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Say
goodbye to all those stock options
Pay-for-performance is here to stay
Related
link:
Top Paid 100
by
Lauren Shepherd
For
Virginia Business
October 2003
A
stellar year equals stellar pay. A not-so-stellar year
— forget about it. That seems to be the new mantra
for executive compensation. Following years of generous
stock options, corporate loans that in some cases required
no interest payments and other goodies such as corporate
jets, boards are tightening their belts when it comes
to executive pay. They’re still rewarding leaders
whose performance boosts the bottom line, but even then
increases are more modest than in past years due to
a prolonged bear market and increased shareholder scrutiny.
In
fact, over the past five years, the average pay of the
state’s highest paid CEOs appearing on Virginia
Business’ annual list has dropped 27 percent, from
$6.1 million in 1999 to $4.4 million in 2003. That’s
not to say that some executives aren’t still making
bundles of money. Take the top officers at NVR Inc.,
for instance, one of the state’s biggest and most
successful homebuilding and mortgage-banking companies.
President and CEO Dwight C. Schar collected a small
fortune and garnered a number one spot on the list of
the top 100 paid executives in the state. After exercising
stock options, Schar earned $94.3 million in 2002. Add
in a $1.5 million salary and a $1.5 million bonus, and
it’s hard to feel sorry about executives’
sagging fortunes.
A
hot mortgage market sparked by low interest rates meant
business was booming at McLean-based NVR, with the company
posting a 22 percent increase in earnings per share
in the second quarter of this year. Like many executives
on this year’s list, Schar was paid for good performance
— a trend that industry experts say will continue
as boards react to the public outcry over excessive
compensation packages wrought by corporate scandals.
“There’s a much closer linkage in pay-for-performance
than we saw maybe five years ago,” says Steve Harris,
a partner at Mercer Human Resource Consulting. “This
has been a trend, and it has continued and sharpened.”
The
link between pay and performance has already started
showing up in national lists of who earns the most,
including an annual survey done by The Wall Street Journal
in conjunction with Mercer Human Resource Consulting.
It analyzes executive compensation packages at 350 of
the country’s largest public companies. Last year
CEO salaries increased a median of 2.2 percent to $925,000,
with 132 companies granting no pay raises, compared
to 92 in 2001. Still, total annual compensation, which
includes base salary and annual bonus, rose a median
10.2 percent in 2002 to $1.8 million, compared to a
decline of 2.8 percent in 2001.
With
multi-million dollar accounting scandals such as the
one that forced Worldcom Inc. into bankruptcy, and CEOs
facing criminal charges, corporate pay is clearly moving
into a different era. Part of the new mindset, says
Harris, is that stock option packages—which have
netted executives multiple-figure salaries for years—aren’t
as important any more. “I do not believe stock
options will go away. I believe that the portion of
pay in stock options will decline,” he says. In
the Mercer survey, the number of CEOs receiving stock
option grants fell from 314 in 2001 to 295 in 2002.
Of course, many of the stock options held by CEOs are
underwater these days, causalities of the stock market’s
poor performance over the last three years.
While
those who work hard are still being rewarded, certain
industries are faring better than others. Besides homebuilding,
strong financial performances in the past year have
also come from firms handling student loans, as well
as defense and energy companies. Three of the top ten
slots on this year’s list are held by NVR executives,
including Paul C. Saville, who came in number two with
earnings of $30 million and fourth-ranked Dennis M.
Seremet, a vice president who earned $19 million. Executives
from Sallie Mae Corp. in Reston, the largest player
in the student loan market, also made the top 10. COO
Thomas J. Fitzpatrick ranked third, with earnings of
$22.9 million, of which $21 million came in stock gains.
CEO and Vice Chairman Albert L. Lord was in the seventh
slot with $11.6 million.
Conspicuously
absent from this year’s list was last year’s
highest paid executive in Virginia, Richard D. Fairbank,
chairman and CEO of Capital One Financial Corp. In lieu
of a salary, Fairbank has been paid in stock options
— about as close to a pay-for-performance system
as one can get. Capital One’s stock took a hit
last year after federal regulators told the company
to double the capital it held against sub-prime loans
and to increase its loan loss reserves. The stock has
since rebounded, so Fairbank may reappear on future
lists, with Capital One’s product lines diversifying
to include auto loans and more international credit-card
customers.
Regardless
of how much money is in a company’s bank, many
industries are beginning to change the way they pay
senior executives. Boards of directors are looking for
new ways other than stock options, salaries and bonuses
to pay executives for a job well done. “Things
are sort of in flux right now,” says Judith Fischer,
director of research at Executive Compensation Advisory
Services in Alexandria. “There’s a turning
away from traditional forms of executive compensation.”
And
we’re not talking corporate perks. The days of
private jets and memberships to exclusive clubs are
long gone as companies fear retribution by scandal-weary
shareholders. “No one even talks about that,”
says Tayloe Negus, an executive compensation consultant
at the Todd Organization in Richmond. “Companies
can’t afford to have the appearance of doing that.”
Instead,
businesses are looking to change the make-up of their
long-term incentive packages for execs. Specifically,
many are moving away from handing out stock options
like so much free candy. “In the ’90s, stock
options were thought of as a silver bullet,” says
Negus. “They were doled out pretty significantly.”
Now,
with federal regulation on the horizon that would require
companies to expense options, companies are less willing
to grant large bundles of stock to their CEOs and executives.
When companies expense options, they will be forced
to include the amount on their financial statements
and be more beholden to stockholders. Several Virginia
companies have already voluntarily complied with the
regulation, including AES Corp. in Arlington and Smithfield
Foods Inc. in Smithfield. Last year, Barry J. Sharp,
executive vice president and CFO at AES, garnered no
stock gains as part of his $3.6 million total compensation.
Another
trend catching on in corporate boardrooms is granting
restricted stock. With this option, an executive has
to wait until the shares vest before they can sell or
transfer stock. In July, Microsoft announced it would
give restricted stock to executives rather than options
— a move Fischer says is an important barometer
for what could happen in the future. “There’s
a slight movement to restricted stock,” she says.
“It’s a philosophical change.” The possible
shift to performance shares is an even more blatant
move toward paying executives for a good year at the
shareholder bank. With performance shares, executives
can earn stock if they meet certain performance benchmarks.
To
industry experts, all these variations have the same
outcome. They allow shareholders more power to make
decisions on how much an executive takes home. And that
trend may not just be for determining how to initially
pay an executive. Companies are now starting to consider
the perceptions and concerns of their shareholders when
determining severance packages for CEOs as well. Massey
Energy and Sprint, for example, have both announced
they will require shareholder approval for large executive
severance packages, called “golden parachutes.”
“I think golden parachutes will be submitted to
more scrutiny in the next few years,” says Julie
Gozan, corporate governance specialist at Amalgamated
Bank, which provides consulting services on corporate
governance issues and employee benefit plans.
It’s
hard to tell how executives feel about the changes,
since most of them don’t like talking about their
salaries. The good news? CEOs will be able to earn awards
by achieving performance goals other than improvements
in a company’s stock price. According to Mercer,
boards may start considering lifestyle benefits. Or
as Jack Welch would say: bring on the wine.
Return
to Virginia Business - October 2003
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