Corporate Governance

Executive Compensation

On this page

• U.S. House Committee Holds Hearing on CEO Pay
• Exec Pay Still Soars - Financial Crises Appear to Have Little Impact on Bonuses
• Poor Performance Pays Big Bucks - Corporate Library Statement
• Justifying American Executive Pay - SEC Pushes Disclosure
• The US Corporate Library "Pay For Failure" Report 2007
• Pace of US Exec Comp Speeds Up in 2006
• Best Practices in Exit Pay
• 'Say on Pay' Builds Momentum in U.S.
• U.S. CEO-Worker Pay Imbalance Grows
• Compensation Consultants and Rising Pay
• Wachovia Chairman - $135 Million Severance Package
• Landmark US SEC Regulation
• SEC Chairman Speech
• Manessman Case

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U.S. House Committee Holds Hearing on CEO Pay

Chief Executives at Citigroup, Merrill Lynch, and Countrywide all attempt to justify their high compensation levels in times of low performance.

On March 7, 2008 the U.S. House Oversight and Government Reform Committee held a hearing on CEO compensation in light of the U.S. sub-prime crisis.  Chairman Henry Waxman requested documents and testimony from the CEOs of three leading financial companies who were in charge during the “meltdown.”  Chairman Waxman’s opening statement reflects the central question he and many Americans are interested in – when companies fail to perform, should they give millions of dollars to their senior executives?

The following are excerpts from testimony given by the three CEOs.  All three companies have suffered enormous losses. Countrywide lost $1.6 billion in 2007 and its stock lost 80% of its value. Merrill Lynch lost $10 billion and its stock lost 45%o of its value. Citigroup also lost $10 billion and its stock lost 48% of its value.  Despite enormous losses, the CEOs were still paid substantial amounts. Their statements reflect their views on how their respective compensation committees justly determined their compensation.  All were critical of “over-exaggerated” compensation estimates in the media and outlined their company is doing now to alleviate the housing crisis.

Charles Prince, Citigroup ($10 million bonus, $28 million in stock options, $1.5 million in annual prerequisites upon retirement)

The Citigroup Board of Directors has instituted processes designed to ensure fair executive compensation. As you will hear in more detail from Mr. Parsons, the Board conducts an independent assessment of executive performance and relies on an independent compensation consultant. (A recent hearing of this Committee highlighted the importance of independent compensation consultants.) Citigroup has worked hard to align management’s interests with the interests of shareholders. For example, Citigroup’s Stock Ownership Commitment requires senior executives to retain at least 75% of the equity awarded to them while employed by Citigroup. Citigroup executives are required to take and hold substantial portions of their annual compensation in stock awards. The primary purpose in mind when we imposed this requirement was to tie our executives’ long-term personal financial interests with those of the company and its stockholders. Now well-recognized as a corporate compensation best practice, Citigroup has had this requirement in place for more than a decade.

Last fall, it became apparent that the risk models which Citigroup, the various rating agencies, and the rest of the financial community used to assess certain mortgage-backed securities were wrong. As CEO, I was ultimately responsible for the actions of the company, including the risk models that eventually proved inadequate. In the interests of the company I had worked so hard to build, I immediately submitted my resignation, and the Board of Directors accepted it a few days later.

I recognize that some have raised questions about my compensation, and much of the information reported in the media is incomplete or inaccurate. I therefore welcome the opportunity to provide the Committee with the complete information.

See complete testimony.

Stanley O’Neal, Merrill Lynch ($161 million upon retirement)

I think it is important to note that the compensation of senior management at Merrill was determined through a rigorous and independent process, and consistent with pay levels in the industry. In January of each year, after a review of the Company’s performance during the prior year, the Board of Directors set performance targets for the following year for all of senior management, including me. Those targets included a mix of revenue objectives, return on equity measures, and some strategic objectives. At year end, the Compensation Committee of the Board, which consisted exclusively of independent directors, met with senior executives to discuss their performance. The Committee then met by itself to set compensation.

Following those meetings, the Board of Directors informed me what my total compensation would be for that year and what my base salary would be for the following year. As a result of the extraordinary growth at Merrill during my tenure as CEO, the Board saw fit to increase my compensation each year. Most of that compensation consisted of restricted stock and stock options. I was required to hold the majority of the stock and options that I was awarded. In fact, I myself initiated a requirement that all of senior management hold onto at least 75% of their stock and options. Therefore, my compensation and my assets increased only when Merrill Lynch performed well for its shareholders and employees, and decreased when it did not.

While I was in charge of Merrill overall, I did not manage the day-to-day aspect of Merrill’s business that invested in mortgage backed securities. However, the sub-prime issues at Merrill arose during my tenure. Thus, when the Board asked me to retire shortly after we announced a large sub-prime related write-down in late 2007, I agreed to step down.

There has been some press about my so-called “severance package.” These stories are inaccurate. The reality is that I received no severance package. I received no bonus for 2007, no severance pay, no “golden parachute…” By having given me a significant part of my compensation in stock and options, the Board ensured that my personal financial interest was closely aligned with the shareholders of the Company. If the shareholders did well, I would do well too. It is true that top executives at public companies in the United States, especially in the financial services industry, are highly compensated. But a great percentage of that compensation, certainly for me, was and is at risk.

