As Pfizer Inc. shareholders assembled in Lincoln, Nebraska, last April for the company's annual meeting, there was a buzz in the air — literally. A small plane circled overhead, pulling a banner that read, "Give It Back Hank!"
The sign captured the mood of investors who had raised angry questions after reading in the March proxy statement about CEO Henry McKinnell's $83 million retirement package. Why was such lavish treatment warranted when the share price had fallen 43 percent over his five-year watch? Besides, hadn't he already earned $65 million during those years?
A withhold-the-vote campaign failed to unseat two of the Pfizer board's compensation-committee members, but did garner an embarrassing 20 percent of the shares voted. And when anti-McKinnell pressure continued to mount, the board finally announced in July that the chief executive would step down.
But one question probably did not occur to shareholders: Why was the drug maker disclosing the value of the retirement package in the first place? The Securities and Exchange Commission had made a proposal in January for new compensation disclosure rules, but had called for them to be reflected in proxy statements next year. Pfizer directors, though, decided that their company would be among the first to include the array of details the SEC proposed requiring — one of them being a calculation of the present value of McKinnell's pension.
The SEC stresses that its new rules, which apply in 2007 to companies that have a fiscal year-end of this December 15 or later (Pfizer's is December 31), aren't meant to influence pay practices. "Our job is not to regulate compensation," says John White, director of the SEC's Division of Corporate Finance. "We just want to make sure disclosure is out there so that the marketplace can make its own judgment."
As McKinnell discovered, though, disclosure has a way of forcing changes that companies might not otherwise make. Compensation experts, in fact, expect the new rules to spur big changes both in how companies set executive pay and in the resulting pay packages themselves. Shareholder activists, among others, are betting on it. "This will mean an absolute quantum leap in the quality of disclosure," says Patrick McGurn of Institutional Shareholder Services. "Compensation committees are now in the hot seat."
Machete and Pith Helmet
The last overhaul of disclosure rules came in 1992, ushering in the compensation tables that are still in use today. The tables, too, were meant to give shareholders a plain view of the amount of money that management was making. Not long after that rule change, however, companies developed and began installing forms of pay that did not have to be disclosed in the tables. These include deferred compensation, supplemental executive retirement programs (SERPs), golden-parachute payments, and a variety of perquisites.
Many investors dislike these forms of pay, of course. Such methods allow firms to grant executives a great deal of money or other benefits — often unrelated to their performance — without clearly detailing it in financial reports.
Consider one common perk: the guaranteed postretirement consulting contract. After Gerald Levin resigned as CEO of AOL Time Warner Inc. in 2002, he was granted a consulting deal with the company that paid him $1 million a year in exchange for making himself available for five days each month. The arrangement, which expired last December, didn't appear in the tables, because Levin was no longer an employee by the time the money was paid. Instead, it was described in the footnotes.
In some cases, compensation is even more opaque. In its 1997 proxy, General Electric Co. noted that Jack Welch would receive "continued lifetime access to Company facilities and services comparable to those which are currently made available to him by the Company." The disclosure gave no further details about what turned out to be tens of millions of dollars in company-paid benefits ranging from the grand (free use of the company's Boeing 737 and use of a GE-owned Manhattan apartment) to the petty (free dry cleaning). It wasn't until Welch's heavily publicized divorce in 2002 that investors saw the full picture.
Compensation-committee reports are often woefully inadequate, consisting of little more than vague pronouncements about linking pay to shareholder value. "In the past, it's been very difficult to judge the rationale behind executive compensation and whether it fits in with the strategic plan of the company," says John Wilcox, head of corporate governance for TIAA-CREF.
The SEC has grown impatient, too. "No shareholder should need a machete and a pith helmet to go hunting for what the CEO makes," chairman Christopher Cox told New York financial writers in a speech this past summer.
The new rules aim to clear away the underbrush. Among other things, they require companies to show the dollar value of such hard-to-measure benefits as stock options, SERPs, and severance terms. Companies will have to provide a total compensation figure for each executive, and file a compensation discussion and analysis, or CD&A, to detail and explain why the company pays what it pays. The CD&A will have to be filed with the 10-K, meaning that the CEO and CFO need to certify it.
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