Here Comes Politically Correct Pay

Board members are looking at CEO pay practices through the eyes of angry shareholders, regulators and employees. That already means some big changes.
By JOANN S. LUBLIN
Staff Reporter of THE WALL STREET JOURNAL
April 12, 2004; Page R1

Michael H. Jordan made an odd demand when Electronic Data Systems Corp. recruited him to run the struggling computer-services company last year. He wanted plenty of stock options that would enrich him only when investors scored a stupendous payday. So, one-half of the roughly one million options bestowed on Mr. Jordan are worthless unless the company's share price rises at least 30%.

The Plano, Texas, concern then did something equally daring. It imposed strict selling restrictions on his initial grants of options and restricted-stock units. The 67-year-old executive won't reap the full bonanza from the sizable awards until March 2008 -- more than two years after he expects to retire.

Mr. Jordan says the risky, premium-priced options and selling limits will force him to "leave the company in outstanding shape with continuing growth momentum." If he had sought a sweeter deal, "I probably wouldn't have gotten it," he admits. "The board felt under the gun" because his ousted predecessor received lavish severance. "No one wants an imperial CEO anymore," adds Mr. Jordan, the former head of CBS Corp.

Welcome to the new world of politically correct pay. Directors increasingly scrutinize their leader's compensation through the eyes of irate shareholders, workers and regulators. Hoping to make the top honcho's pay more palatable to critics, some are embracing innovative equity plans with steep performance hurdles, ceilings on option windfalls and lengthy stock-retention requirements. Other boards are dropping the most controversial practices, such as megagrants of restricted stock and options, huge departure packages and "evergreen" employment contracts that renew automatically.

"More companies get the message: The old rules don't apply anymore," says Richard L. Trumka, secretary-treasurer of the AFL-CIO in Washington. But in the name of better optics, he cautions, "there's a lot of smoke and mirrors."

Nobody should weep for the CEO, however: Even the most sweeping moves won't shrink chief executives' bulging wallets overnight. In fact, the latest numbers show that their dough keeps rolling in. CEOs in office at least two years enjoyed a 7.2% rise in salary and bonus last year to a median of $2,118,000, according to an analysis of current proxy statements for 350 major U.S. corporations by Mercer Human Resource Consulting, New York.

The cash-compensation upturn occurred after a 10% increase the prior year to a median of $1,802,053. (The 2002 figure reflects a slightly different sample of 350 businesses.) And once again, raises for the biggest boss were significantly better than those for white-collar subordinates. Paychecks of nonunion salaried staffers grew 3.6% -- their smallest rise since the Mercer survey began in 1989 -- after climbing 3.8% in 2002. (Overall, U.S. wages and benefits increased 4.1% last year, a brisker pace than the 3.2% advance the year before.)

This gap persists because bonuses, typically tied to profits, are routinely awarded to corporate commanders but not to white-collar employees. The median base pay for the No. 1 executive increased 3.8% in 2003, compared with a 2.2% rise in 2002.

Reflecting their employers' median 19.2% pickup in profits last year, chiefs saw their bonuses grow 6.7% to a median of $1,110,087 in 2003. The leap was reminiscent of 2002, when bonuses zoomed 15% to $917,943.

Into the Stratosphere

A few titans' bonuses hit stratospheric levels. Citigroup Inc., which had record profits last year, gave Chairman Sanford "Sandy" Weill a whopping $29 million bonus. (He relinquished the CEO title last fall.) Mr. Weill had volunteered to forgo a cash or stock bonus for 2002 because of the banking giant's lackluster stock performance at that time.

Total direct compensation for corporate captains jumped 16.4% last year to a median of $3.6 million, Mercer's analysis found. The latest number compares with a 15% increase to a median of $3,022,505 in 2002. Besides salaries and bonuses, this figure includes the value of restricted stock at the time of grant, gains from option exercises and other long-term incentive payouts.

The stock-market rebound also sweetened CEOs' pot of option rewards. They had a median $1,909,849 realized gain from exercising options, compared with $1,683,509 the prior year. Altogether, 145 business heads cashed in a median of 95,128 options, compared with the 146 who exercised a median of 92,910 options during the bearish 2002.

One indication of the heightened emphasis on truly shareholder-friendly pay is the firmer link between CEO remuneration and investor returns. Total direct compensation for those in charge of the 10 best-performing concerns jumped 21.6% to $2,382,000 last year, the Mercer study found. Heads of the 10 companies with the poorest returns weathered a 51.4% decrease to a median of $1,150,860. The median total shareholder return, which equals stock-price appreciation plus reinvested dividends, was 26.9% among surveyed companies.

Yet plenty of good and bad performers remain perched atop huge stashes of options. Henry R. Silverman, chief of successful Cendant Corp., cashed in 2.77 million options for a gain of roughly $37.2 million last year -- and still owned 33.6 million exercisable options worth $287.2 million by year end. Among analyzed companies with the worst returns, Darden Restaurants Inc.'s CEO, Joe R. Lee, owned the biggest stockpile of exercisable options -- 2,014,686 options worth $24.65 million when fiscal 2003 finished May 25.