In short, I believe the compensation process was independent and functioned to ensure that my interests and those of Merrill’s shareholders were closely aligned and remain closely aligned.

See complete testimony.

Angelo Mozilo, Countrywide Financial ($120 million in compensation and sales of Countrywide stock)

The Board has adopted a compensation policy that aligns the interests of top executives with shareholders by making compensation largely performance based. That philosophy guided my compensation. From 1982 through April 2007, our stock price appreciated over 23,000 %. As a result, earlier in this decade, I received substantial income from performance-based bonuses earned under a formula based on earnings per share.

This bonus formulation was approved on at least two separate occasions by the company’s stockholders. Over the years, a significant portion of my compensation was in the form of stock options rather than cash. As the stock appreciated, the value of my own holdings also increased in value. In December 2004, in consultation with my financial advisor as we prepared for my retirement, I exercised a number of outstanding options, a significant number of which were about to expire, and sold the underlying stock pursuant to plans established with the advice of counsel. Notwithstanding these sales, today I remain one of the company’s largest individual shareholders, because I believe in Countrywide.

In recent years, the issue of executive compensation and severance pay has been a focus of governance experts, regulators, the media and the general public. In my case, there have been reports that I stood to collect $115 million in severance. While those numbers were grossly exaggerated, I have voluntarily elected to forego the specific severance payments that had been included in my contract in the event of a transaction like the one with Bank of America.

As I reported in a press release, upon completion of the Bank of America transaction, I will give up approximately $36.4 million in severance payments, and an additional $1.1 million in future consulting fees and other perquisites, for a total amount foregone of approximately $37.5 million. I will continue to receive my pension, which accrued over my almost 40 year career with the company, as well as several prior years’ earned compensation which I had voluntarily deferred. Neither constitutes severance, and both would be payable to me on my retirement, whether or not the company entered into a transaction with Bank of America or any other entity.

See complete testimony.

A complete list of testimony given at the hearing is posted on the House Committee’s website.

Posted 3/10/08

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Exec Pay Still Soars - Financial Crises Appear to Have Little Impact on Bonuses

Recent news articles report the extent of the paradox

At a time when the finance industry is taking substantial hits, year-end bonuses are soaring.  Just last week, Seattle-based Washington Mutual awarded Chief Executive Kerry Killinger 3.2 million stock options for 2008, despite a share price drop of 70 percent last year due to mortgage losses, Reuters reported.

Washington Mutual is certainly not the exception.  The lead in a Bloomberg article stated “Wall Street's five biggest firms are paying a record $39 billion in bonuses for 2007, a year when three of the companies suffered the worst quarterly losses in their history and shareholders lost more than $80 billion.”  Bonuses actually exceeded the $36 billion distributed in 2006 when the industry reported all-time high profits.  Merrill Lynch, the largest U.S. brokerage, said it paid $15.9 billion of compensation and benefits for 2007, exceeding the company's $11.3 billion of revenue, Bloomberg reported.  These bonuses are coming at time when New York-based companies are also cutting jobs, an action which has been attributed to the collapse of the subprime mortgage market. 

House Oversight and Government Reform Chairman Henry Waxman plans to question CEOs involved in the subprime mortgage crisis about their multi-million dollar pay packages, reported The Politico, an American political news online publication.  They will most certainly be asked to justify their sky-high compensation at a time when their companies are losing billions of dollars due to the mortgage meltdown.  The hearing is scheduled for February 7.

Mounting pressures seem to be encouraging some to rethink executive compensation.  The Wall Street Journal reported that the chairman and chief executive officer of Countrywide Financial Corp., Angelo Mozilo, is giving up $37.5 million of severance pay, fees and benefits in the face of the mortgage crisis.  He won't give up retirement benefits and deferred compensation that he has already earned, according to Countrywide. He retains a pension plan and supplemental retirement plan whose present value totaled about $24 million as of December 2006.  Despite his benevolent efforts, Mozilo is one of the CEO’s requested to testify during the Waxman hearings on February 7.

Martin Wolf, in his Financial Times column, attributes huge bonuses on the basis of short-term performance to problems in the financial industry.  By paying these bonuses, “banks create gigantic incentives to disguise risk-taking as value-creation.”  As recent history shows, Mr. Wolf argues that banking is very much tied to the public interest.  He recommends that it is therefore necessary that regulators get involved to ensure incentives are aligned to outcomes. (Editorial Cartoon from The Financial Times)    

Posted 1/30/08

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Poor Performance Pays Big Bucks

Statement from The Corporate Library on executive compensation titled "Too Little, Too Late" by Senior Research Associate, Paul Hodgson.

Stanley O’Neal’s departure from Merrill Lynch with “no severance” and no 2007 bonus would seem to present a picture of a decisive board in control. Yet, when “no severance” equals $161.5 million and an office and executive assistant for three years, what else did they think they needed to give him?

