Above Board

Regulators and shareholders want compensation committees to explain why CEOs make so much.

Any doubts that compensation committees would come under fire were erased this past September, when New York Stock Exchange chairman Dick Grasso was forced to resign over his controversial deferred compensation package of close to $140 million.

The guns were already loaded. Just one month before, Securities and Exchange Commission chairman William H. Donaldson had taken on the issue in the bluntest possible terms. “One of the great, as-yet-unsolved problems in the country today is executive compensation and how it is determined,” he told a National Press Club audience in August. True, compensation committees have more independent members—thanks to the Sarbanes-Oxley Act of 2002 as well as proposed reforms issued by Nasdaq and, ironically, the NYSE. But Donaldson also noted that they must now “begin to look into exactly what they’re compensating for” and move beyond “simple issues like earnings per share and the increase in earnings per share” when paying executives.

Donaldson’s frustration with compensation committees is shared by investors. This year, a record 322 nonbinding shareholder proposals have sought to rein in executive pay, according to the Investor Responsibility Research Center. The issue starts, of course, at the top, where the link between CEO pay and performance remains mysterious. In 2002, CEO total annual compensation (base salary and bonus) actually rose by a median of 10 percent, according to a survey conducted by Mercer Human Resource Consulting, while total return of the S&P 500 shrank by 24 percent. Little wonder, says Barbara Hackman Franklin, former U.S. Secretary of Commerce and a member of five corporate boards, “there’s a building public perception that something is out of whack with executive compensation.”

This is not really a new observation. In 1997, BusinessWeek magazine named The Walt Disney Co.’s board “the worst in America,” a year after its compensation committee awarded CEO Michael Eisner a 10-year contract that included 8 million options. That same week, Eisner scored the single biggest payday for an executive (until that time), earning a $565 million profit from exercising some of his options.

What’s upping the ante now, however, is the bright light recent scandals have shone on boards, in particular the workings of comp committees as well as audit committees. Rating systems such as those offered by Institutional Shareholder Services and The Corporate Library are punishing companies with less-than-desirable governance practices. And compensation committees are not only being asked to publicly explain their rationale for CEO pay, they may also soon face personal liability if they approve a flawed package.

In fact, says Edward J. Speidel, Buck Consultants’s national executive compensation practice leader, “2002 and especially 2003 should be considered watershed years for comp committees.” In response, says Donald Gallo, a principal at Sibson Consulting, companies are instituting reforms designed “to get their houses in order before the next round of [regulatory] assault.”

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Historically, a seat on the compensation committee gave members a front-row view of pay and strategic practices. CEOs liked to sit on comp committees of other companies to keep tabs on their peers’ compensation, explains Franklin. And since compensation “can influence the behavior of executives,” adds Speidel, many directors used their committee assignment to gain influence with the CEO.

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