Ways to Restore Investor Confidence In Compensation
What boards can do to ease shareholder anger over pay packages
By Joann S. Lublin
The Wall Street Journal
Monday, April 9, 2007
Outrage over executive compensation has hit a boiling point.
And it may get worse before it gets better.
New proxy disclosure rules approved by the Securities and
Exchange Commission last July are shedding a harsh light on the
breadth of corporate chiefs' oversized packages. The overhaul
requires companies to provide a total compensation figure for
each of their top five officers.
The new rules also give investors a better handle on
perquisites, pensions, deferred compensation and stock-option
grants -- awards that previously were buried in the fine print
of public filings, or not disclosed at all.
The revelations, combined with the extensive scandal over
backdated stock options, make board pay panels a bigger target
for investors' ire. Activist investors are increasingly trying
to block the re-election of directors involved in controversial
compensation awards. Through April 4, investors also had
submitted 281 shareholder resolutions related to executive pay
-- far more than the 173 proposed for all of 2006, according to
Institutional Shareholder Services, a Rockville, Md., firm that
advises institutional investors.
Board members typically blame their inability to control runaway
rewards on competitive pressures -- especially when the boards
are recruiting new management. "Most compensation committees
want to do it right," says Norman Augustine, a retired Lockheed
Martin Corp. CEO who heads such panels at ConocoPhillips and
Procter & Gamble Co. "The difficult question is, 'What is the
right thing?' "
Here are 10 tips for boards that might produce executive-pay
plans acceptable to disgruntled stockholders. The suggestions
come from activists, compensation experts and a handful of
1. Make sure the board's pay consultants don't also work for
Last October, 13 institutional investors sent a letter to the 25
biggest companies in the Standard & Poor's 500-stock index,
asking pay-panel chairmen to disclose whether their companies
had other business relationships with their executive-pay
advisers. The letter outlined steps to avoid such conflicts of
interest. Consultancies that counsel boards about pay for the
top brass occasionally earn fatter sums by running benefit
programs for management.
Most of the 23 companies that responded complied in part with
the shareholders' requests, though not all have adopted written
policies stating intentions to avoid such conflicts of
interest. The letter "was the primary reason" Morgan Stanley
directors replaced Hewitt Associates Inc. as their consultant,
says a spokesman for the New York financial-services firm.
Hewitt, which declined to comment, also advised Morgan Stanley
management about pensions. The Morgan Stanley pay panel pledged
to consider for approval any work that its next consultant does
for management when fees exceed $25,000.
Several other businesses, including Verizon Communications Inc.
and Wal-Mart Stores Inc., face shareholder proposals this year
on whether they should reveal ties between their board's pay
adviser and management. The new proxy rules don't require
disclosure of the relationships.
2. During outside CEO hunts, set limits on the projected
compensation, hire a savvy negotiator and find a back-up
Too often, critics say, boards desperate for fresh leadership
blindly agree to star prospects' exorbitant demands. This
picture is starting to change.
Setting a pay range at the outset of Gateway Inc.'s 2006 search
for a new chief executive "gave us a channel marker of what's
reasonable," says Joe Parham, compensation panel chairman. "We
wanted to do a course correction."
Last September, directors of the computer maker filled the top
spot with J. Edward Coleman, a former Arrow Electronics Inc.
executive. His package fell in the middle of the directors'
desired range, Mr. Parham says. Among other things, the new CEO
received about 2.2 million options valued at $1.95 million. His
predecessor, Wayne R. Inouye, got 10 million options in 2004,
the year he joined.
Boeing Co. directors retained Robert Stucker, a Chicago attorney
who usually represents executives, to help them hammer out an
accord with W. James McNerney before Mr. McNerney assumed
command in summer 2005. Board members "wanted somebody who was
the expert," someone close to the situation says.
Mr. McNerney accepted less-generous severance than he was
eligible for at 3M Co., his prior employer -- where Mr. Stucker
had represented him. Mr. Stucker, chairman of the Chicago-based
law firm Vedder Price, says negotiating on boards' behalf during
CEO contract talks accounts for 20% of his practice, double the
proportion five years ago. Mr. Stucker declines to comment on
whether his prior representation of Mr. McNerney posed a
conflict of interest during his subsequent dealings with the
Boeing board on Mr. McNerney's pay.
3. Skip severance for anyone with a sizable stock stake and
"Severance is completely unnecessary" for wealthy officials,
says Michael S. Kesner, a principal in Deloitte Consulting's
executive-compensation practice. Investors shouldn't "provide
the executive's great-great-grandchildren with a payday," he
CEOs themselves sometimes initiate such moves. That was true at
Home Depot Inc., says an informed individual, where Frank Blake,
the new chief executive, insisted on a more modest pay package
than his predecessor, Robert Nardelli. In addition to spurning
a guaranteed bonus, supplemental pension and restricted shares,
Mr. Blake now lacks the guaranteed severance he had before he
advanced from executive vice president.
Mr. Blake's deal "is a vast improvement over the Nardelli
package. But it took shareholders three years of complaining to
get Home Depot directors to hear us," says Richard Ferlauto,
director of pension and benefit policy for the American
Federation of State, County and Municipal Employees union, in
William A. Osborn, chairman and CEO of Northern Trust Corp.
since 1995, recently terminated his employment-security
agreement. The accord would have given him a lump sum equal to
three years of salary and bonus -- plus five years to exercise
his options -- if he lost his job within two years of a change
in control at the Chicago bank-holding concern.