Such a situation highlights the dire condition of executive compensation in this country. When a compensation committee retains discretion over whether a severance package will be offered, it would seem to suggest that it will exercise that discretion in favor of shareholders. Yet all this meant was that it decided not to pay the approximately $30 million in cash severance that might have been due had Mr. O’Neal pulled off a merger with Wachovia. The remainder of his “non-severance” was outside the discretion of the compensation committee altogether and was governed by the rules of the retirement plan and the equity plans. Both compensation plans were approved by the board; these dictated that once Mr. O’Neal reached the age of 55 he was retirement eligible. He was therefore immediately vested in his retirement benefits—which cost, at this age, twice the amount they would have had he retired at 65. And his vested stock and options, as always the most substantial part of any separation package, continue to vest on their normal schedules.

In this way, his stock and options are likely to be worth more than if they had vested immediately and had to be exercised within a specified period. If another CEO is employed who begins to sort out the mess the company is in right now, the stock price might rise—as will the value of Mr. O’Neal’s holdings—and he will end up benefiting from someone else’s labor.

Only when boards wake up to the fact that long-term incentives that are supposed to be based on service and performance should only vest if those service and performance conditions are met will such a situation be impossible.

But while the board is trying to present itself as decisive and in control now, where was its oversight when the strategic decisions that led to this massive write-off of value were being made. Since it also looks as if the board may be considering an external candidate who would likely cost more than $161.5 million to recruit, it appears to have failed in yet another of its most important duties: ensuring a proper succession plan is in place.

Finally, The Corporate Library has rated the Merrill Lynch board as a high risk board for all but 18 months of the five years we have provided ratings on company governance. This level of disquiet was based largely on concerns about compensation practices at the firm.

Nell Minow, The Corporate Library’s editor, has aptly described Merrill’s board as “sub-prime.” Its actions now are too little, too late.

So, where does Mr. O’Neal’s “non-severance” stack up against some of the most egregious severance packages of this millennium? Table 1 gives a list of perhaps not the 10 most excessive, but certainly 10 of the most excessive golden goodbyes. Despite “not” receiving any severance, Mr. O’Neal still manages to come in fifth. The Corporate Library has written in detail about each of these separations and has also provided a blueprint of how to avoid them in two reports, called Golden Parachutes and Cushion Landings and Paying CEOs to Stay at Home.

The problem of excessive severance is not a problem that is going to go away very soon, despite all the shareholder activism surrounding it, unless boards and CEOs come to some agreement as to how to curtail some of the benefits of being fired.

Offering protection for taking a risky job is not inherently a bad idea. From a governance point of view, it is usually a good one. But when such protection rises to the heights we have seen, it raises the spectre of a conflict of interest, it makes it sometimes more profitable to be fired than to go on working, and it makes it sometimes more profitable to arrange a merger even where there are no long-term benefits to be had from the transaction. And when the benefits continue to be paid regardless of whether the CEO walks into another job a day or a year or three years after being fired, it doesn’t even make sense. 

See The Corporate Library's website.

Posted 11/2/07

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Justifying American Executive Pay – SEC Pushes Disclosure

Financial Times Study Uncovers Huge Executive Pay Gaps, SEC Reviews Executive Pay Reporting Methods

A U.S. study conducted by the Financial Times has found the pay gap between Chief Executive Officers and the second most highly paid top executive to be astronomical.  Chief executives have been paid up to 10 times more than their top lieutenants.  The Financial Times reported on October 8, 2007 that “the gap has been steadily rising since the 1960s and 1970s, partly due to the recent explosion in options awards for chief executives.”

The CEO at Sallie Mae, Thomas Fitzpatrick, earned more than 10 times that of June McCormack, the Executive Chief Vice-President.  At more than 30 other companies the Financial Times reviewed, the gap ranged from four to seven times.

By coincidence, the Financial Times survey was published as the U.S. Securities and Exchange Commission released new and revised rules to improve on disclosure standards for executive compensation that were first published almost a year ago.  In developing its new rules, the SEC conducted a review of how 350 companies complied with the original standards in their reports to shareholders.  The SEC’s findings were released in early October 2007.   

Two trends emerged from the SEC’s review – the required Compensation Discussion and Analysis section of companies’ reports should be more focused on how and why a company arrives at specific executive compensation decisions; and, the manner in which companies present their reports. 

In its comments to companies who sent in their disclosure reports, the SEC noted, “Where a company provided a lengthy discussion about its compensation philosophies, we suggested that it improve its Compensation and Discussion and Analysis by explaining how and why those philosophies resulted in the numbers they presented in the required tables.  Similarly, where a company provided a lengthy discussion about its decision-making process, we suggested that, rather than explaining the process, it explain how its analysis of relevant information resulted in the decisions it made.”

The SEC also encouraged companies to present their information in a clearer and more precise manner – one that is better organized and presented for both the lay reader and the professional.  The SEC explained that its reviews are ongoing.  Not less than 45 days after it completes the review of a company’s filing, it posts the correspondence containing its comments on its EDGAR system. This is the website where all companies, foreign and domestic, are required to file registration statements, periodic reports, and other forms electronically.  This information can be downloaded and is free to the public.

