The Association of U S West Retirees



Fewer options
With less lift from stock-option gains, executive pay in the state lost a bit of altitude last year -- a trend that could continue.
By John J. Oslund and Patrick Kennedy, Staff Writers
Minneapolis Star Tribune
Monday, May 21, 2007

With one glaring exception, Minnesota's 100 highest-paid CEOs cashed in fewer stock options in 2006 than they did in 2005.  The exception was UnitedHealth Group's former CEO, William McGuire, whose large stock-option gains ($124 million in 2006 alone) have come at a great cost both to him and his company.  UnitedHealth is Minnesota's biggest contribution to the options-backdating scandal, which led to McGuire's forced departure last fall.

Excluding McGuire, Minnesota's highest-paid CEOs took home 8 percent less in total compensation than the same group did last year, with the fall-off in gains from stock options responsible for much of the decline.  Options gains were off 20 percent year over year.

Compensation committees also granted fewer new options to Minnesota CEOs in 2006 than in 2005.

With less lift from stock-option gains, median total compensation for Minnesota's 100 highest-paid CEOs -- the point at which half the packages are higher and half lower -- dropped 23 percent last year to $1.373 million.  However, that median figure now has topped the $1 million mark for the third consecutive year.

All together, 58 Minnesota executives took home $1 million or more in total pay last year, compared with 66 in 2005.  Total compensation includes salary, bonus and other sources of income, including gains from the exercise of previously issued stock options.

No one is predicting that stock options will disappear.  But after elevating the paydays of both deserving CEOs and those who were simply lucky enough to reign during bull markets, stock options appear to be on the wane as the cornerstone of executive pay.

Options lose their luster

Always controversial, stock options have also become expensive, thanks to an accounting-rule change in 2006 that requires companies to record a charge against earnings when new options are granted.  Previously, only a footnote disclosing the estimated value of option grants was required.

"People still expect there will be an options element in executive-level jobs," said V. John Ella, an attorney with Jackson Lewis in Minneapolis who specializes in executive compensation.  "It may be a decreasing portion of total compensation, but it is not going to disappear as a tool."

Critics of options -- ranging from business-school scholars to big-name investors like Warren Buffett -- point out that they're based on what at best is a crude measure of a company's success:  its stock price at a certain point in time.  At worst, they say, options are an incentive to manage for short-term profits and, in some cases, to cheat.

(Options entitle the holder, after a vesting period, to buy a share of the company's stock for a predesignated lower price.  Options have value only if the company's stock price achieves a higher target level called the strike price.  The difference is the gain.)

In 1999 -- the last full year of the 1990s bull market before the tech bubble burst -- options gains accounted for 70 percent of total compensation for Minnesota's highest-paid CEOs.  Last year the figure was 41 percent. (Comparisons exclude McGuire's stock-option sales.  In February 2006, he exercised $124 million worth of options before the backdating controversy surfaced.)

In theory, options reward executives who increase the market value of their companies.  In practice, however, those who are merely along for the ride can be richly rewarded, too.

"It is difficult to show there is a correlation between high levels of pay and consistent, superior company performance," said Robert Kennedy, professor of ethics and business law at the University of St. Thomas.  In other words, Kennedy added, "It was hard to be punished for poor performance."

Cozy relations between CEOs and their board members also make it easy to game the system, he said.

The options backdating scandal, which has snared about 140 public companies ranging from UnitedHealth to Apple, Home Depot to the Cheesecake Factory, underscores the point.  Backdating effectively takes the risk out of risk-based incentives, because grant dates for the shares are chosen through hindsight, ensuring a profit.

Defenders of stock options say for that for executives at high-risk, start-up firms short on cash but long on potential, options still offer a powerful incentive.  But the recent changes in the way companies must account for options make them less attractive.

As a result, said Thomas Martin, an attorney with the Dorsey & Whitney law firm in Minneapolis, the use of stock-option grants has declined from about three of every four executive pay packages at public companies early in the decade to about 40 percent last year.

"Stock options are expensive and difficult and are gradually being phased out," he said.

At many companies, grants of restricted stock have replaced options as the preferred way for rewarding top managers.  Those outright grants of stock typically vest over time and can be forfeited if the manager is fired or leaves the company.  Some restricted stock grants are tied to performance goals, although most are tied to the "passage of time," Martin said.

