Shareholder advocates and lawmakers have harshly criticized huge compensation packages. Better disclosure has led only to bigger gains. Even when investors get the chance, they rarely vote against outsized pay.
Despite the growing attention over the last 25 years, the average chief executive’s compensation at big companies has increased more than 600 percent, to $8 million dollars a year after adjusting for inflation. Meanwhile, the ratio between the average pay for a top executive and a worker, which held steady in the 30 years before 1980, has more than quadrupled, to a multiple of 170, according to recent academic research.
“I don’t actually believe we have made any real progress — or very, very little,” said Robert A. G. Monks, a longtime corporate governance advocate. “If we cannot effectively monitor and control what the principal executives are paid, we are kidding ourselves if we can control anything else.”
So what can be done to tie pay more closely to performance, and cut back on excessive benefits and perks?
Executive compensation issues are tricky; the devil is often deep in the footnotes of proxy statements, employment agreements and stock option plans. It will take a concerted effort by both investors and boards to effect real change. Otherwise, lawmakers have threatened to get involved. “It’s not like Iraq, where everybody says it is bad, but nobody says what to do,” said Lucian Bebchuk, a Harvard Law School professor who has been an outspoken critic of executive pay. “The problem is making the process and the people who play a key role in making the decisions want to make improvements.”
Here are eight steps that compensation experts say might help rein in executive pay:
HIRE INDEPENDENT ADVISERS Despite what appears to be an obvious conflict of interest, it is still common for a compensation consultant, hired by the company’s top managers for lucrative actuarial or benefits work, to also help the board evaluate those same executives’ pay.
New Securities and Exchange Commission rules will require companies to disclose the name of their pay adviser. But unlike the rules for auditors, they stop short of requiring them to parse out their other financial ties to the company.
“You certainly don’t want the outside adviser to the compensation committee to become beholden to the company,” James F. Reda, an independent compensation consultant, said.
PICK THE RIGHT PEER GROUP Every computer geek understands the phrase “garbage in, garbage out,” but pay experts say that too many boards are relying on bad survey data or misuse it when compiling a list of comparable companies known as a peer group.
“If they are attempting to use any type of peer group, they truly need to ensure they are comparing apples to apples,” said Mark Van Clieaf, managing director of MVC Associates, a consulting firm that specializes in compensation plan design.
So how can companies keep the right company? First, use a handful of peers that are in the same industry as a starting point. They will likely have similar profit margins, growth patterns and competitive pressures. Comparisons against other big companies, admired companies, or fast-growing companies often do not make sense, experts say.
Next, adjust for the complexity and size of the job. “The C.E.O. role at Procter & Gamble is far more complex than at Campbell’s Soup,” Mr. Van Clieaf said. “If you are going to use Johnson & Johnson and P.& G. as possible benchmarks, you need to be clear that the work is not exactly comparable.”
He added, “People are confusing pay equality with pay equity.”
SET TARGETS. STICK TO THEM. Boards need to be clear about their expectations for management and then be willing to adjust them accordingly, pay experts say.
Targets should be revisited based on changes in the business environment each year, said Michael Kesner, an executive pay consultant for Deloitte & Touche. “Reserve the right to adjust bonuses up or down based on the quality of earnings,” he added. “If you made your earnings per share goals by buying back stock, have you really earned your bonus? I would say no.”
REVIEW AND NEGOTIATE Boards are packed with some of the country’s best and brightest deal makers. But when it comes to compensation, several compensation advisers say, they are often reluctant to negotiate.
Review the pay package’s main elements annually for items that are not locked in by an employment contract. For example, perquisites like golf memberships or personal use of the company jet could be capped or exchanged for a set amount of cash. That is what Lockheed Martin recently did.
Other items, like above-market interest rates, can similarly be eliminated. “There are companies crediting 12 and 13 percent interest rates on deferred compensation balances,” Mr. Kesner of Deloitte & Touche said. “That makes no sense.” Neither does paying dividends on shares of restricted stock that the executive has not yet earned, he added.