Meanwhile, in the Financial Times story, Christopher Ailman, a money manager at the California State Teachers’ Retirement System, is quoted as saying, “Paying chief executives an excessive amount relative to their number twos is a warning signal that the chief executive may have the compensation committee sewn up and that the board is not doing a god job of the succession plan.”

However, the newspaper also reported some business reactions to the SEC’s new disclosure rules. Centrex, a homebuilder, said the new policy “oversimplifies to the point of misleading about the context” of pay awards. Many companies feel justified in granting their CEOs such hefty salaries, which they now have to more carefully outline in their reports.  Some companies cited share price performance, CEO responsibilities, and length of service as other valid methods of determining executive pay.

Posted 10/11/07

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Pace of US Executive Compensation Growth Increases

The pace of pay growth for the chief executives of the U.S.’s biggest companies increased in 2006, reported a new study by the New York-based Mercer Human Resources Consulting for The Wall Street Journal (4/9/07). According to the study, which polled 350 major US corporations, salaries and bonuses of chief executives grew 7.1% after growing at the same rate in 2005 and skyrocketing 14.5% in 2004. The 2006 gain outpaced the 3.7% increase in pay for white-collar staffers.

According to the study:

1. 185 chief executives exercised stock options during 2006 for a median increase of $3,299,193, down from the 192 doing so in 2005 for a median gain of $3,493,440.
   
   
2. Median total direct compensation—now redefined to cover salary, bonuses and other annual incentives along with the initial value of restricted shares, stock options and other long-term incentive awards—jumped 8.9% to $ 6,548,805.

The following graph is excerpted from Mercer's website:

10 year trends (percentage change over prior years)

Posted 4/10/07

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Best Practices in Exit Pay

ISS Compares Severance Pay and 'Golden Parachute' Practices Across Countries

In its report, Exit Pay: Best Practices in Practice, US-based Institutional Shareholder Services, a provider of proxy voting and corporate governance services, argues that the long-time controversial issues of CEO severance pay and 'golden parachute' packages (awarded to executives who suffer a loss in position when the company experiences a change in control) will likely become even more prominent in the US this year.

The report explains key issues surrounding the topics, gives examples of company best practices reform suggestions, and compares US systems to those in other countries.

Among the reports findings:

• Exit Package Issues Will Likely Become More High-Profile in 2007
  This is largely due to new executive compensation disclosure requirements from the US regulator, the Securities and Exchange Commission, which will take effect in the upcoming 2007 proxy voting season. Because of the new rules, investors at many companies will for the first time see in one place the total dollar value of executive exit packages.
  
  
• Global Practices in Exit Pay
  The following table presents an overview comparison of exit pay policies across countries. For more detailed analyses of country policies see the full report.
  
  

Best Practice in Severance and Golden Parachutes

• Employment contracts: The report argues that companies should avoid entering into employment contracts, which are often used as a recruitment incentive but have been blamed for many instances of excessive executive compensation. According to the report, companies should sign contracts only under limited circumstances for a short time period, for example, three years for new hires.

• Severance agreements: While proponents of severance packages argue that they help to recruit talent and mitigate lawsuit risks, critics argue that executives are no more entitled to safety nets that average employees and that that employment terms should not outlast the situations that give rise to severance. The report argues that, “severance provisions should avoid giving the appearance or the reality of ‘pay for failure.’ The severance formula should be reasonable; e.g., severance multiples should be 1X, 2X or 3X of salary and bonus. The latter should be defined as the target bonus for the year in which employment ends, or else the average bonus over the past few years. Long-term incentive awards should be excluded.”
  
  Examples of US companies that have limited severance pay to a multiple of 2.99X salary and bonus without shareholder approval include: Borders Group, Coca-Cola company, Verizon Communications, Hewlett-Packard, American Electric Power.
  
  

• Change-in-control/golden parachute payments: While advocates of change-in-control packages or “golden parachutes” contend that they can retain key employees in times of transition and enhance executive objectivity in deal making, many critics argue that overly-generous packages often produce conflicts of interest. According to the report change-in-control payments should be 'double-triggered' – made only when there is a significant change in company ownership structure AND there is a loss in employment or significant change in job duties associated with the structure change. Golden parachute provisions should exclude excise tax gross-ups and allow for the acceleration of vesting of stock options and other equity awards only under a doubletrigger change in control.”
  
  Examples of Best Practices in U S companies include Circuit City Stores, which sets the golden parachute multiple at 2.99X, and AutoNation which requires shareholder approval for any change-in-control pay exceeding 2.99X.

• Better succession planning by Board of Directors’ can help curb executive compensation:According to ISS, 28 percent of the approximately 5,000 public companies tracked by its “Corporate Governance Quotient” have board approved CEO successions plans as of January 2007 – a huge increase from the 2 percent that had them in January 2004. According to the report, two companies stand out as examples of best practice in succession planning: McDonalds, which was forced to replace two CEOs within two months in 2004 due to illness and death, and General Electric, known for its training programs and deep bench.

