Compensation Design Group
|Recent Meet the Streets|
John A. Lucas
Does the top dog at a company that's in the doghouse really deserve such a large bone?
After all the recent turmoil in corporate America, many investors are looking at the no-interest loans, ever-expanding stock options and giant bonuses that many chief executives take home -- and are questioning why. Tyco International ( TYC) CEO Dennis Kozlowski was paid more than $5 million in salary and bonuses during 2001, not including millions of dollars in stock options. And he signed a new employment agreement that runs through 2008, and in doing so picked up another 800,000 in restricted shares. That's not bad take-home pay for the head of a company whose stock is down almost 50% year to date. The trend is not isolated to Tyco. At troubled Lucent ( LU), returning boss Henry B. Schacht will have five times as many stock options as his predecessor. And the rich are just getting richer. According to a study from William H. Mercer, an executive pay consulting firm, the average total direct compensation (salary and bonus plus long-term incentive grant values) for CEOs was $5.2 million in 2000, up 13.7% from the previous year. To get the lowdown on whether executives are taking home too much, we talked to Frank Glassner, CEO of executive-compensation consultant firm Compensation Design Group, which is based in New York. Glassner has been working in the field of compensation and strategic consulting for 26 years, and was the national director of the Deloitte & Touche Strategic Rewards Practice prior to founding Compensation Design Group in 1991. TSC: Tyco International's boss, Dennis Kozlowski, has a pretty nice compensation package. Is this kind of compensation package unusual for an executive whose company has a stock price down more than 50% since the year began? Glassner: Well, given the fact that the performance of the company is off, I would say yes. We are stepping away from pay for performance here. It's bad for the company to come back and reissue so many stock options and reward someone for a downturn in performance, or for that matter, to say let's forget about all those stock options we gave in the past and let's give some brand new ones
at a lower strike price. You know, we all collectively know the instinct is that underwater stock won't keep that CEO swimming for long. So, the concept is to regrant or grant very, very large amounts of options when you have a downswing in the market of the company. And to lower the exercise price to allegedly remotivate the CEO. Employee shareholders and the community in general hate this practice. That's akin to changing the rules midgame. And besides, when the CEO was supposedly motivated, why didn't he boost the stock performance then? TSC: You touch on an interesting point -- repricing stock options to reincentivize CEOs. Why don't corporations stick to their guns and demand more from their CEOs? Glassner: You and I have been talking about pay for performance. It seems that we have forgotten about that. CEO jobs over the past 10 years, and especially over the past five, have really become akin to becoming a rock star or a world-class athlete. This greed, coupled with free agency, has driven the values up beyond recognition for the good old survey median for executive salaries. The pay-for-performance stuff is something that we would and could give more focus to. What also comes into play is what reforms are probably going to come on line right now. First and foremost, where are the boards of directors when we go into a crisis like this? The board of directors had to have approved Kozlowski's grant. The board of directors had to have approved, and had oversight of, pay for performance. So what happens? If corporate directors aren't to blame, who is? These are the people who are charged with overseeing the affairs of the company in the shareholders' best interest, including the reasonableness of executive pay and its link to company performance. TSC: What happens when CEOs are also on the board? Do they actually vote on their own compensation? Glassner: No. They are members of the board, but due to changes in pay-disclosure rules and board makeup for public companies that occurred in the mid-1990s, which was a time when most compensation committees were asleep at the switch with regard for real pay-for-performance regulation, the compensation committee is prohibited from having a CEO sit on it. So even though a CEO is the chairman of the board or listed as that they are not allowed in on their own compensation meetings. TSC: Still, those are awfully close bedfellows. Do boards simply rubber stamp a CEO's wishes? Glassner: Yes and no. Let's look at compensation professionals and the boards, where even though we've got these regulations for executive pay programs, that sort of good old boy network, which sometimes includes a lot of obliging consultants as well, and just plain lack of effort, really allows the snowballing effect of high nonperformance based pay to gain speed. TSC: Why has executive pay skyrocketed so much? Glassner: Executive pay has skyrocketed because of stock options, generally, and equity-based pay. If we look at the growth in the Dow, for example, over the same period of time, the Dow increased far greater than the multiple in pay for performance that you're talking about. However, the ships float up and down in the tide. And people (are being) paid just because there's an increase in the marketplace vs. really focusing back on the executive performance. TSC: One of the reasons often cited for such generous compensation for employees is to help retain them. In fact, at Lucent, returning boss Henry B. Schacht has a compensation package that's very rich. He's receiving five times as many options as his predecessor. In media interviews, spokespeople said the company paid Schacht so handsomely to ensure that management was stable during Lucent's road to recovery. Is retention such a major problem in the executive suite? Glassner: Is retention an issue? Yeah, as long as the employee is performing. However, if pay and performance are not matched -- and that includes upswings and downswings -- then, in fact, you might lose that executive. If pay is up there and performance is down, per chance, we should probably get a spine and lose that executive. TSC: If you are the top guy at an S&P 500 company, aren't these guys worth what they're getting? Glassner: In many cases, yes. In many cases these days, no. The question we have to ask now is: Will the compensation committees of the boards across