Rolling Back Executive Pay

By THOMAS McCARROLL

To hear Silicon Graphics president Edward McCracken tell it, taking away the executive's most prized form of compensation -- stock options -- would be nothing less than a disaster for American business. High-tech companies, like his computer-manufacturing firm, would be unable to recruit top engineers and software programmers, warns McCracken. They would then lose their competitive edge. "The next thing you know," he says, "the Japanese would be taking over, and all of Silicon Valley would be at risk."

That, in a nutshell, is the view of corporate America, which continues to cling to its massive compensation packages in spite of lower earnings and large layoffs. Now, however, after years of insisting on their right to pay themselves what they think they are worth, corporate executives face a rising howl of protest they may not be able to ignore. And their favorite form of income -- the stock option, which makes up as much as 90% of their total pay -- is a major target.

Last week saw a double-barreled threat to outsize compensation packages. First, President Clinton proposed eliminating tax deductions by corporations for executive pay of more than $1 million, which would have a profound impact on how much the company's top managers are paid. Clinton left a loophole for "performance based" compensation, which could include stock options. But at the same time, the Financial Accounting Standards Board, which sets the standards for America's accountants, was considering a rule that would force companies to deduct the value of stock options from their earnings. That too would have an immediate and dire effect: it would reduce profits up to 48% for the average small firm and 3% for the typical big corporation. It would also drastically curtail the use of stock options by companies.

Indeed, the FASB plan comes as excessive corporate compensation is being attacked from all quarters, including Congress, where two bills now propose similar changes. One, a bill sponsored by Minnesota Representative Martin Sabo, seeks to end tax breaks for corporations that pay CEOs more than 25 times what the lowest-paid employee earns. And in January, Michigan Senator Carl Levin reintroduced legislation that would force companies to account for the payment of stock options on their profit statements.

! A movement by shareholders to limit executive pay is also gaining support. Stockholders at 43 companies last year submitted proposals to limit executive pay, and that number is expected to double this year. Even the Securities and Exchange Commission is cracking down. Under new SEC rules, companies must provide, in their annual report to shareholders, some value for the stock options granted to executives. "Executives have been praying for this issue to cool down," says Graef ("Bud") Crystal, a leading compensation consultant. "But it's not, and they're going to stay on the hot seat."

The hottest issue by far is "stock incentives," usually in the form of options that are given to executives outright and allow them to buy company stock at a set price later on. The idea is that as the stock goes up, the employee's rights to buy shares at the older, fixed price become more valuable. While stock options are rare in countries such as Japan and Germany, about 90% of U.S. firms provide them to their senior-level executives. Some companies -- such as PepsiCo, Pfizer and Silicon Graphics -- offer options to all employees, from the mail room to the boardroom. U.S. executives cashed in some $4 billion worth of stock options last year, in contrast to $2.1 billion in 1991.

Although designed to provide executives with a strong incentive to perform well over time, stock options often seem to be used to reward executives who perform poorly. One prominent example is Advanced Micro Devices chairman Walter J. ("Jerry") Sanders. Although his firm's stock price has declined 35% over the past seven years, Sanders has pocketed some $29 million in option profits during the same period. United States Surgical Corp. chairman Leon Hirsch has been awarded 2.8 million shares (current market value: $186 million) since 1991, even though his company's stock has underperformed the Standard & Poor's 500 index by 3 percentage points. The award is an extreme example of so-called mega-options, grants consisting of at least 250,000 shares. The number of mega-options issued by corporations has increased 300% since 1990.

Annoyed, shareholders have moved to curb such abuses -- just as they have moved to remove a number of CEOs in recent months. Under pressure from big institutional investors, for example, ITT Corp. drastically altered the stock- option plan for its chairman, Rand Araskog. He had received an outright stock gift with no strings attached. The company replaced the grant with a ^ plan based on performance. AT&T also upped the ante for its CEO, Robert Allen. Allen was once awarded 45,000 shares just for staying on the job. Now, he will receive 250,000 shares, but only if the value of the company's stock appreciates 20% to 50% by 1997.

In spite of the growing opposition, corporate management continues to successfully oppose curbs on its executive payrolls. The FASB plan, for example, is facing opposition that its chairman, Dennis Beresford, describes as "unprecedented." Of more than 350 letters on this issue so far received by FASB from companies, accounting firms and stock exchanges, only one or two support the rule change. Leading the charge against the proposal is the Business Roundtable, a New York City group representing 200 CEOs. In a letter to FASB, Citicorp CEO John Reed, who heads the Business Roundtable's accounting task force, said the plan would have "negative effects" on U.S. competitiveness. Small and midsize firms oppose the plan because it would force them to curtail or severely limit their only affordable means to attract top executive and technical talent.

Congress is also divided on the issue. Although Senator Levin strongly backs the proposal, his Michigan colleague, Donald Riegle, opposes it. In his letter to FASB, Riegle, the chairman of the Banking Committee, wrote that the plan "could undermine the competitiveness of American industry without any corresponding benefit to the users of corporate financial statements."

But even if the companies prevail on the accounting standard, victory is unlikely to bring them any lasting peace. In an era of massive and painful corporate downsizing, richly paid executives are out of step with the times. And while they may win a battle or two, it is almost certain that they will have to settle for something less than the grand lucre that came their way in the days of Reagan and Bush.

CHART: NOT AVAILABLE

CREDIT: [TMFONT 1 d #666666 d {Source: Hay Group}]CAPTION: THE SHIFT IN CEO PAY