Executive Pay

By THOMAS McCARROLL

AT THE HYATT REGENCY IN Pittsburgh last week, senior managers of the $3.3 billion bank holding company Equimark sat in miserable silence while a shareholder, retired C.P.A. Joseph Cestello, scolded them for their "outrageously generous" compensation, including stock options and hefty retirement pay. Cestello even suggested that the company's board resign "for lack of oversight" and demanded that Equimark, whose losses totaled $148 million in the past two years, adopt policies that would tie pay to performance.

There is nothing unusual about gadflies and dissidents using yearly stockholder gatherings to air their gripes, while executives wait in patient condescension and other shareholders fidget. But Cestello, 74, received a loud round of applause, and his motion received 16% of the votes -- an alarming vote of no-confidence in management by the standards of such gatherings. "I was pleased with the outcome," says the investor. "At least I didn't get laughed off the stage."

On the contrary, Cestello had addressed a topic that is no laughing matter these days. Like the managers of Equimark, a growing number of chief executives this spring are feeling compelled to defend their gargantuan paychecks. After a decade of unchecked growth -- during which CEO pay grew four times as fast as the income of the average worker and three times the rate of corporate profits -- executive compensation has become a hot-button issue. From investors, big and small, to public officials at every level, ceos are catching flak as never before.

Plainly put, stockholders are angry because their investments are increasingly bogged down by lackluster corporate earnings while the boss's pay goes through the roof. In Washington a growing chorus on Capitol Hill is , calling for some form of government intervention. And CEO compensation has become a presidential campaign issue for both parties. Vice President Dan Quayle recently criticized "some of these exorbitant salaries paid to corporate executives unrelated to productivity." Democrat Bill Clinton has called executive salaries "excessive."

Spurring the revolt is a ruling made earlier this year by the Securities and Exchange Commission, historically sympathetic to management on such issues, that made it easier for shareholders to challenge companies on CEO compensation through the proxy system. Shareholders at 43 companies, including Chrysler, IBM and Eastman Kodak, have submitted proposals seeking to curb executive pay. Next year the number could double. Says Ralph Whitworth, president of the United Shareholders Association: "What we're witnessing is a full-scale rebellion against corporate greed run amuck."

The numbers are breathtaking. The top five American CEOs earned a combined $322 million in income last year. Even departing CEOs managed to walk away with huge sums. Hamish Maxwell, who retired as head of Philip Morris, was awarded a generous retirement gift of $24 million, mainly in stock grants and options. Earlier this year, former Compaq Computer CEO Joseph ("Rod") Canion, who was ousted by his board last year, was awarded $3.6 million. And N.J. Nicholas, the co-CEO at Time Warner who, in February, was also bumped by his board, is expected to land softly with a salary, deferred pay, bonuses and stock estimated by some at up to $45 million. Even the nation's leading charity, United Way, fell into the controversy after it was disclosed that president William Aramony, who was forced out, was paid $463,000 a year and enjoyed lavish perks.

Typically, an executive's pay is determined by the board of directors' compensation committee, which usually recommends a package consisting of a mix of incomes. The base salary, for instance, generally accounts for a third of an executive's compensation, while an additional 15% comes from annual bonuses. The rest -- upwards of 50% -- is paid in stock incentives, usually in the form of options that carry no risk if the stock price declines. Critics complain that corporate boards lack clearly delineated formulas for setting pay and that they are not independent enough because chief executive officers often serve as chairmen of boards. The conflict of interest can be eliminated, they argue, by preventing the CEO from wearing both hats. Consultant Graef | Crystal charges that compensation committees are often loaded with other high- paid CEOs. "It's a cozy you-scratch-my-back-I'll-scratch-yours arrangement," he says. "If you're a CEO, you don't want Mother Teresa or the Sisters of Charity on your compensation committee."

Often missing is any real link between pay and performance. Although American corporations are losing ground to foreign rivals, their executives continue to be the most richly paid on earth. While the average Japanese chief executive earns $400,000 in annual pay and the typical head of a major German company makes about $800,000 a year, most heads of major U.S. companies make $1 million to $4 million a year. This disparity was embarrassingly highlighted earlier this year when the Big Three auto chiefs accompanied President Bush on an ill-fated trade mission to Japan. Although General Motors', Ford's and Chrysler's combined losses totaled $7.5 billion last year, their top executives were together paid $5.3 million. Their counterparts at Toyota, Nissan and Honda collectively made $1.8 million.

While common sense may dictate that executives are rewarded for successes and punished for failures, corporate America stands such logic on its head. Company profits declined for the third consecutive year in 1991, plunging 19%. But CEO pay increased 6%, not counting bonuses and long-term incentives. Westinghouse Electric CEO Paul Lego took a 69% pay cut when his bonus for '91 was eliminated. But he was awarded 700,000 shares in options, with a present- day value of $4.1 million, even though the company lost $1.1 billion last year. Counting the options, Lego actually received a 41% increase in compensation. By contrast, Japanese executives recently competed with one another to see who would take the largest pay cut in the wake of the Tokyo stock-market plunge.

"Pay masks a much bigger problem," says Robert Monks, whose group, Institutional Shareholder Partners, has waged proxy fights for board representation at Sears, Roebuck. "The real problem is the lack of accountability. CEOs are today's absolute monarchs and their boards are the House of Lords, and they feel they can thumb their noses at us shareholders without fear of being held accountable. But I guarantee you, the days of corporate royalty are over."