For the full report visit ISS' website.

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‘Say on Pay’ Builds Momentum in U.S.

On February 14, 2007 life and health insurer Aflac Inc. became the first U.S. company to give stockholders a formal ‘say on pay’ when it announced that its board of directors has approved a resolution giving shareholders a nonbinding vote on executive compensation.

The decision comes at a time of increasing attention to executive pay in the U.S. - on January 25, 2007, 41 institutional investors brought together by the American Federation of State, County and Municipal Employees (AFSCME) Pension Plan and investment firm Walden Asset Management announced the filing of shareholder resolutions at 44 major US corporations asking for shareholder votes on executive compensation. That same day an international group of fund managers – including Hermes of the UK and ABP, Europe's biggest pension fund -  and the Association of British Insurers, representing a fifth of UK investors, wrote to the U.S. Securities and Exchange Commission requesting advisory votes on pay at U.S. companies (Financial Times, 1/26/07). According to media reports, around 10 companies, including Pfizer, Intel Corp., Bristol-Myers Squibb Co., Schering-Plough Corp., American International Group Inc., JPMorgan Chase & Co. and Colgate-Palmolive have created a working group, which met last week with AFSCME and Walden to address the proposals. 

Shareholder Voting in the UK

The investor proposals could model the system used in the United Kingdom in which shareholders ratify or reject packages executives have already received by casting nonbinding confidence or no-confidence votes on executive pay (Associated Press 2/15/07). Since its 2002 enactment, the UK law requiring this has thus far been successful in curbing pay increases. Other countries in which shareholders vote on executive pay include Australia, the Netherlands and Sweden.

Proponents of the system cite several benefits including increased dialogue between companies and investors, longer-term performance goals for compensation plans, and the recent move by many of Britain’s largest corporations from CEO salary to performance-based pay, which many attribute to the implementation of advisory votes. However, many U.S. companies oppose granting shareholder advisory votes contending it would enable hedge funds and other short-term investors to hold companies ransom.

It is possible that the U.S. will adopt a similar system: on February 14, the same day that Aflac announced its decision, U.S. Congressmen Barney Frank, Chairman of the House Financial Services Committee, announced that the committee will hold a hearing on executive compensation on March 8. According to Reuters, the hearing is part of Frank’s plan to legislate increased shareholder participation in determining executive compensation. Mr. Frank responded to earlier comments made by President George Bush (see News), in which the president blasted excessive compensation at U.S. companies, but placed responsibility for capping pay packages on corporate boards, not the government or shareholders. "I agree with President Bush that excessive executive compensation has become a problem, but disagree with his view that we should do nothing about it," said Frank.

Disclosure vs. Votes

The debate highlights three broad questions: 1. whether executives at public companies deserve the vast sums of money they typically earn; 2. how clearly companies should be required to disclose to shareholders the make-up of executives’ salary, bonus, and stock packages; and 3. what control shareholders should be allowed to exert over these packages.

In July of 2006 the U.S. Securities and Exchange Commission, which regulates America’s stock market, issued a new set of guidelines requiring greater disclosure of executive pay at publicly traded companies. While many investors have argued that the new rules will actually increase pay as executives begin to demand what their peers are earning, others, such as the funds filing motions, maintain that the rules do not go far enough in including shareholders in compensation decisions. "These rules are exceedingly important to get a full view of executive compensation, but as the SEC Chair Cox has stated, the SEC's role is to provide information for investors," said Timothy Smith, Senior Vice President of Walden Asset Management and President of the Social Investment Forum in an interview with SocialFunds.com (1/30/07), "It is up to the markets to act to provide checks and balances on compensation."

"Shareholders expect compensation committees to establish appropriate measures that tie
executive pay to company performance," said Connecticut Treasurer Denise L. Nappier who is in charge of the state's $23bn retirement fund and has been active in pressing for increased corporate accountability on executive pay (SocialFunds.com, 1/30/07). "Far too many compensation plans are fashioned in such a way that executives are rewarded regardless of long-term return on investment. An advisory vote gives shareholders the opportunity to let compensation committees know when they’re not making the grade,"

Posted 2/16/07

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CEO-Worker Pay Imbalance Grows

New data from the Economic Policy Institute:

In 2005, the average CEO in the United States earned 262 times the pay of the average worker, the second-highest level of this ratio in the 40 years for which there are data, reported the Economic Policy Institute on June 21, 2006. In 2005, a CEO earned more in one workday (there are 260 in a year) than an average worker earned in 52 weeks.

The 1980s, 1990s, and 2000s have been prosperous times for top U.S. executives, especially relative to other wage earners. This can be seen by examining the increased divergence between CEO pay and an average worker’s pay over time, as shown in Figure A. In 1965, U.S. CEOs in major companies earned 24 times more than an average worker; this ratio grew to 35 in 1978 and to 71 in 1989. The ratio surged in the 1990s and hit 300 at the end of the recovery in 2000. The fall in the stock market reduced CEO stock-related pay (e.g., options) causing CEO pay to moderate to 143 times that of an average worker in 2002. Since then, however, CEO pay has exploded and by 2005 the average CEO was paid $10,982,000 a year, or 262 times that of an average worker ($41,861).

