Fannie Mae, under pressure from its regulator, yesterday swept away an executive pay structure that richly rewarded its senior officers for rapidly increasing the company's bottom line.
In an announcement after the stock market closed, the troubled company said its board of directors decided Thursday that senior executives would be compensated instead based on nonfinancial factors related to meeting affordable housing goals, making progress on correcting its books, implementing an agreement with regulators to increase capital and tighten internal controls, and "company culture."
Under the old pay system, chairman and chief executive Franklin D. Raines was paid $5.4 million in cash compensation, plus more than $11 million in long-term incentive payments, as well as stock options in 2003. He set the District-based mortgage giant on a five-year plan, watched closely by Wall Street, to increase earnings. Raines resigned late last year after regulators found the company had misapplied key accounting rules and would have to correct financial statements since 2001.
Fannie Mae's regulator, the Office of Federal Housing Enterprise Oversight, issued a report last fall that criticized the company's internal controls and accounting systems. It also cited "an executive compensation structure that rewarded management for meeting goals tied to earnings-per-share, a metric subject to manipulation by management." And it said: "The problems relating to these accounting areas . . . have emerged from a culture and an environment that made these problems possible."
The effect of the changes is that Fannie Mae's top executives received, on average, a 45 percent pay cut in 2004, the company said. Fannie Mae didn't pay any cash bonuses or stock options to senior executives last year and agreed to link incentive pay to the new, nonfinancial goals in 2005.
In the past, Washington-based Fannie Mae has sought to compensate its senior executives, including Raines, at the 65th percentile of their peers in the financial services industry, the company said. The goal now is to pay them at the 50th percentile, or about average.
The new stance seeks to walk a fine line between satisfying OFHEO and the imperative to compete for the executive talent need to run one of the country's largest mortgage investment operations.
"The compensation actions seek to balance two considerations: the company's performance, as well as the need to recruit, retain and maintain experienced and effective leadership as Fannie Mae works through this period," said Joe K. Pickett, chairman of the Fannie Mae board's compensation committee.
Corrine Russell, an OFHEO spokeswoman, declined to comment on Fannie Mae's action. The company said the changes to its pay policies were reached in close consultation with the regulator, and that more permanent changes to its executive compensation policies are underway.
In last September's report, OFHEO said Fannie Mae executives manipulated an accounting rule to an extent that earnings per share in one year were 1 cent above the company's goal, which increased cash bonuses to senior executives.
Before the new pay policies were instituted, most of a Fannie Mae senior executive's pay was tied to growth in the company's earnings per share, and most of it was in the form of a cash bonus and stock options. But for at least 2005, earnings growth won't be a factor at all, and all of an executive's incentive compensation will be in the form of restricted stock. Restricted stock is a direct award of company stock that can't be sold until a period of vesting is complete, typically three to five years. Unlike stock options, which yield a profit for the holder only if a stock price rises, restricted stock fluctuates in value after it is awarded.
Fannie Mae didn't award any restricted stock to its top three officers in the past three years.
Some shareholder advocates argue that stock options encourage executives to increase short-term profits to boost a stock price at the expense of long-term value. Several major companies, including Microsoft Corp., have stopped awarding stock options in favor of restricted stock.
Daniel H. Mudd, who was named interim chief executive in December after Raines's ouster, was given a salary of $850,000 a year, and for 2004 was granted 95,710 shares of restricted stock valued yesterday at about $507,000. He wasn't paid a bonus or granted options. In 2003, he was paid more than $2 million in cash compensation and was granted options on 105,749 shares.