Until this year, investors seeking to submit proposals aimed at curbing executive pay were largely frustrated by SEC rules that disallowed such petitions on the basis that compensation was a matter of day-to-day ! management. But under pressure from Congress and some institutional investors, the SEC changed its tune by allowing shareholders to put "nonbinding" resolutions to a vote at annual meetings.

Such petitions threaten to turn once passive annual meetings into rancorous affairs. Two weeks ago, for example, shareholders at Baltimore Gas & Electric asked the company to "voluntarily cap the total pay and other compensation of its executive officers to no more than 20 times the pay of the average employee of the company."

The measure was defeated, but many corporate boards are choosing to negotiate a peaceful settlement with aggressive shareholders rather than face an embarrassing tongue-lashing. When the United Shareholders Association, whose 65,000 members own $320 billion worth of stock in 4,000 major corporations, sponsored a petition challenging the compensation for the executives at Time Warner, top officers of the company quickly paid a visit to negotiate a deal: the group agreed to drop its challenge on pay, and the company would eliminate its takeover defenses, including so-called poison-pill provisions designed to scare away potential bidders.

The California Public Employees' Retirement System, known as Calpers, the nation's largest public pension fund, sent letters to 12 corporations, including American Express, ITT and Dial (formerly Greyhound). One by one, senior executives from each company paid a visit to Calpers' Sacramento headquarters to negotiate with its chief, Dale Hanson. American Express boss James Robinson, for instance, immediately bowed to Calpers' demands that the company set up an independent compensation committee. Only Dial has so far refused to meet with Calpers.

ITT CEO Rand Araskog, whose $7 million in 1990 compensation touched off a maelstrom, agreed to a dramatic overhaul of his pay package. The company replaced outright stock grants with options based on the performance of the company's stock, and Araskog agreed to reduce the size of his annual bonus. Says Hanson: "Shareholders are waking up to the fact that they're owners and not just investors."

Some companies slashed pay unilaterally. Ford CEO Harold Poling, for example, took a 6.6% pay cut last year, while Avon boss James Preston froze his salary at $610,000 and lowered his bonus 23%. IBM chairman John Akers took a 40% cut, reducing his compensation by $1.1 million, to $1.6 million. Others are revamping their pay structure. AT&T junked its stock-option plan in favor of an incentive package based on staggered performance targets.

Not everybody caves. Two weeks ago, Coca-Cola chairman Roberto Goizueta stood up before shareholders and defended his 1991 pay of $86 million, which included a record $80 million in stock grants, on the grounds that under his management, Coke stock had increased 1,300%. Goizueta was interrupted four times -- by thunderous applause. U.S. Surgical CEO Leon Hirsch, who earned $118 million in salary and stock incentives, maintains that he's worth it. "I'm not paid enough," he says. Since 1988, U.S. Surgical's market capitalization has, to his credit, increased 1,350%; in the past three years, shareholders have enjoyed a 22% return on equity. In addition, Hirsch challenges the $118 million calculation: counting the stock-incentive portion of his pay ($115 million) is misleading, he claims, since the options won't be exercised until later years. He blasts the compensation consultants who estimate executive pay as "a bunch of self-appointed pseudo experts who thrive on sensationalism and pure hokum." A recent survey conducted by the National Association of Corporate Directors found that chief executives are extremely reluctant to grant outsiders any power over their pay. Although 20% said they would be willing to have shareholders approve directors' compensation, only 8% were willing to give them similar control over their own pay. Says Edmund Pratt Jr., the recently retired CEO of Pfizer and chairman of General Motors' compensation committee: "We're making far too much of this issue. It has become the political hot button. They're comparing our pay to office boys' and the Japanese without knowing what Japanese get. When you compare executive pay with what private entrepreneurs make, or sports figures, musicians and entertainers, or even lawyers, we're kind of poor."

Kevin Murphy, associate professor at Harvard Business School, charges that the campaign against CEO pay "is a disguised attack on wealth." By holding CEO pay up to public criticism, he says, "we run the danger of driving our best people out of the boardroom."

But CEO pay has emerged as a populist issue that no politician can resist. This year Michigan Senator Carl Levin introduced the "Corporate Pay Responsibility Act," which, among other things, would permit shareholders to vote on the policies directors use to set compensation. The real target of the bill is stock options, which Levin describes as "stealth compensation" because the value of options does not show up on the books of companies as expenses. So long as companies don't have to expense the value of options against earnings, says Levin, executives will be generous about awarding themselves this form of pay.

A bill sponsored by Minnesota Congressman Martin Sabo is even more drastic. He wants to bar companies from taking income tax deductions for pay that is more than 25 times what the lowest-paid employee makes. The Sabo bill, say analysts, would set an arbitrary ceiling on how much CEOs should be paid. Sabo chose the multiple 25 because it would result in a salary of roughly $200,000. "That's what the President of the U.S. gets," says Sabo. "Why should some corporate executive get more?"

The SEC is contemplating new rules that would force companies to disclose executive compensation more fully in proxy materials. In addition, it would compel boards to justify in the annual report or proxy statement what a CEO's pay really is -- in all its components -- and why it's reasonable. Companies would be required, for example, to spell out in a new summary table which elements of executive pay are cash and what the present values of stock grants and options are -- something only compensation experts are able to calculate now.

Originally, when shareholders were few in number, they had real control over the companies they owned. But as corporate "democracy" widened ownership, the power of shareholders became diffuse, while corporate management grew in strength. The new assertiveness by pension-fund managers and stock-owner groups, abetted by the changes contemplated by the SEC and Congress, should serve to restore some power to the real owners of each company. After all, argues the new breed of rebels, that's what capitalism is all about.

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