*Data note:
CEO pay is realized direct compensation defined as the sum of salary, bonus, value of restricted stock at grant, and other long-term incentive award payments from a Mercer Survey conducted for the Wall Street Journal and prior Wall Street Journal-sponsored surveys. Worker pay is the hourly wage of production and nonsupervisory workers, assuming the economy-wide ratio of compensation to wages and a full-time, year-round job.

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“Gilded Paychecks”: Rising Executive Compensation and the Role of Consultants

In 2004, one-half of executives in leading U.S. corporations enjoyed total compensation (including salaries, bonuses, and stock options)  - that was more than 104 times the average pay of U.S. workers pay, while 10% of executives earned more than 350 times the average workers’ pay. The best compensated U.S. corporate executives took home over 700 times the compensation of the average America in 2004, according to data compiled by Pearl Meyer & Partners, an affiliate of Clark Consulting, and published on April 9, 2006 in The New York Times in a special report on executive pay by Eric Dash. The report is the first in a series of articles, entitled "Gilded Paychecks," on the subject of compensation.

The data shows a drastic widening of the gap between executive pay and average worker compensation in the U.S. from the early 1980s. In 1940, for example, half of executives earned more than 56 times the average workers pay. The latest numbers provide a broad context for an extensive discussion about the appropriateness of major compensation packages to America’s business leaders. It is an issue that is under review at the U.S. Securities and Exchange Commission and is being raised at many annual meetings of U.S. companies that are currently taking place.

No issue in this framework has created more concern for shareholders than the awarding by boards of directors of substantial compensation rises to chief executive officers of companies whose stock price has declined. The issue is illustrated by a story in The New York Times on April 10, 2006, “Advice on Boss’s Pay May Not Be So Independent” by Gretchen Morgenson.

Morgensen reports that, in 2005, Ivan G. Seidenberg, Chairman and Chief Executive Officer of Verizon Communications Inc. received $19.4 million in salary, stock and other bonuses, constituting a 48% rise in his overall compensation. In 2005, however, the stock price fell 26 percent, bondholders’ value dropped, and the pensions of 50,000 managers were frozen. Verizon’s earnings declined by 5.5 percent in 2005.

In defending its decision to increase Mr. Seidenberg’s pay, Verizon’s Board of Directors pointed to “challenging” performance targets and standard executive reward packages in the industry. The board also underscored the fact that Mr. Seidenberg’s pay was determined with the help of an “outside consultant” who answers to the board.

Conflicts of Interest

According to the article, however, this consultant is Hewitt Associates, an employee benefits management and consulting firm, which has a substantial array of consulting contracts with Verizon which, according to the report, have amounted to over half a billion dollars since 1997. The reporter suggests that the consultants, which secure their contracts from management, had a conflict of interest on advising the board on the CEO’s remuneration.

Executive pay consultants are increasingly being used by the compensation committees of boards of directors. The reporter writes that the procedures behind, and justifications for, the conclusions reached by the consultants and the full reasoning behind board compensation decisions rarely come to light and have received little to no public analysis.

While compensation committees of board of directors should consist solely of independent directors without ties to management, according to the latest U.S. corporate governance standards, the New York Times report provides details on Verizon’s board that raise questions about just how independent the compensation committee members are. Morgensen reports that boards of directors are frequently composed of executives from other companies that have a strong incentive to keep average executive pay high. While SEC regulations require compensation committees members to be unconnected to the executives whose pay they control, the links between the two are often said to be subtle and hard to control, frequently stemming from years of running in the same social circles or sitting on the same boards.  A number of key members of the Verizon compensation committee sit on the same boards as does Verizon’s CEO, for example.

Possible Solutions

The Securities and Exchange Commission is currently considering suggestions for a new set of executive compensation disclosure rules, which it aims to introduce before the 2007 proxy season (see Landmark US SEC Regulations and SEC Chairman Speech lower on this same page). It has suggested regulations that would require companies to publicly name pay consultants, as well as provide far more detail on all aspects of executive remuneration, including perks and retirement packages. It would also oblige companies to divulge more about how compensation committees operate and establish pay. The rules, however, would not compel businesses to reveal information on any other contracts consulting firms have with the company. Moreover, critics have argued that they would not increase the role that shareholders have in setting pay.

Many NGO’s and experts have joined the SEC in proposing solutions to the compensation issue. The Committee for Economic Development, for instance, in its recent report, “The State of Corporate America After Sarbanes-Oxley” (See Corporate Governance, Views and Analysis) stressed that the issue of excessive compensation must be considered in terms of both “process and disclosure.” It underlined its belief in the validity of market forces and individual performance in setting executive salaries as well as its opposition to “specific rules, laws, or regulations that place artificial limits on compensation.”  The report suggested, among other things, that compensation committees should fully disclose not only compensation decisions but also the reasonings behind them. It further suggested that determinations of pay relative to performance should be based on long-term increases in corporate value. Finally, it recommended that companies maintain the right to recall executive bonuses should targets not be met.

