VideoAny doubts that compensation committees would come under fire were erased this past September, when New York Stock Exchange chairman Dick Grasso was forced to resign over his controversial deferred compensation package of close to $140 million.
The guns were already loaded. Just one month before, Securities and Exchange Commission chairman William H. Donaldson had taken on the issue in the bluntest possible terms. "One of the great, as-yet-unsolved problems in the country today is executive compensation and how it is determined," he told a National Press Club audience in August. True, compensation committees have more independent members—thanks to the Sarbanes-Oxley Act of 2002 as well as proposed reforms issued by Nasdaq and, ironically, the NYSE. But Donaldson also noted that they must now "begin to look into exactly what they're compensating for" and move beyond "simple issues like earnings per share and the increase in earnings per share" when paying executives.
Donaldson's frustration with compensation committees is shared by investors. This year, a record 322 nonbinding shareholder proposals have sought to rein in executive pay, according to the Investor Responsibility Research Center. The issue starts, of course, at the top, where the link between CEO pay and performance remains mysterious. In 2002, CEO total annual compensation (base salary and bonus) actually rose by a median of 10 percent, according to a survey conducted by Mercer Human Resource Consulting, while total return of the S&P 500 shrank by 24 percent. Little wonder, says Barbara Hackman Franklin, former U.S. Secretary of Commerce and a member of five corporate boards, "there's a building public perception that something is out of whack with executive compensation."
This is not really a new observation. In 1997, BusinessWeek magazine named The Walt Disney Co.'s board "the worst in America," a year after its compensation committee awarded CEO Michael Eisner a 10-year contract that included 8 million options. That same week, Eisner scored the single biggest payday for an executive (until that time), earning a $565 million profit from exercising some of his options.
What's upping the ante now, however, is the bright light recent scandals have shone on boards, in particular the workings of comp committees as well as audit committees. Rating systems such as those offered by Institutional Shareholder Services and The Corporate Library are punishing companies with less-than-desirable governance practices. And compensation committees are not only being asked to publicly explain their rationale for CEO pay, they may also soon face personal liability if they approve a flawed package.
In fact, says Edward J. Speidel, Buck Consultants's national executive compensation practice leader, "2002 and especially 2003 should be considered watershed years for comp committees." In response, says Donald Gallo, a principal at Sibson Consulting, companies are instituting reforms designed "to get their houses in order before the next round of [regulatory] assault."
Top Quartile
Historically, a seat on the compensation committee gave members a front-row view of pay and strategic practices. CEOs liked to sit on comp committees of other companies to keep tabs on their peers' compensation, explains Franklin. And since compensation "can influence the behavior of executives," adds Speidel, many directors used their committee assignment to gain influence with the CEO.
What they didn't change was the direction of CEO compensation. Aided by the bull market and the backfiring of several regulatory efforts (the 1992 proxy disclosure requirement drove salaries up, since CEOs could see what their peers were making; the 1993 capping of the tax deduction for executive salaries at $1 million made that figure the de facto standard), CEO pay packages rose 90 percent between 2000 and 2002 alone, according to The Corporate Library. And even as economic times got tougher, executive pay kept increasing. CFOs at the largest public companies saw their median bonuses rise 17.5 percent in 2002, the biggest increase in four years, according to a proxy survey conducted by Mercer Human Resource Consulting for CFO.com.
Part of the problem, says Nell Minow, co-founder of The Corporate Library, is CEOs in America are like the children of Garrison Keillor's mythic Lake Wobegon—all of them are supposedly above average. Most companies want to be able to say that their CEO is in the top quartile of all chief executives. And how do you prove yours is one of the best? Pay him or her in the top quartile. Says Speidel: "All companies want their CEOs to be paid in the 75th percentile; they just never wanted to question whether their performance justified that amount."
The dynamic between the committee and the often hard-charging CEO also led to compensation giveaways. At WorldCom, compensation-committee members reportedly referred to former CEO Bernard Ebbers as "God," "Jesus Christ," and "Superman," and awarded him compensation to match, including a $400 million loan and a $1.5 million annual severance package (amounts they are now trying to recoup). And since traditionally the CEO hires the consultant (or oversees the hiring) who develops the executive-compensation package, it's not surprising that comp committees often received inflated proposals, says Franklin.
Reader Comments» Post a comment