Thanks to his seniority and longevity, "I have significant
equity ownership in Northern Trust and am retirement-eligible,"
the 59-year-old banker wrote in a Feb. 20 letter to the
company. As of Jan. 1, he owned about 2.2 million shares and
options exercisable within 60 days. "An employment security
agreement for me is unnecessary," his letter added.
4. Retreat from "pay for failure" by making it easier to
fire for cause.
Investor advocates have long complained about extravagant
departure deals for unsuccessful CEOs. An officer terminated
because directors believe he committed serious misdeeds usually
loses exit payments. But ousters for cause can be costly. In
September, three former CEOs won millions after challenging
boards that fired them.
A few companies have devised new reasons to fire their leaders
for cause. Thus, Walt Disney Co. directors can terminate CEO
Robert Iger for cause if he refuses to give testimony or
cooperate with an investigation "into his or the company's
business practices," his October 2005 contract states.
The trend hasn't spread yet because "boards want to keep the CEO
happy," concedes Jerry W. Levin, chairman of Sharper Image
Corp. "That's why shareholder activism over this is a good
5. Take a skeptical view of "peer group" comparisons.
Under the new disclosure rules, proxies must describe and name
peer companies that boards use to gauge pay competitiveness
while creating compensation plans. The problem: Management
frequently persuades board pay panels to pick competitors that
will justify juicier deals.
Consider Eli Lilly & Co. The pharmaceutical maker's latest
proxy statement says directors judge its pay practices against
eight other drug manufacturers, including Johnson & Johnson,
because "Lilly must compete with these companies for talent."
But J&J is much larger and more complicated than Lilly. "When
you compare [Lilly's] CEO to that company's, all that does is
ratchet up the pay for someone with a less complex job," says
Denise Nappier, Connecticut's state treasurer. She oversees a
$24 billion pension fund for public workers.
A Lilly spokesman, Mark Taylor, responds that Lilly uses
top-tier pharmaceutical companies like J&J as benchmarks "to
make sure we are aligned in offering competitive packages."
6. Kill unjustifiable perquisites.
A limited retreat is under way for perks. Companies have
trimmed extras ranging from personal flights on the corporate
jet to financial counseling.
Next year, Gannett Co. "will no longer provide its senior
executives with any allowance for home security systems or club
membership fees," the newspaper publisher's latest proxy says.
But in certain cases, directors have enlarged other forms of
remuneration to make up for lost perks.
Boards fear the hazards of publicizing perks amid the ruckus
over executive rewards. The new proxy rules require revealing
perks of $10,000 or more apiece. Prior rules limited such
disclosures to those valued above $50,000.
7. Link all long-term incentives to performance goals.
Without such ties, executives at poorly performing businesses
can make money exercising their options amid a rising stock
General Electric Co. earned kudos in 2003 when it replaced
options and restricted shares for Chief Executive Jeffrey R.
Immelt with "performance share units." The units pay out based
on cash flow and stock performance. GE shares generally have
underperformed the S&P 500 index since Mr. Immelt took the helm
in September 2001.
But few companies have emulated GE. Directors say, " 'It's a
good idea, but we don't see other people doing it,' " notes Paul
Hodgson, senior research associate for Corporate Library, a
Portland, Maine, governance-research firm. Ten companies have
received investor resolutions this year recommending linking a
substantial amount of equity compensation, such as options and
restricted shares, to performance.
8. Divulge precise measures that shape payouts for
performance-based awards, and set hurdles high.
Despite the new proxy rules, businesses still may conceal
performance goals for competitive reasons. Many do.
Investors should be able to figure out whether generous bonuses
reflect good performance or poorly set targets, says Lucian
Bebchuk, a Harvard Law School professor and co-author of the
book "Pay Without Performance."
Fuller disclosure would produce "more stringent hurdles," says
Michael McCauley, corporate-governance director for Florida's
State Board of Administration, which manages about $135 billion
of public-employee pension assets.
9. Conduct regular checkups about pay practices.
Boards are trying different approaches. Gateway's pay panel
will decide this month whether to request an annual internal
audit of option grants and similar long-term awards, Mr. Parham
says. "I think it's a great idea" that might someday involve
external auditors, too, he adds.
ConocoPhillips directors will consider rotating their pay
consultant every five years. "The benefit clearly is that you
will get a fresh look," says Mr. Augustine, chairman of the
ConocoPhillips pay panel.
Other boards are seeking second opinions about their pay plans
and their advisers from rival consultancies. Scott Olsen, head
of PricewaterhouseCoopers' reward practice, says he does this
about six times a year, up from "never" five years ago.
10. Give investors a voice about executive-pay packages, a
right that exists in four countries.
So far in 2007, shareholders have submitted proposals at 64
companies seeking an advisory vote on executive pay. Confronted
with such a resolution, Aflac Inc. agreed to give investors a
nonbinding vote on pay starting in 2009. At&T Inc. and Northrop
Grumman Corp. tried unsuccessfully to block the proposals from
their proxy ballots this year.
U.S. Rep. Barney Frank, the Massachusetts Democrat and new
chairman of the House Financial Services Committee, introduced a
bill last month requiring annual advisory votes. The measure
passed that committee late last month, and heads now for a full
"Say-on-pay" proponents hope investor censure -- or the threat
of it -- will encourage directors to trim excessive awards and
better link pay with performance. An advisory vote "tamps down
the potential for CEO greed," says AFSCME's Mr. Ferlauto.
"Shareholders will have to replace compensation committees that
don't heed these votes."
--Ms. Lublin, the management news editor for The Wall Street
Journal in New York, served as contributing editor for this
Write to Joann S. Lublin at