different pieces that make up a pay package. Many, for example, are reigning in common safety nets for chief executives - like contractual promises of huge severance if the company is acquired, or even if the C.E.O. is fired for incompetence.

They are also increasingly trying to link pay packages - most specifically, the size of bonuses, or the conditions attached to the vesting of restricted shares - to actual corporate performance, particularly total return to shareholders. "Finally, companies are focusing on the performance part of the pay-for-performance equation," Ms. Koors said.

Examples are easy to find. When net income at Aramark, a food services company, slid 13 percent, total pay for Joseph Neubauer, its chairman and chief executive, fell 20 percent - and his bonus shrank 47 percent. When net income at Unisys, the computer maker, plunged 85 percent last year, Lawrence A. Weinbach, then its C.E.O., got no bonus and saw his overall pay drop by 17 percent.

An even starker example is the arrangement for John R. Alm, who became chief executive of Coca-Cola Enterprises, the soft-drink bottler, in January 2004. His contract stipulates that he will lose all his restricted stock if he is no longer at the company when his shares vest in five years. More significantly, he will forfeit all the shares if the stock price has not climbed 10 percent at vesting time, and he will lose half of them if it has not increased by 20 percent.

Still, many shareholders are not satisfied. Reviewing C.E.O.'s pay - and how company boards' compensation committees set it - is at the top of the to-do list for many institutional investors and shareholder activist groups, now that they have succeeded in making companies more forthcoming about revenue, profits and other financial results.

"Whether compensation committees are effectively linking pay to performance is now a major corporate governance concern," said Martha L. Carter, a senior vice president of Institutional Shareholder Services, which advises big investors.

Only one concern - the proliferation of stock options - has abated. A new regulatory requirement to expense options, combined with a sluggish stock market that made many of them valueless in 2000 through 2003, has caused a stampede away from options. Several compensation consultants say they expect that options will soon represent less than 30 percent of total compensation, down from more than 60 percent today.

Not all alternatives are being warmly received. Shareholders decry plans that do not use "hard" measures of performance, such as total return to shareholders. For example, few are applauding Microsoft's two-year-old decision to grant restricted stock on the basis of customer satisfaction and market share, or Disney's plan to tie compensation to performance against the Standard & Poor's 500 index.

Shareholders do want companies to adopt "claw back" provisions that force executives to repay bonuses paid for results that later must be restated, a situation that has kept Qwest, for one, in the news this year.

They are also resisting rich change-of-control clauses that provide windfalls to any C.E.O. whose company is acquired, even if that chief gets a high-ranking job at the new company. The $95 million or so that James M. Kilts will probably receive as a result of selling Gillette to Procter & Gamble is raising ire even among those who laud his performance as Gillette's leader.

They also decry "pay for failure" contracts that heap riches on dismissed chiefs. Carlton S. Fiorina, for instance, left Hewlett-Packard with a severance package that included $14 million in pay, a $7.38 million bonus and $21.1 million in additional compensation from restricted stock holdings and pension payments.

Shareholders complain about how difficult it is for outsiders to glean such things as the tax implications of deferring executive compensation or the worth of supplemental retirement plans and other forms of "stealth compensation" that do not readily leap off the proxy. "The way the proxies are now, you can't really figure out how anyone, even Carly, got paid," Ms. Wood of Calpers said, referring to Ms. Fiorina.

Ms. Carter of Institutional Shareholder Services concurred. "Companies have simply got to do a better job of disclosing total pay packages, and how they play out in different scenarios, such as the C.E.O. being fired or the company being acquired," she said.

In January, for the first time, institutional shareholders, led by Calpers, invited top compensation consultants to a meeting in New York to discuss their concerns - and to persuade the consultants that they were part of the problem.

A TOP complaint was that the consultants feed data to compensation committees piecemeal, reporting what other companies are offering in supplementary pensions one day, the trend on bonuses a few days later, the value of stock options a week after that. The directors, in turn, set the different components of their own chief executive's pay package in equally disjointed fashion.

