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The Gorilla Across the Table

Increasingly free of CEO influence, compensation committees appear set to push back on executive pay and perks.
David M. Katz, | US
December 9, 2002

In a divorce, it's the little ones who get hurt worst.

Take the case of Jack Welch, former chairman and CEO of General Electric. In the middle of a widely reported breakup with estranged wife Jane Beasley Welch, Welch -- and his former employer -- found themselves facing a public relations nightmare in September. According to court papers filed by Jane Beasley Welch, General Electric was apparently paying its retired CEO a king's ransom to serve as a part-time consultant and full-time flier of the General Electric flag.

As part of Welch's consulting/pension package, shareholders were apparently picking up the tab for a Manhattan apartment, room service from Jean-Georges, and satellite television at Jack's four homes. GE's board was also providing Welch with "continued lifetime access to Company facilities and services comparable to those which were made available to him by the Company just prior to his retirement," according to a company proxy. In further appreciation of his years of distinguished service, GE also presented Welch with courtside seats at New York Knicks games -- a present better left unwrapped.

In the aftermath of the pillorying, however, a sheepish Welch agreed to pay the company back for his use of its "facilities and services." GE's directors went even further. In November, the board passed a raft of corporate governance changes. One of the moves: Outside directors at GE will meet without management present at least three times a year.

Widely hailed by shareholder rights activists, GE's move was hardly a stunner. Under proposed corporate governance standards issued by the New York Stock Exchange (NYSE) in August, non-management directors at NYSE-listed companies (like GE) must meet without management on a regular basis.

The stock exchange proposal did not generate much press coverage at the time. In fact, with all the attention being paid to board audit committees of late, the newfound independence of compensation committees has been overlooked by many in the business press.

But some observers believe the growing sway of compensation committees could have an impact on the bankbooks of senior executives. For one thing, committee members who meet more often in private will likely be tougher negotiators when dealing with under-performing CEOs and CFOs. And in fact, GE's board named its compensation committee chair, Andrew Sigler, to run those non-management meetings.

Naming the comp committee chief to oversee the broader non-management group seems sure to clinch a spot for executive pay at the top of the agenda at those meetings. What's more, more independent compensation committees will undoubtedly be more skeptical of management requests for pay boosts -- particularly if directors are puzzled by company financials. Like audit committees on the accounting front, compensation committees are likely to become the last word on questions of executive pay.

Pushed by the NYSE proposal, which will almost certainly win approval from the Securities and Exchange Commission, outside directors are likely to spend more quality time together behind doors closed to senior management. At those sessions, they're sure to get an earful from comp committee members about the pay of top executives relative to their corporate performance.

Indeed, the days of rubber-stamping compensation packages for powerful senior executives may be coming to an end. "With performance and stock prices being so underwater at many companies," says Charles Elson, director of the Center for Corporate Governance at the University of Delaware, "the concern [is] that you're seeing ever-increasing levels of compensation in an era of decreasing corporate profitability."

Free to Be Me
Certainly, recent revelations about over-the-top executive pay packages at bankrupt companies like Enron and WorldCom have made executive pay a hot topic in boardrooms. Expect those discussions to get even more heated, too. With CEOs and CFOs increasingly absent from meetings, outside directors will "talk more freely about [management] performance," says Elson "And comp factors into that."

On the other hand, the exclusive sessions are no panacea for the excesses of executive comp, critics say. "The problem is, what's supposed to be going on behind those closed doors?" says Peter Clapman, senior vice president and chief counsel for corporate governance for TIAA-CREF, the huge teachers' pension fund. "Shareholders are not going to know about this until decisions are made."

Independence alone, apparently, does not a truly effective manager of executive comp make. Seemingly independent comp committees have overused stock options and approved their use in ways "that did not produce an alignment of interests" between managers and shareholders, Clapman asserts.

Other NYSE proposals, however, seem particularly primed to push compensation committees to engineer such linkups. Under one provision, for example, comp committees would be given sole authority to hire and fire compensation consultants. (To see how that provision could touch off battles inside corporate boardrooms, see "Gunfight at the Comp Committee Corral.")

