How Much Is Enough? The New Rules Of Executive Compensation

Increased Shareholder, Regulatory And Media Scrutiny Generates Momentum For Reforms, Pay For Performance Models

A storm is brewing and it's about to change the corporate landscape as we know it.

Shareholders, government regulators, governance activists and consultants, the media and institutional investors are poised to pounce on mostly large, public companies that have piled tens of millions of dollars worth of salary and benefits, perks, long-term incentives, stock grants and bonuses on their celebrity CEOs and other C-Suite executives with few guarantees of performance.

Once highly regarded executives such as former General Electric superstar Robert Nardelli, who recently departed his CEO role at Home Depot with a golden parachute worth a reported $210 million, and Richard Grasso, the former chairman of the New York Stock Exchange who has defended his $190 million pay package, have now become the poster boys for unreasonable CEO pay.

Now, the emboldened voices of shareholders are fueling a reform movement set against a backdrop of ongoing government investigations into the backdating of stock grants as well as a spike in civil and criminal litigation over alleged excesses in executive pay.

The directors of an increasing number of corporate boards – two-thirds of whom admitted that executive pay was out of control in a recent Corporate Boardmember Magazine survey – are being pushed to enter more pay-for-performance contracts with their top management teams.

What's more, the 2007 proxy season will be highlighted by new Securities and Exchange Commission pay disclosure rules that will, for the first time, expose more embarrassing details about total executive compensation to the light of day – and investor discontent.

New legislative proposals are also anticipated from Congress this year, led by a proposal sponsored by Congressman Barney Frank, the new chairman of the House Financial Services Committee. Frank will promote legislation that would require shareholder approval of executive compensation plans and the "clawback" of company money if a departed CEO or other senior executive didn't deliver on their performance goals.

Frank recently told the National Press Club that increasing public concern about executive pay the levels it has reached in recent years is "not just a matter of envy. It has reached a point where it has some macroeconomic significance."

The congressman cited the work of Harvard professor Lucian Bebchuk, whose research has revealed that the pay earned by the top five officers at the country's public companies between 1993 and 2002 totaled about $250 billion, or nearly 10 percent of aggregate profits.

"We have a hostile environment today," says Pearl Meyer, cofounder and senior managing director of Steven Hall &Partners, an independent executive compensation and governance consulting firm based in New York.

"We're caught in a vice," Meyer adds, "between the populist demands of the workers' unions, government reformers and the media…and on the other hand, the investors who are represented by institutions, mutual funds, venture capitalists and other special interests who are seeking to enhance the value of their investments and trading positions."

Governance reforms advanced by Sarbanes-Oxley and the agenda pushed by investor voting advisors in the wake of recent CEO pay scandals have resulted in new standards of reasonableness when it comes to setting senior management pay. More companies and their Compensation Committees are concerned with the alignment of executive pay to both stated corporate philosophy and total return to shareholders.

The Kincannon &Reed team has already seen some evidence of progress to marry the interests of shareholders, boards and the business champions whose experience, vision, leadership and past performance is worth recruiting and also worth paying for.

Take, for example, the move by the board of Home Depot in announcing the appointment of Frank Blake as its new chief executive and its immediate disclosure that his 2007 salary will be $975,000. Blake's total pay could shoot up to $8.9 million this year – far short of his predecessor's $24 million salary – but only if the growth of the company's stock (and shareholders' collective wealth) reaches certain goals.

There is broad consensus that the price of attracting and retaining exceptional senior-management talent should be set by the free market, but there is also significant reason make executive compensation more transparent for shareholders.

It's also clear that the executives who demand the most generous pay packages are going to have to back up their promises with performance that drives and sustains shareholder value. And boards are going to have to invest more time not only in recruiting senior corporate leadership, but in understanding the market drivers and shareholder concerns that should guide their approval of the most handsome pay and performance incentives.

"Ensuring that CEOs who lead the creation of corporate value and stock market wealth for their shareholders are well motivated and rewarded based on performance is the biggest pay challenge facing boards," pay consultant Pearl Meyer contends.

"But," she warns, "there's no one-size-fits-all solution. Compensation architecture needs to be tailored to each organization's strategy and challenges."

Until next time...

Kincannon & Reed
March 2007