Corporate Boards Listening to Shareholders on Executive Pay

We were all supposed to be in this together.

Now, before you get too excited, we wasn't all that inclusive. 'We' meant executives and shareholders. Our interests were supposed to be aligned so that the more share prices rose, the more executive pay rose with it. But the share price was supposed to be the cause of the pay increases, not an incidental benefit of it.

Most of the really large pay increases occurred in what are nominally referred to as 'public' companies. This means they issue shares that can be purchased by the public. The benefits to that system are that gazillions of shares can be sold so that bazillions of dollars or euros or yuan can be raised and, presumably, allocated for productive uses - like executive compensation. But there are a few rules that go along with that right to be public. Well, more than a few if we're being totally candid, but dealing with them is what lawyers and accountants are for.

As the accompanying chart and the following article explain, our paths diverged somewhere around 1999. That, you may recall, is when the dotcom bubble began to grow and anything seemed possible. We had that nasty crash in 2002 and another in 2008. While the public may have felt it, executives did not.

But a not so funny thing is starting to happen. As investors start to slowly dip back into the capital markets they are evincing a nervy insistence on re-establishing a connection between share price performance and compensation. And corporate boards are beginning to get that this might be both beneficial - and necessary. JL

Gretchen Morgenson reports in the New York Times:

"Management is beginning to realize that it’s not just about their compensation. We also have to make sure that the shareholders benefit. That’s the change I’m seeing.”

RAISES may be hard-won for most American workers these days, but for those fortunate few in the executive suite, the pay increases just keep on coming. Last year, the median chief executive at a United States company with more than $5 billion in revenue received about $14 million, 2.8 percent more than in 2011, according to an annual pay analysis conducted by Equilar. The 2012 increase, though relatively modest, still represents a raise for most of those who inhabit the corner office (and whose companies had filed the data by the end of March).

A more important question may be this: Do this year’s figures show any evidence of progress toward a new pay paradigm? You know, where the gap between the compensation of executives and workers narrows, or where company directors put shareholders’ interests before those of the hired hands?

After looking over the numbers, I asked some experts in the compensation arena if they’d seen any promising shifts toward greater fairness in executive pay.

“The more things change, the more they stay the same,” said Brian T. Foley, an independent compensation consultant in White Plains.

Still, there were some encouraging signs. Some outliers, like Alan R. Mulally of Ford Motor and James P. Gorman of Morgan Stanley, took pay cuts in 2012 because their company’s performance declined. That’s the way it’s supposed to be.

And there are some cases where shareholders are actually reining in executive pay. Consider the work of some 128,000 Verizon shareholders who are also retirees of the company.

Known as the Association of BellTel Retirees, this group, for the last 15 years, has achieved a series of corporate governance and executive compensation changes at the company. This year, the association won a partial victory in a battle over performance-based stock awards. The company, according to its proxy statement, agreed to reduce such awards to senior executives when Verizon shares underperformed, a change the retirees had urged.

The retirees have also proposed that Verizon shareholders approve any severance package that exceeds 2.99 times an executive’s base salary plus incentives. This proposal will be voted on at the company’s annual meeting on May 2.

There is movement elsewhere, too. James F. Reda, an independent compensation consultant in New York, said he was noticing a shift among boards to award lower compensation to incoming chief executives, especially if they are from inside the company. “When new C.E.O.’s are hired, in a lot of cases, they are getting below-median total-compensation packages, with the idea that higher pay will get phased in over time,” Mr. Reda said. “New hires are not coming up to the C.E.O. level of pay right away as they did in the past. Now boards are making sure that they work out.”

Mr. Reda’s point brings up what compensation experts say may be the most formidable roadblock to fairer pay practices: longstanding chief executives who prefer the status quo and who hold sway over their directors.

Jon F. Hanson joined the board of HealthSouth in late 2002, just before a long-running accounting fraud at the company came to light. He has been its chairman since 2005 through a turnover of the company’s top management and board. “When a new C.E.O. comes in,” he said, “it emboldens the compensation committees to look at the methods we are using to compensate our C.E.O.”

In a vote last year, 98.8 percent of HealthSouth shareholders supported its pay practices; the compensation of its C.E.O. Jay F. Grinney stayed essentially flat last year, even though the company turned in solid gains in the period.

“It’s the hardest to introduce a new form of compensation when you have a long-entrenched C.E.O.,” Mr. Hanson said.

There are plenty of those around, of course. And that may explain why a pay practice that has contributed mightily to ever-rising compensation — the use of the corporate peer group — remains intact at most companies.

Using peer groups to determine executive pay was supposed to ground it in reality, basing it on the practices of similar companies. Instead, such benchmarking created a kind of arms race in pay.

One problem is that the makeup of the peer group is easily manipulated. For example, if a medium-size company uses much larger and more complex businesses as its benchmark, its compensation can be skewed, sending it far higher than it should be.

“Peer-group data is, as always, part art, part science,” said Mr. Foley, the compensation consultant. “It can be very constructive if done well, but can also be heavily gamed.”

A decade ago, directors at the New York Stock Exchange awarded Richard A. Grasso, its chief executive at the time, $140 million in compensation. He was compared against a peer group made up of companies with median revenue more than 25 times that of the exchange and median assets 125 times its own.

A furor erupted back then, but the reliance on peer groups goes on. A compelling paper on the problems with peer groups was published last fall by Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, and Craig K. Ferrere, a fellow there. In it, the authors argue that corporate directors should eliminate peer groups and instead “develop internally consistent standards of pay based on the individual nature of the organization concerned, its particular competitive environment and its internal dynamics.”

Investor groups have embraced this argument against benchmarking, said Yale D. Tauber, the director of programs on executive compensation at the Conference Board Inc. “There is a growing dissatisfaction with where benchmarking takes us,” he said.

BUT effecting change in the boardroom on pay matters is a glacial process.

“When you have a new idea that is different from the status quo, there’s always some resistance to it,” explained Mr. Hanson, the HealthSouth chairman. “The dialogue is in the early stages, but at least people are discussing management’s compensation and benchmarking it against how they are performing and how the shareholders are doing.