Consultants acknowledge the problem, and larger firms have begun to add up total compensation, both for peer-group companies and for the client's proposed pay package. "They used to only ask us for information about direct pay, because they got data about benefits and perks from others," said Pearl Meyer, chairwoman of Pearl Meyer & Partners. "But compensation committees are now taking a more holistic approach to executive pay, so we are now giving them all of the information."

Governance experts say the full board increasingly wants a better handle on compensation committee deliberations. Many directors fear that they will all be held accountable for egregious pay packages.

"The Dick Grasso situation has made a lot of directors more cognizant of the need to get the total picture, see how all the pieces - the base salary, restricted stock, options, perks, retirement benefits - add up," said Eleanor Bloxham, president of the Corporate Governance Alliance, a consulting firm in Westerville, Ohio.

She was referring, of course, to the brouhaha that arose when directors at the New York Stock Exchange said they were ignorant of the full extent of the pay package they had approved for the exchange's former chairman, Richard A. Grasso.

Several companies are voluntarily disclosing much more pay information to their shareholders. These companies have replaced what Ms. Koors called "the standard proxy boilerplate" - a statement that pay was set competitively - with fuller descriptions of how boards derived the packages they awarded.

The proxy for Becton Dickinson, for example, included a summary table that laid out the value of total compensation. Honeywell's proxy listed the value of perks like legal fees and personal use of corporate planes and cars. Siebel Systems has promised investors that next year it will begin disclosing the operational and stock-price hurdles that management must scale for restricted shares to vest.

"The companies know that new disclosure rules are coming, so they want an 'attaboy' from shareholders for being ahead of the curve and doing it voluntarily," Ms. Koors said.

Slowly but steadily, companies are responding to shareholders' clamor for pay packages to reward long-term thinking, too. This year's proxies show that companies increasingly insist that executives and directors hold about five times their pay in stock, thus making it harder for them to cash in on any short-term lift in the company's fortunes.

Cardinal Health, for the first time, is requiring its chief executive to hold shares equal in value to five times his salary, and its directors to hold the equivalent in shares of four times their annual retainer. Cendant this year increased its ownership rule for its chief executive to six times salary, from five.

"Companies are basically saying to their chiefs, 'We want to keep you on the hook, to make sure that you are not benefiting from a short-term gain that is not sustainable,' " Ms. Koors said.

EXECUTIVES who do not lead the company down a profitable path may find it harder to develop other ways to cash in.

Thomas J. Neff, the chairman of American operations at the executive recruiting firm Spencer Stuart, says he has seen a move away from grants of restricted shares that automatically vest after three or five years. In their place, companies are giving shares that vest only if the company hits preset goals for book value, total return or other measures the board deems crucial to success.

Mr. Neff says that fewer companies are agreeing to automatically vest all options or restricted shares if the chief leaves and that many now offer one or two years of compensation, maximum, upon departure, a sharp drop from the three to five years of pay that used to be routine. "Boards are no longer routinely letting the C.E.O.'s lawyer draft the contract," he said.

Several companies have clearly learned from past mistakes. The contract of L. Dennis Kozlowski at Tyco International called for an immediate payout of about $135 million if he was dismissed, and a retainer of $3.4 million annually for the rest of his life. His voluntary resignation released Tyco from the terms of the agreement, but directors clearly are cognizant of how expensive fulfilling the contract terms could have been.

Tyco's new severance policy limits compensation to twice the executive's base salary and bonuses at the time of termination. In a merger or change-of-control situation, departing executives would receive up to 2.99 times their base salary and bonus. And Tyco now awards stock options that are priced higher than the share price on the day of issue.

Directors are less likely to clamp down on the pay of newly recruited bosses. Consider the package for C. John Wilder in his first year as the TXU Corporation's chief executive: $1 million in salary, a $16 million bonus and $37 million in long-term incentives.

Newcomers have boards at a negotiating disadvantage, compensation experts say. Because they took a gamble by switching jobs, most successfully insist on either a hefty sign-on bonus in cash and stock, or a soft landing - that is, rich severance - in case they fail.

Both eventualities get shareholders' dander up, but experts say the boards have little choice.

"You need to supercharge the offer," Mr. Neff said, "to create an incentive for a person to come in."