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U.S. Banker Receives $135 million

Wachovia Corporation, a major U.S. banking group with headquarters in Charlotte, North Carolina, reported on January 30, 2006 that Wallace Malone, a vice chairman and director, will retire with a severance package valued at $135 million. Mr. Malone had headed South Trust Corporation which was acquired by Wachovia in November, 2004. In a filing with the Securities and Exchange Commission the retirement payment, according to The New York Times. This sum comes on top of the $473 million worth of Wachovia shares that Mr. Malone owns as a result of the sale of South Trust and including a $10 million a stock grant that he received last year.  Last year the former head of Gillette, Mr. James M. Kilts, who had held the position for four years, became eligible for a severance package worth $175 million when his company was acquired by Procter & Gamble.

The Securities and Exchange Commission is reviewing current corporate compensation practices. Numerous shareholder and investor groups, as well as public interest groups, are also reviewing the degree to which top executive compensation is fully disclosed by companies and the scale of key awards.

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Two Reports: SEC Action Pl,an on Executive Compensation and SEC Chairman's first major statement explaining his goals on compensation transparency.

The U.S. Securities and Exchange Commission Makes Landmark Decision to Increase Transparency in Corporate Compensation

(January 17, 2006)
The Following is the Press Release issued by the SEC:

The Securities and Exchange Commission today voted to publish for comment proposed rules that would amend disclosure requirements for executive and director compensation, related party transactions, director independence and other corporate governance matters, and security ownership of officers and directors. The proposed rules would affect disclosure in proxy statements, annual reports and registration statements. The proposals would require most of this disclosure to be provided in plain English. The proposals also would modify the current reporting requirements of Form 8-K regarding compensation arrangements.

The proposals would refine the currently required tabular disclosure and combine it with improved narrative disclosure to elicit clearer and more complete disclosure of compensation of the principal executive officer, principal financial officer, the three other highest paid executive officers and the directors.

New company disclosure in the form of a Compensation Discussion and Analysis would address the objectives and implementation of executive compensation programs - focusing on the most important factors underlying each company's compensation policies and decisions.

Following this new section, executive compensation disclosure would be organized into three broad categories: compensation over the last three years; holdings of outstanding equity-related interests received as compensation that are the source of future gains; and Retirement plans and other post-employment payments and benefits.

• A reorganized Summary Compensation Table would be the principal vehicle for showing three-year compensation and would include additional information.
• A new column would report total compensation.
• A dollar value will be shown for all stock-based awards, including stock and stock options, measured at grant date fair value, computed pursuant to Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, to provide a more complete picture of compensation and facilitate reporting total compensation.
• The "All Other Compensation" column would include the aggregate increase in actuarial value of pension plans accrued during the year and all earnings on deferred compensation that is not tax-qualified.
• The threshold for disclosing perquisites would be reduced to $10,000 and interpretive guidance is provided for determining what is a perquisite.
• Two supplemental tables would report Grants of Performance-Based Awards and Grants of All Other Equity Awards.
  
  
• Disclosure regarding outstanding equity interests would include
• the Outstanding Equity Awards at Fiscal Year-End Table, which would show outstanding awards representing potential amounts that may be received in the future; and
• the Option Exercises and Stock Vested Table, which would show amounts realized on equity compensation during the last year.
  
  
• Retirement plan and post-employment disclosure would include
• the Retirement Plan Potential Annual Payments and Benefits Table, which would disclose annual benefits payable to each named executive officer;
• the Nonqualified Defined Contribution and Other Deferred Compensation Plans Table, which would disclose year-end balance, and executive contributions, company contributions, earnings and withdrawals for the year; and
• disclosure of payments and benefits (including perquisites) payable on termination or change in control, including quantification of these potential payments and benefits.

A Director Compensation Table, similar to the Summary Compensation Table, and related narrative would disclose director compensation for the last year.

The proposals would update, clarify, and slightly expand the disclosure provisions regarding related person transactions. Principal changes would include a disclosure requirement regarding policies and procedures for approving related party transactions, a slight expansion of the categories of related persons and a change in the threshold for disclosure from $60,000 to $120,000. The requirement to disclose these transactions would also be made more principles-based, and would require disclosure if the company is a participant in a transaction in which a related person has a direct or indirect material interest.

A proposed new item (Item 407 of Regulations S-K and S-B) would require

• disclosure of whether each director and director nominee is independent;
• a description of any relationships not otherwise disclosed that were considered when determining whether each director and director nominee is independent; and
• disclosure of any audit, nominating and compensation committee members who are not independent.
  
  

Proposed Item 407 also would consolidate corporate governance related disclosure requirements currently set forth in a number of places in the proxy rules and Regulations S-K or S-B. This would include disclosure regarding board meetings and committees, and specific disclosure about nominating and audit committees. Proposed Item 407 would also require similar disclosure regarding compensation committees and a narrative description of their procedures for determining executive and director compensation.

The proposals would require disclosure of the number of shares pledged by management.

