Does CEO Pay Align With Performance?

An annual study by the global consulting firm Watson Wyatt revealed that compensation committees at U.S. companies had been making significant adjustments to how they compensate their chief executives even prior to the recent financial crisis, marking a clear departure from the age-old practice of honoring popular executives with extra premium packages.

January 12 2009 by Fayazuddin A Shirazi


Contrary to the prevailing practice of awarding hefty pay packages to popular and charismatic CEOs – unmindful of the company performance – for the first time in years, U.S executives at companies that recorded low levels of performance were granted less pay opportunities as against those which performed well.

An annual study by the global consulting firm Watson Wyatt revealed that compensation committees at U.S. companies had been making significant adjustments to how they compensate their chief executives even prior to the recent financial crisis, marking a clear departure from the age-old practice of honoring popular executives with extra premium packages.

Speaking to CE Online, Ira Kay, global director of executive compensation consulting at Watson Wyatt, said that the current economic conditions alongside shareholder outcries, media criticism apparently contributed to the changed perception amongst the compensation committees.

“The legislative bailout package and the ongoing financial crisis, coupled with continued pressure from shareholders, the media and executive pay critics, are leading compensation committees to make their executive pay programs more shareholder-friendly,”VbCrLf says Ira Kay.

Additionally, a recent poll on executive pay by LA Times and Bloomberg revealed that three-quarters of those surveyed say banks that got a chunk of the government money should cancel all bonuses to employees this year. About half of those say that all Wall Street groups, regardless of whether they received government money, should cancel bonuses.

The Watson Wyatt’s annual analysis of executive pay trend revealed that for the first time in years, CEOs associated with non-performing companies were granted lesser pay opportunities than their counterparts at companies that were performing relatively better. Total direct compensation for CEOs at low performing companies was $8.1 million from 2005 to 2007, noticeably lesser than the average pay of $10.7 million for CEOs at high-performing companies, the survey said.

Ira Kay feels that although companies are taking steps in the right direction to appease the shareholder and media outcry over excessive executive pay, challenges still remain as there has always been a lack of historical relationship between performance and pay opportunity, which is mostly seen as a source of significant criticism of corporate America, says Ira Kay.

Even the Mercer study released last year disclosed a similar CEO pay trend linked to company performance. According to the Mercer study, CEO total direct compensation declined among the 350 companies analyzed by Mercer, with CEOs of the largest companies taking the sharpest reduction, a 15.8 percent cut. Corporate performance declined in 2007 on average among the companies analyzed.

“In the face of a slowing US economy and weakening corporate performance, CEO total direct compensation among many large companies is declining, as boards have heard the message that pay has to be linked to performance. That is the conclusion of Mercer’s study of US CEO compensation trends, based upon analysis of the latest proxy filings of 350 companies within the Fortune 1000,”VbCrLf a report from Mercer, the leading human resource and financial advisory firm said.

Companies such as FedEx, Motorola, Gannett, Gymboree, KLA-Tencor, Continental Airlines, JetBlue Airlines, and Glu Mobile have all announced pay cuts for their CEOs, mostly due to reduced earnings and burgeoning costs as a result of deepening economic crisis.

Shipping giant FedEx CEO Fredrick W. Smith will  have a pay reduction of 20 percent, Motorola cut the pay of its co-CEOs, Greg Brown and Sanjay Jha, by 25 percent, while computer hard-drive maker Western Digital went even further, slashing its CEO’s annual base salary by a third, to $600,000. See chart below.

Continental Airlines, Glu Mobile, Jet Blue Airlines have reported losses worth $236 million, $56.9 million and $4 million for the September quarter respectively. While companies such as Motorola, FedEx, Gannett, KLA-Tencor have recorded reduced revenues and declining earnings per share for the third quarter 2008.

Interestingly, a Business Week report revealed that there are at least 40 companies which have filed documents with the SEC in the last six months to cut the salaries of their senior executives. Twenty-six of those companies did so in November and December alone, said the BW report quoting Equilar, the Redwood Shores, CA based executive compensation research firm.

On the other hand, companies such as Costco Wholesale Corp. and Tennessee Valley Authority (TVA) have announced hike in the CEO pay packages inline with company performance. President and Chief Executive, James Sinegal, of Costco received a 25 percent jacked up compensation valued at $3.8 million for the 2008 fiscal year, while President and Chief Executive Officer of TVA Tom Kilgore got more than $200,000 pay raise to lift his compensation package above $2 million, which is considered as one of the highest to any federal employee. Both the companies have reported increased revenues at $72.48 billion and $10.4 billion respectively.

Further, a latest survey by BDO Seidman- one of the leading accounting and consulting organizations- released during mid-December, revealed that 49 percent of chief financial officers (CFOs) at U.S. oil and gas exploration and production companies say their companies’ executive compensation programs are now more closely tied to performance than they were before new proxy disclosure rules became effective, and 44% say they employ greater discipline in setting executive compensation opportunities since the rules were published.

“Nevertheless, shareholders will have a microscope on executive pay in 2009, and companies that have not developed and communicated transparent programs that link compensation to performance will be feeling increased pressure to implement best practices,” said Lance Froelich, a Senior Director in the National Energy Industry Practice at BDO Seidman, LLP and Regional Practice Leader for the firm’s Compensation and Human Capital Consulting practice.

However, the Associated Press review of compensation for the heads of companies in the Standard & Poor’s 500 index, released early last year reported huge disparity between CEO pay and company performance with the median pay package adding up to nearly $8.4 million.

The AP study quoted names of CEOs who received hefty pay checks despite the dismal company performance. The AP list included names such as John Thain, Merrill Lynch with $83 million pay package, Leslie Moonves, CBS Corp., with $67.6 million, Richard Adkerson, Freeport-McMoran Copper & Gold Inc., with $65.3 million, Bob Simpson, XTO Energy Inc., $56.6 million and Lloyd Blankfein, Goldman Sachs Group Inc., $53.9 million.

Interestingly, the latest pay figures indicate that Merrill Lynch CEO, John Thain (79 percent), Leslie Moonves (50 percent) and Richard Adkerson (40.8 percent) have all recorded an enormous decline in their pay packages.

CEO Compensation Analysis

Rank

Executive

Company Name

Compensation ($ Mil) 2007 & 2008

Percentage Reduction in Pay  %

Reduced Tentative Compensation in ($ M )

1

John Thain

Merrill lynch

83

- 79.16 %

17.3

2

Leslie Moonves

CBS

67.6

- 50.22 %

33.65

3

Richard Adkerson

Freeport-McMoran Copper & Gold Inc

65.3

- 40.80 %

38.66

4

Lawrence W Kellner

Continental Airlines

10.33

-40 %

6.19**

5

Richard Wallance

KLA-Tencor Corporation

10.63

-40 %

6.37**

6

Craig A Dubow

Gannett

7.46

-40 %

4.47**

7

MatthewK Mccauley

Gymboree Corporation

5.67

-40 %

3.40**

8

David Barger

JetBlue Airlines

-

-40 %

-

9

John F Coyne

Western Digital

8

- 25%

6

10

Gregory Q Brown

Motorola

7.12

- 25 %

5.69 **

11

Sanjay K Jha

Motorola

-

- 25%

-

12

Fredrick Smith

FedEx

32.21

- 20 %

25.8**

**  Ranked as per the pay variance percentage

** The compensation figures for Sanjay Jha & David Barger are not disclosed in the SEC filings. However,  the respective firms have indicated a tentative reduction in their compensation figures.

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