To assure that executive pay is aligned with company performance, she says, compensation committees should consider scenario-planning exercises in which the key metrics governing an executive’s pay are put through different circumstances. On the two compensation committees she chairs, “we use tally sheets to plot the financial metrics against salary and performance-based compensation to see where things might end up down the line. Each company is different, which is why one-size-fits-all regulations just don’t work. You want to set up healthy tensions and checkpoints that encourage salespeople to sell like crazy, but then have a finance person who has to approve the pricing and margins before things get out of control.”
Such checks and balances also are in play at AEP. Koeppel assists the board in linking business outcomes with compensation metrics. “We take the board through new scenarios every year,” she says, noting that finance provided “a wider range of possible outcomes this year in light of the economy.”
AEP’s board has the discretion to make adjustments to the compensation plan if they perceive it to have negative unintended consequences. Directors did that earlier this year, when the company lowered its 2009 earnings guidance. The board changed AEP’s methodology for annual incentive compensation by increasing the threshold earnings per share needed to fund the program, moving it to the midpoint, rather than the low end, of the company’s earnings guidance. The board decided that “requiring employees to work harder to achieve incentive awards more-appropriately balanced employee and shareholder interests, since shareholders would be negatively impacted by the lower anticipated earnings,” Koeppel says.
Such best practices may be moot, however. “The die has been cast,” says Kay. “We’re in a deep recession and people are looking for victims. Executive compensation is number one on that list. The government is getting high marks from the public. For the time being, Corporate America cannot defend itself.”
Russ Banham is a contributing editor of CFO.
Putting More Claws in Clawbacks
One of the less controversial aspects of executive-compensation reform concerns clawbacks, or procedures for retrieving bonuses from executives whose managerial prowess was evident only for the very short-term, if at all. But current laws can make retrieving undeserved bonuses tricky. There isn’t much case law on the subject, with only one successful clawback to draw from — a 2007 settlement with William W. McGuire, former CEO of UnitedHealth Group, who was required to repay $468 million of his bonus for allegedly backdating stock options.
A spate of pending litigation may change that. In April the SEIU Master Trust, a consortium of pension funds with approximately $1.3 billion in assets, demanded that the boards of directors of 29 major companies in its investment portfolio investigate more than $5 billion of incentivized executive pay alleged to have been tied to poorly understood derivatives and other financial instruments. Since 2005, the top five most highly paid executives at the 29 firms, which include AIG, Wells Fargo, Citigroup, American Express, Goldman Sachs, and McGraw-Hill, received more than $3.5 billion in cash and equity pay and more than $1.5 billion in stock options. During that same period, the share prices of the 29 firms plummeted.