The proposals would modify the disclosure requirements in Form 8-K to capture some employment arrangements and material amendments thereto only for named executive officers. The proposals would also consolidate all Form 8-K disclosure regarding employment arrangements under a single item.

The proposals would require companies to prepare most of this information using plain English principles in organization, language and design.

Comments on the proposed rules should be received by the Commission within 60 days of publication in the Federal Register.

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New US SEC Chief Pledges to Increase Corporate Transparency, Starting with Executive Compensation

In January 2006, the SEC Chairman provided the detail of broad approaches towards executive compensation that he highlighted in a major speech on December 12, 2005. That presentation by Chairman Christopher Cox at the New York Economic Club provides thew basic context for the work that is unfolding at the SEC in 2006 that may well lead to major increases in transparency of Board actions at major corporations on corporate compensation.

Mr. Co0x started by stressing that the SEC will strengthen rules to ensure that shareholders have clearer information on executive pay, while also moving to radically simplify reporting requirements by corporations in order to enhance the clarity of public information.

Chairman Cox asserted that, “When it comes to giving investors the protection they need, information is the single most powerful tool we have. It's what separates investing from roulette. If the SEC is truly to succeed in helping investors and in ensuring compliance with the law in the securities industry, we'll need nothing less than an all-out war on complexity.”

He said that the complexities of SEC rules often impede compliance. “When it comes to disclosure documents intended for investors, nothing is more complicated than the description of executive compensation. We aim to simplify it, and make it more meaningful,” he noted.

In this area the SEC wants to see “information that's clear, complete, and comprehensible.” He said the SEC “will propose disclosure that permits a complete and accurate understanding of the compensation package. Any judgment or action taken on that information is up to boards of directors and investors, not us. It is absurd to think that the owners of an enterprise should be denied full knowledge of how much they're paying their employees. The shareholders own the company, and the executives work for them. Think about it this way: Which of our nation's corporations issues signed, blank payroll checks for its employees to fill in the amount, learning only after the employee has cashed it just how much that check was for?”

Interactive Data

Mr. Cox said: “Making our mandated disclosures actually useful to investors is the idea behind another SEC initiative: interactive data. The beauty of interactive data is that it will not only make today's 10Ks, proxies, and mutual fund prospectuses more useful to investors, but it will also eliminate much of the time and expense that companies currently devote to filing SEC reports.”

He pointed out that today the SEC has over 800 different forms and “the SEC might have need of no more than a dozen. The key to making this happen is looking at the data on the forms independently from the forms themselves. That's what we mean by interactive data. Computer codes can tag each separate piece of information on a report, and tell us what it is: operating income, interest expense, and so forth. That way, every number in a report or financial statement is individually identified, both qualitatively and quantitatively. For individual investors, this means they'll be able to use more sophisticated software tools to analyze the information from SEC filings in real time. For the SEC, it means we could organize our database not around individual reports, but instead around the companies who file them.”

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Corporate Governance: Different Views in Different Countries Germany on Trial

On December 21, 2005, the Germany Federal Supreme Court ruled in favor of public prosecutors who appealed the acquittal earlier in the year of top corporate executives in a case involving Mannesmann. The case brings to the fore stark differences in compensation for successful business executives. Over the last year, for example, several top executives of major U.S. corporations whose firms were acquired went home with vast multi-million dollar payments. A perspective on this major German case was provided on December 22, 2005 in an editorial (fully reproduced below) in The Financial Times.

Markets on trial
Nearly six years after Vodafone acquired Mannesmann, the repercussions continue to reverberate around Deutschland AG. Yesterday's decision by the federal appeal court to order a retrial of six Mannesmann directors over bonuses paid to its chief executive after the takeover battle has further damaged the country's reputation as a place to do business. It also reinforces the view that Germany is a country where distrust of success and nationalist protectionism outweigh the rights of shareholders.

The facts in the Mannesmann case are simple. Vodafone succeeded in its bid only after a fierce defence by the German telecommunications giant that forced the British mobile telephone group to pay €175bn (£119bn). The share price had risen 176 per cent over the previous year and the largest shareholder proposed paying bonuses worth more than €74m to the chief executive and other managers.

Such a practice would be uncontroversial in other market economies. But it aroused controversy in Germany where the interests of the company and its diverse stakeholders rate more highly than the rights of shareholders. Court proceedings for breach of trust were brought against six directors, including Josef Ackermann, Deutsche Bank chief executive. The case was thrown out but that ruling has now been dramatically overturned.

There was also a storm among Vodafone shareholders over bonuses paid to its chief executive following the Mannesmann purchase. Yet this was entirely justified given the subsequent plunge in the British group's share price - as so often happens after acquisitions. Mannesmann shareholders, by contrast, were enriched by the performance of their managers and were entitled to reward them appropriately.

The six defendants now face more years of legal uncertainty and distraction from their working lives. The ruling also highlights the shallow roots that the concept of shareholder value has put down in Germany. It will inhibit the development of a more dynamic corporate culture in a society that has an aversion to risk-taking and the concomitant rewards for success. And it will reinforce international perceptions that this is a country where the normal rules do not apply when it comes to mergers and acquisitions involving its flagship companies.

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