Surveyed leaders' median unrealized gains from all options totaled $8.49 million, far higher than the prior year's $3.1 million. Overall unrealized option gains for polled executives rose to $7.37 billion from the depressed $4.1 billion in 2002.

Like a growing number of major corporations keen to embrace politically correct pay, Cendant no longer doles out stock options to its veteran leader. The New York travel and real-estate services company abandoned them in 2002 because Mr. Silverman already held so many shares and options.

Mercer reported that 278 of the 350 businesses in the latest study gave their highest officer options, down from 295 the year before. Options came under attack after senior executives of several scandal-torn businesses profited handsomely from exercising them just before bad corporate news broke.

Opting Out

John Faraci, chairman and CEO of International Paper Co., dislikes stock options because they never motivated him much. "We could perform in a mediocre sense and the stock price could go up because of a rising market," the 54-year-old executive says. Soon after the large paper producer in Stamford, Conn., promoted him to his present posts last November, he dropped options in favor of performance-based restricted shares. Mr. Faraci and fellow senior executives can sell those shares only if International Paper achieves a better return on investment and total shareholder return than the median player in its peer group. "This is what winning is all about," says the chief executive, who in January collected 220,000 restricted shares tied to those measures.

International Paper is "going in the right direction," says Ed Durkin, corporate-affairs director at the United Brotherhood of Carpenters and Joiners of America. The union recently withdrew a shareholder resolution there advocating the switch. (Recipients of restricted stock without strings attached may sell them after a specified period, prompting critics to dub them "pay for pulse.")

General Electric Co. earned similar kudos when it decided last fall to replace options and restricted shares for its chief Jeffrey R. Immelt with "performance share units." Every unit equals one share. Half vest in 2008 if GE's cash flow increases an average of at least 10% a year. Mr. Immelt will get the rest that year if GE's shareholder return meets or outperforms the five-year cumulative total return of companies in the Standard & Poor's 500-stock index.

But some pay specialists believe the Fairfield, Conn., conglomerate set the bar too low. "A 10% average annual increase in cash flow over five years looks substantial, but in four of the past five years, the company has done better than that," says Brian Foley, an executive-compensation consultant in White Plains, N.Y. And "matching the S&P 500 doesn't seem particularly heroic," Mr. Foley says.

GE spokesman Peter Stack disagrees, saying that over the past two decades or so, "GE would not have hit these marks between a quarter to a third of the time, depending on how you measure it."

Options' popularity also has dimmed because several hundred businesses now count them as expenses in their financial results. An earnings charge is expected to become mandatory next year.

Trying to minimize such expenses, Schlumberger Ltd. joined the bandwagon for better optics by imposing a ceiling on option payouts. The big oilfield-services concern awarded Chief Executive Andrew Gould 415,000 options this January -- and capped his potential gain at 125% of their $55.90-a-share exercise price. Even if Schlumberger's share price skyrockets, he will never make more than $69.88 per share from cashing in those options.

The cap "puts a boundary on wealth creation by people at the top," observes Steven Hall, president of Pearl Meyer & Partners, New York pay consultants. "I view it as a nifty move that other companies may adapt."

In the drive for more politically correct CEO pay, huge helpings of equity are vanishing, too. Last year, leaders of 34 businesses tracked by Mercer won megagrants, down from 69 in 2002 and a peak of 103 in 2001. Mercer considers an option megagrant to be one with a face value of at least eight times an individual's salary and bonus. A restricted-stock megagrant is worth at least two times that amount. The face value is the number of options or restricted shares times the market price at the date of grant.

H.J. Heinz Co. was among the 74 companies that omitted their chief executives' giant gifts in 2003 after providing them at least once in the prior two years. William R. Johnson, chairman, president and CEO of the Pittsburgh food maker, received 388,483 options, his smallest serving in four years. During the year ended last April 30, Heinz also provided him with 98,142 restricted-stock units initially valued at $3.2 million. He acquired a third of those shares when Heinz reached certain earnings targets in fiscal 2003. But he, like nine other top executives, can't sell them until they leave.

Shareholder Pressure

The retreat from king-size equity portions will quicken because many directors fear ridicule -- or worse. "You could be embarrassed in front of your investors or have votes withheld" for your re-election to the board, warns Charles Elson, head of Nuevo Energy Co.'s board pay panel and the University of Delaware's Weinberg Center for Corporate Governance.

Behind-the-scenes lobbying by shareholders is intensifying the shakeup in CEO pay. Consider Schering-Plough Corp., a major drug maker that suffered significant losses last year and anticipates worse results this year.

The Kenilworth, N.J., business wooed Fred Hassan to be chief executive last April partly by promising a 2003 bonus of as much as $3 million. Things turned bleaker so fast that he canceled his 2003 bonus four months later. He also inaugurated a broad compensation overhaul to focus management harder on maximizing shareholder value over time.