Another provision, which would require board nominating committees to consist solely of independent members, seems sure to strip some comp committees of pro-management bias. Under the proposed rule, nominating committees would be less beholden to chief executives when they pick comp committee members or ax them, the reasoning goes.

Under such a setup, management's influence on a compensation committee would most certainly wane. Says Elson: "You don't have the fear of replacement that, in the old days, would be engendered by conflicting with the CEO over comp."

In fact, Elson, who is chair of the compensation committee at Nuevo Energy Company, sees comp committees increasingly populated by crusty retired CEOs with scant sympathy for today's jaw-dropping pay packages.

Moreover, the proposed NYSE changes may be injecting oomph into committee deliberations. "I definitely am already seeing that the [NYSE] guidelines are making a difference," notes Richard Harris, a senior executive compensation consultant for Mercer Human Resource Consulting. "It's almost like what we saw back in the early nineties, when the SEC changed the proxy reporting rules."

Ship Jumping
Adopted by the commission in 1992, the rules, among other things, required companies to include in their proxies a table breaking out the compensation of each of their top five executives. Before that, "you could just report a blended base salary and bonus amount," Harris recalls. "It was much, much more difficult to understand how executives got paid."

When the change happened, the effect on comp committees was dramatic. Recalls Harris: "We saw the immediate impact that comp committees took much more responsibility for thinking about how executives got paid."

While this effect petered out during the lengthy economic boom, Harris believes, "there's more energy in comp committees today." One sure sign of rejuvenation: Employers are offering top executives fewer perks, he says.

Of course, some compensation experts say newly empowered compensation committees need to tread lightly when nixing perquisites.

During the furor surrounding Jack Welch's retirement package, for instance, the former GE CEO said he was able to wring such a great compensation package from the conglomerate because he had done a good job running the company. He also pointed out -- and rightly so -- that there was no shortage of suitors lining up to lure him away from GE.

The dilemma for compensation committee members is obvious. Cut back too much on compensation and a highly prized CEO or CFO might jump ship. Cut back too little, and shareholders might jump down the chairman's throat.

"Compensation committees have been and will continue to be faced with the tension of trying to do -- and not overdo -- the right thing," asserts Robert Agate, a retired CFO of Colgate-Palmolive and a director at The Timberland Company, Allied Waste Industries, and eXcelon Corp.

But, Agate adds, they still must ensure "that compensation is competitive to attract and retain the best talent."

The Tough Don't Get Going
In fact, it's not terribly likely that boards will gut the compensation packages of top-notch CEOs and CFOs.

Barry Bregman, the partner in charge of Heidrick & Struggles' CFO practice, grants that comp committees will be "challenging more, doing more due diligence, and making more external comparisons with what other companies are doing." But all that scrutiny will actually help boost total compensation levels for finance chiefs, the headhunter predicts.

How's that? When they comparison-shop, Bregman argues, comp committees will see that "the level of pressure these guys are under merits higher comp structures."

Maybe. But if the overall compensation of some executives doesn't suffer at the hands of aggressive comp committees, the incentive component of pay packages will be increasingly linked to performance. And that could put a dent in some executives' net worth.

For instance, if employers start granting restricted stock to executives rather than stock options, they will saddle those managers with a new downside risk. When options expire out of the money, all an executive loses is "the expectancy of wealth, Elson explains. "With stock you actually can have wealth diminishment, and that's a different [incentive]."

One compromise comp committees may think about is building company performance targets into stock option awards. Fast-food chain Wendy's, in fact, has been basing the number of options it grants to its top executives on how well the company does compared to the S&P 500 in total shareholder return. According to Kerrii Anderson, the company's CFO, each executive's basic stock option award is adjusted up or down based on whether the company performs better or worse than the index.

Although the possibility of offering restricted stock is on Wendy's radar screen, Anderson says, the company isn't prepared to stop dispensing options just yet. "That's a high area of sensitivity," she says. "If you take something away you will have to give something in return -- or you will not be able to attract or retain very highly qualified people."