America really take the necessary steps to reverse the significantly negative trend that started? I believe they will, with a little prodding from the compensation professionals and also from the media. TSC: What companies currently have the worst most pricey compensation packages? Glassner: I would certainly say Tyco. Enron goes without saying. Global Crossing goes without saying. Lucent. Lucent has not learned its lesson. AT&T ( T) has not learned its lesson. Pay is for performance. If you perform well, you will be paid handsomely. If you have handsome returns for your shareholders, they will get up and applaud. TSC: How do you gauge performance at a company? Can you gauge it? Glassner: There is not a shred of evidence that significant compensation of executives has really improved company performance across America. What's probably going to happen now, in reforms, just like companies have their annual accounting audits and their tax audits. What's going to happen now is that there's going to be a performance audit as compared to pay. We've looked at companies now for some years and we've done these executive report cards. TSC: And what were your findings? Glassner: Some companies perform very well. But it's not only shareholder returns. This reform that I predict will happen over the next few years is going to really look at and evaluate the risks that management faces and how well it's conducting the business. In other words, how much pay has been put at risk. And let's look at the company's relations in regards to its industry sector and its employees and in regards to the community. TSC: Over the course of your 27-year career, you've seen the nature of compensation change tremendously. What are the biggest mistakes that companies make when compensating their executives? Glassner: It really has to do with the boards. It has to do with the counsel, both inside and outside, that the board's getting. And is the board willing to stand up and say this executive or this group of executives is not performing well as compared to the rest of the marketplace, and stop making excuses. How many compensation professionals, both internally and externally, tell their boss or client what they need to hear instead of what they want to hear? In reality -- not very many. Some executive compensation consultants have only recently climbed on this pay-for-performance bandwagon. Our firm, Compensation Design Group, has been one of the biggest supporters, since its inception, in supporting pay for performance. TSC: Aren't stock options supposed to be an incentive-based kind of performance? Don't executives benefit if they drive the stock up? Glassner: It does work, but there are other measures people can put in there to make sure that stock options are pay for performance, such as premium-priced options. Just to give the Lucent fellas a big slug of stock options when the market's down and the American economy is down doesn't solve anything. To give them fair-market value strike prices at where things are today doesn't help anything. But then to say, I'm going to give you this slug of stock options, instead of at $10 a share, where it's trading at today, I'm going to give you so many options that are 100% vested today, however they're going to be at $20. And then I'm going to give you another slug that is 100% vested today that's at $30. And so the big incentive is, while you're holding all these options, they really don't become all that valuable until the stock price really goes up. You need to put a double-trigger in there. TSC: I suppose the bottom-line question for the individual investor is, how can I tell if my CEO is overpaid? Glassner: You're going to see egregious payouts of both cash and benefits to these executives while the stock and company performance continue to go down. Lucent just did it. TSC: A lot of this has to do with the tightness of the labor market, with issues of retention and attracting a CEO. How tight is the executive labor pool? Glassner: I think the labor market for outstanding executives is always going to be there. However, I think that the availability of the jobs for outstanding executives would open up if corporate America and the American public in general would start questioning the performance of these CEOs. This is like 1991 all over again. Sort of the heart of Gulf War recession, but far worse. I don't think we ever had anything that was as bad as Enron. We're only through the first few layers of the onion. Historically, with regard to executive pay, when it was time to have a spine in front of the boards or compensation committees or when it's time for the board to have a spine -- to say that these executives are being paid far too much money -- that only a handful of board members and only a handful of outside executive pay consultants really step up to the challenge without regard to personal consequences. In light of this impending corporate governance that's going to come onto us right now, it's going to be much easier to do what's right. From the standpoint of the media, from the standpoint of professionals, from the standpoint of board members, let's all agree to do that right from now on. I can't fix the past. Some of the spinelessness of these executive pay consultants and board members is probably not too distant a cousin from corporate greed. It's human nature. Most executive-pay consulting work grew out of the tax practices of the accounting and law firms. Mission critical was to maximize the after-tax income of the executive. In some cases, with reckless disregard for the interest of the shareholders or the taxpayers. After all, you have people that consider the executives to be the customer. And the customer is always right. Especially in cases where the consultant's firm provides other lucrative consulting work and audit work and tax work for this customer. And in many cases, the big accounting firms have, in fact, compensation and benefits-consulting practices. TSC: So, they could also have a conflict of interest? Glassner: The executive pay consultant's inclination to rock the boat, especially when you have millions of dollars in other consulting work, is nil. The law firms have executive pay practices. Why would you want to rock the boat and tell someone what they need to hear? TSC: Why aren't boards outraged? Glassner: Because the boards, in many cases, do not want to step up to bat and say this is wrong. And that's why I say, right now, right this second, let's get an agreement from corporate America and the American shareholder public and say let's do this.