The S.E.C.’s new disclosure rules may help expose some of these hidden forms of pay. Savvy board members can also use these items as bargaining chips. “These are things the board can easily fix,” Mr. Kesner said. “It’s a matter of resolving to do it.”
AVOID CONTRACTS Boards say they want to pay for performance. Then, they often go out and ink contracts that Bill George, the former Meditronic chairman and chief executive, likens to a divorce settlement. “They pay people very well if they fail,” he said.
Golden parachutes and make-whole option awards may be necessary to lure a seasoned leader to a tough situation, but those protections are often left in place. Boards should be able to ratchet some of them down after a few years if the chief executive remains at the helm.
When employment contracts already exist, boards should try to tighten up their terms. In the last year or so, many boards have begun adding so-called clawback provisions to their executives’ contracts, a clause that allows them to recoup compensation in the case of an earnings restatement or a termination for cause. But just having one in place is not enough; boards must enforce them — something that several have been reluctant to do.
Perhaps the simplest solution to problems arising from contracts is to eliminate them altogether by focusing more on succession planning. “If you promote someone from within,” Mr. George said, “there is not the need for a contract.”
SCRUTINIZE PENSIONS Compensation consultants are expecting another round of “holy cow” moments as boards prepare this year’s proxy statements and see the amounts that executives have socked away in deferred compensation programs and supplemental retirement plans. In some cases, there may be eight zeroes or more.
History, however, does not have to repeat itself. For one, boards need to factor in an executive’s accumulated wealth when making annual pay decisions.
Similarly, boards need to figure out how their decisions can reverberate through an executive’s pension plan. Directors also need to be on the lookout that pension calculations have not been inflated by including huge bonuses, option dividends or restricted stock.
For example, Exxon Mobil paid bonuses to Lee R. Raymond, its former chief executive, for the years 2003 to 2005 that were on average $3.4 million higher than he had received in the previous three years. Those awards did not just increase his paychecks at the time. They increased them for life.
Without those increases and some smaller salary gains, Mr. Raymond would have taken home a pension worth just under $66 million, according to analysis by Brian Foley, an independent compensation consultant in White Plains. But largely because those larger bonus payouts were included, the lump-sum value of his pension jumped to $98.4 million, an increase of 33 percent.
LET SHAREHOLDERS VOTE Ever since Britain became the first country to require a shareholder advisory vote on executive pay in 2002, the idea has been gaining traction in the United States, especially among institutional investors. Each year, British boards must put their pay plans in front of shareholders. Although the vote is nonbinding, it does provide a forum for investors to tell the company’s management what they think.
So far, the embarrassment potential of the vote has been effective.
“Companies in the U.K. have begun to have a dialogue with their larger investors with specific aspects of compensation prior to putting them together,” said Keith Johnson, chairman of Reinhart Institutional Investor Services in Madison, Wis. “There is more dialogue, more feedback, more two-way listening between directors and shareholders.”
GET MONEY MANAGERS TO VOTE The biggest influence on executive compensation can be the managers of funds that are typically among the largest shareholders of a company. Money managers, however, frequently do not exercise an opposing vote.
Of the 1,225 stock-based compensation plans that American companies put to a vote, for example, only 25 of them failed to secure a majority vote in the first six months of 2006, according to Glass, Lewis & Company.
One explanation, pay experts say, is that big mutual funds are often seeking the money management business of companies in which they own large stakes and may be reluctant to oppose management as a result. Other big investors, like pensions and hedge funds, may decide that the cost of mounting a campaign may not outweigh any potential benefits.
As a start, the International Roundtable on Executive Remuneration, a global group of pension funds, is trying to enlist big pension fund investors.
The group suggests that its members incorporate instructions to address corporate governance and compensation issues into the money manager’s mandate before they hand over their funds. Next, it suggests members ask money managers to clearly articulate how they are going to vote on executive pay, and their reasons for doing so. Then, hold those manager accountable when the pension funds conduct annual reviews.
“If they are given a mandate from a large group of pension funds, they have to take it seriously,” said Daniel Summerfield, an adviser to USS, a big pension fund that is the British equivalent to TIAA-CREF.