Nevertheless, it took two meetings with disgruntled institutional investors last winter before Mr. Hassan accepted the radical notion of indexed stock options. Such options lack value until a company's share price outpaces an external benchmark. Starting next year, Schering-Plough will index 20% of the options awarded Mr. Hassan and other senior executives -- probably based on how well its shareholder return and earnings stack up against those of rivals.

Equally unusual, the company's latest proxy thanks the union-owned Amalgamated Bank and the California Employees' Retirement System for helping to devise the indexed-option program. "One needs to keep an open mind on new ways of compensating people," Mr. Hassan says.

Schering-Plough endorsed the new approach partly because "there's a desire to not be on the front page" over unacceptable executive-pay tactics, suggests Melissa Moye, chief economist for trust and investment services at New York-based Amalgamated.

Private negotiations with investors unhappy about extravagant severance packages may spare United Rentals Inc. the dual public embarrassment of a shareholder resolution and a "Vote No" campaign this spring.

For months, the equipment-rentals provider ignored letters from the AFL-CIO's Mr. Trumka challenging "excessively generous" severance promised to top executives through employment contracts that renewed automatically. Mr. Trumka's first missive, sent last August, also accused CEO Bradley Jacobs and President John Milne of engaging in unacceptable self-dealing because the United Rentals board originally approved their accords in 1997 -- when they were its sole members.

Speaking on behalf of Messrs. Jacobs and Milne, United Rentals current Chief Executive Wayland R. Hicks said that "it is not uncommon for start-up companies to enter into important agreements before a full board is in place." He also said those agreements "reflected the substantial capital" invested in the company by the men, its principal founders.

Amalgamated has submitted a resolution for the company's annual meeting next month urging that investor approval be required for any severance pact that exceeds 2.99 times a senior executive's salary plus bonus. And the AFL-CIO launched a drive to withhold support for re-electing Messrs. Jacobs and Milne to the board.

Scaling Back

The company, based in Greenwich, Conn., is now scrambling to disarm its pay critics. When Mr. Hicks succeeded Mr. Jacobs as CEO in December, he took a one-year contract, and his potential severance was just $1 million. (Mr. Hicks's former employment agreement would have given him severance of as much as 10 times his salary and bonus). Late last year, United Rentals also created a special panel of independent directors to review executive officers' compensation.

"I expect that we will be adopting a number of new policies, including the elimination of evergreen contracts, reduced severance arrangements and more use of performance-based plans," Mr. Hicks says. He pitched the looming reforms when he met with 30 union and public-pension representatives in Washington late last month. Amalgamated and the AFL-CIO are still pursuing their United Rentals campaigns.

Chief executives' cushy postretirement deals, long derided as "stealth wealth," have begun to fall out of favor as well. Mr. Jordan, for instance, didn't ask EDS for pension credit for more years than he had worked. He also doesn't participate in EDS's supplemental executive retirement plan. "I had seen the rising public interest in pension enhancement as the new trap door for corporate money," he says. And, he adds, "I've retired two times before."

Not everyone heeds the growing clamor for more politically palatable pay, however. At Motorola Inc.'s annual meeting last May, angry shareholders stood to denounce the substantial 2002 compensation awarded to Chairman and CEO Christopher Galvin, grandson of the company's founder, despite Motorola's depressed share price and extensive layoffs.

That same month, directors of the Schaumburg, Ill., telecommunications-equipment producer handed Mr. Galvin an additional one million options plus 500,000 restricted shares worth $4.3 million. Those hefty equity grants, based on the board pay panel's assessment of corporate performance and peer-group data, created a strong incentive "to increase the value of the company," the latest proxy says. A few Motorola directors opposed the largesse, but ultimately supported the full board's belief that Mr. Galvin should "be paid commensurate with CEOs of major corporations," an informed individual says.

But Motorola's falling share of the mobile-phone and wireless-infrastructure markets cast a dismal backdrop to Mr. Galvin's last year. The board subsequently lost confidence in him, and Mr. Galvin agreed to resign last September. Outsider Edward J. Zander replaced him in early January.

Motorola's pay protests last year have morphed into formal investor activism this year. At its annual meeting next month, shareholders for the first time in more than two decades will consider resolutions promoting curbs on excessive executive pay. One measure would cap the chief executive's annual salary at $1 million, among other things. Motorola guarantees Mr. Zander a salary of at least $1.5 million. Both proposals, drafted by union pension funds, would ban stock options for senior executives.

Stockholders voted on a record 201 executive-pay resolutions in 2003, and a record 49 won a majority of votes cast, reports the Investor Responsibility Research Center in Washington. So far this year, 289 such measures have been submitted -- overwhelmingly by union-related entities.

"We have to be as vigilant as we've ever been," Mr. Trumka says, "and make sure these nascent pay reforms take root in corporate America."

Write to Joann S. Lublin at joann.lublin@wsj.com3

URL for this article:

Hyperlinks in this Article:
(1) http://online.wsj.com/documents/Execpay_ceocomp04.pdf
(2) http://online.wsj.com/article/0,,SB108170340323479614,00.html
(3) mailto:joann.lublin@wsj.com