At Supervalu, for example, CEO Jeffrey Noddle has a special retention bonus of restricted stock tied to the company's Albertson's acquisition, according to the company's latest proxy filing.  Noddle received 305,157 shares of restricted stock valued at $9.5 million, 25 percent of which vests at the end of year three, 25 percent at the end of year four, and 50 percent at the end of year five.  The grant also contains performance criteria including stock price targets and the completion of a CEO succession plan.

Measuring the use of restricted stock among the 100 CEOs in this year's survey was complicated by the fact that the accounting changes affecting options and restricted stock took effect in January 2006.  Many companies on our list closed their fiscal years before then under the old accounting rules.  The trends should become clearer in the years to come.

Payday highlights

Among the 100 highest-paid CEOs on our list, cash compensation rose slightly in 2006.  The median salary and bonus for Minnesota executives rose 2 percent in 2006 to $789,474;  the comparable figure for 350 CEOs surveyed by the Wall Street Journal climbed more than 7 percent to almost $2.6 million.  In both cases, the figures compare this year's sample with last year's sample, and the population may be slightly different because of executive turnover.

Meanwhile, salaries for rank-and-file workers in the Midwest rose between 3.6 and 3.8 percent in 2006, a bit faster than in 2005, according to a survey of about 1,300 employers by World at Work, a salary-tracking firm.

Payday highlights from this year's survey:

  UnitedHealth's McGuire pulled down the biggest salary, $2.1 million.  Target CEO Ulrich's $1.66 million placed second.  Stratasys CEO S. Scott Crump was lowest at $190,000.

  Of the 100 CEOs, 78 got a raise, 13 got the same salary as the prior year, and five took salary cuts.

  James Cracchiolo of Ameriprise Financial got the biggest bonus:  $9.46 million.  3M Co. CEO George Buckley came in second at $7.4 million.  Jay Fishman of the Travelers Companies Inc. (formerly St. Paul Travelers) got the third-biggest bonus, $6.5 million.  The smallest bonus -- $15,000 -- went to Karen Gilles Larson, retired CEO of Synovis Life Technologies.

  Overall, 85 of the 100 CEOs got a bonus last year, including 19 who got $1 million or more.  Fifteen received no bonus, up from 12 in 2005.

  Of the 44 CEOs who sold stock options last year, the biggest exerciser was McGuire ($124 million);  followed by Target's Robert Ulrich ($26.1 million) and Thomas Oland of Techne Corp. ($21 million).

Best buys

Of the top five CEOs delivering the best three-year total returns to shareholders, none is among the top 10 highest-paid executives.

The overall best buy for shareholders by this measure was Rodney Young of medical products firm Angeion Corp.  Young ranked No. 82 in total pay but delivered the highest three-year total return:  386 percent.

He was followed by David Goronkin (No. 56) of Famous Dave's (255 percent);  Richard Braun (No. 36) of Medtox Scientific (236 percent);  Marti Morfitt (No. 23) of CNS Inc. (229 percent), and Brad Anderson (No. 16) of Best Buy (184 percent).

Among the 10 highest-paid CEOs, one-year returns were positive at eight companies (UnitedHealth and St. Jude Medical were the exceptions).  The biggest one-year gainer among the top 10 was H.B. Fuller, where CEO Al Stroucken delivered a 70 percent return before leaving the adhesives maker in December to take the CEO post at Owens-Illinois.

Overall, one-year total returns for the 100 companies were positive at 62 and negative at 36 (there were two initial public offerings -- Capella Education and U.S. BioEnergy Corp.).

Total return for the Standard & Poor's 500 index was 15.8 percent in 2006, while the Bloomberg-Star Tribune index of Minnesota's 100 largest companies rose 8.9 percent.

Female CEOs

Five female CEOs made our list, the same number as last year.  Morfitt, who sold tiny CNS to giant GlaxoSmithKline, got $3.99 million, to become the highest-ranking female CEO at No. 23.  Buffalo Wild Wings CEO Sally Smith came in at No. 40 with total pay of $1.66 million.  Gilles Larson ranked No. 74 with $663,000.

The former CEO of struggling Lenox Group, Susan Engel, ranked No. 76.  She resigned under pressure in January.  Kathleen Iverson of manufacturing technology firm CyberOptics ranked No. 88.

John J. Oslund
Patrick Kennedy