Companies desperate to hang on to their hot chief executive or lure a dazzling young star once had almost unlimited tools at their disposal. They could dole out enormous loans and later forgive them, bestow piles of stock options and provide access to lush perks such as corporate jets and palatial homes.
But those days are, if not over, at least on hold. Congress outlawed loans by companies to executives and directors last year. Under rising pressure from shareholders, many companies now count option grants as an expense against reported earnings, meaning they are no longer such a tempting way to pay top talent without scuffing up the bottom line. Many firms that still decline to expense options expect to be forced to do so sooner or later and are thus phasing out options grants or at least reducing their size.
Meanwhile, pampering executives with gilded luxuries is a tougher sell when stock prices are anemic and investors are leery of $6,000 shower curtains (Tyco International Ltd.'s L. Dennis Kozlowski), free Manhattan apartments (General Electric Co.'s Jack Welch) and $1-a-month jet leases (WorldCom Inc.'s Stiles A. Kellet Jr.). So what's a company to do?
Executive compensation consultants say corporate boards are eager to avoid further revelations of exorbitant pay packages. But the consultants also say board members continue to embrace the cult of the indispensable chief executive and fear that any big cutbacks could reduce their chances of keeping or landing a star. So they are considering new ways to stay competitive, including awarding more restricted and performance-based shares and handing out bigger signing bonuses and other straight cash awards.
"The 20,000-foot view is that it's going to be harder for public companies to attract executives without being able to offer loans as they once did," said Dan Moynihan of the executive pay consulting firm Compensation Resources. "You will see much more in the way of signing bonuses and outright cash to replace the loans. And you will see much more restricted stock handed out."
Consultants and reform advocates say whether the net result will be lower executive compensation remains to be seen. Also unknown is how the investing public will react to bigger bonuses and other payments, particularly if corporate performance does not improve. While hard data on compensation trends will not be available until spring when many companies file proxy statements with the Securities and Exchange Commission detailing executive pay, anecdotal evidence that change is afoot is already piling up.
This week, Walt Disney Co. disclosed in its proxy statement that despite the company's poor performance in 2002 it had awarded chief executive Michael Eisner a bonus of $5 million in restricted stock. The company awarded him no cash bonus and no options. Eisner has received enormous options grants in the past. Disney said it rewarded Eisner for the "effectiveness and quality" of his leadership during "a difficult economic environment." Critics of lavish executive pay expect similar language to dominate proxies this spring as executives reap big bonuses despite poor corporate performance.
Also in recent days, Siebel Systems Inc. founder and chief executive Thomas M. Siebel, sued by shareholders unhappy with the size and accounting of his stock option package, gave up the right to buy 26 million shares, all the options granted to him since 1998. Retailer Kmart Corp. said it might sue former executives over allegations that they misled the board about retention bonuses, loans and other compensation. Maryland officials threatened to veto a deal to sell the state's largest health insurer because they did not like the $119 million merger incentive package set up for CareFirst BlueCross BlueShield executives, and Christos M. Cotsakos, chairman and CEO of online brokerage E-Trade Group Inc., resigned after being roundly criticized for an $80 million package in 2001 that made him the brokerage industry's best-paid executive.
Last year, incoming WorldCom chief executive Michael D. Capellas ran into heavy resistance when a federal judge sharply criticized his proposed pay package, saying it was so generous that it raised questions about the company's commitment to ethical reform.
Consultants say they expect compensation trends to continue, particularly the replacement of options with restricted stock. Restricted shares generally require that executives hold them for a fixed period, often two to three years or more, before they can sell them on the open market. Moynihan and others said they expected those time periods to lengthen to five or even seven years. Restricted stock is now favored by corporate governance advocates who say it encourages executives to focus on long-term growth and profitability, which in turn is good for all shareholders. Stock options, these people say, encourage managing the short-term stock price, which can in turn encourage balance sheet manipulation and other accounting sleight of hand.
Of course, compensation consultants point out that different kinds of stock grants tend to slide in and out of fashion every few years, depending on market conditions. Some shareholder advocates, for instance, derided restricted stock in the late 1970s, calling it "pay for pulse" because it rewarded executives for meeting easy goals and did not provide enough incentive for fast growth.
Scott Olsen, co-director of consulting firm Towers Perrin's executive compensation practice, noted that the move away from options has been underway for at least three years as the number of options increased and began to more seriously dilute the value of outstanding shares.
Several consultants also said they had been hearing from companies eager to change the way they compensate directors on their audit committees. Under the Sarbanes-Oxley corporate reform bill, audit committee members must be independent. They also face increased responsibility to oversee a company's outside auditors. All of which means they will command bigger pay packages.
"Companies are looking at the pay and retention packages for audit committee members and wondering if they are sufficient and concluding that they are probably not," Olsen said.
There is, of course, disagreement on what the year may bring. Compensation consultant Pearl Meyers said she expected to see many firms "reprice" stock options that are "underwater," or priced higher than the underlying shares are trading on the open market, making them worthless, at least for the time being. But Gary Locke of Towers Perrin said firms would not risk exposing themselves to ridicule by repricing underwater options. "Repricing has such a bad reputation that companies are not even considering it as an alternative. They don't want to touch it."
Reform advocates also note that times have not changed entirely. The Sarbanes-Oxley legislation, for instance, does not address the large number of outstanding executive loans. In fact, a study released last month by the Corporate Library, a shareholder activist group, found that over one-third of the nation's largest companies, as measured by market capitalization, have loaned cash to executives, with an average of $10.7 million per loan, and that current executive indebtedness totals $4.5 billion.
Most of these loans were made to help executives buy company stock, something shareholder activists generally applaud. But significant loans were also made to cover home improvements, alleviate cash flow problems, pay legal expenses and fund special investments, the report said. The biggest loans came from the most scandal-plagued companies, including WorldCom ($160.8 million for former CEO Bernard J. Ebbers) and Tyco ($61.7 million for former CEO Kozlowski).
Paul Hodgson, a researcher at the Corporate Library and author of the report, said because relocation loans are outlawed, companies will have to award larger bonuses to entice executives to pricey locations such as New York, Los Angeles and San Francisco.
That could be hard, however, if corporate earnings remains dismal. "If companies paid little or no bonuses in 2001, and then had a bad 2002, will they follow the same pattern and pay no bonuses in 2003? I don't know the answer to that but it will be very interesting to see," said Peter Opperman, a senior consultant at Mercer Human Resource Consulting, a leading executive compensation firm.
Hodgson of the Corporate Library also said that while he expected options grants to go down, he does not expect them to disappear, because companies that do not offer them will suffer in competition for talent with the ones that do. Hodgson also said U.S. companies might begin considering a compensation tool popular in Great Britain: performance shares. Such shares are awarded to executives as they hit performance targets, and thus may be more palatable to investors.
Finally, one group of winners in the new environment, consultants said, could be privately held firms that in the past could not compete with the big options packages handed out by publicly traded firms. "They are going to be able to do things that the publicly traded companies can't, like offer loans," said Moynihan of Compensation Resources. "All this bodes well for private companies that in the past had to settle for middle-tier talent."