By Jessica Silver-Greenberg and Alexis Leondis
www.bloomberg.com
Kenneth Feinberg, the paymaster at companies rescued by the U.S. Treasury, recently cut cash compensation for executives at American International Group Inc. and General Motors Co. He said some companies are buying into his credo of pay tied to performance.
Pay expert Graef Crystal, a former adviser to Coca-Cola Co. and American Express Co., has concluded that pay for performance is a fiction.
Leslie Moonves, chief executive officer of CBS Corp., was the highest paid CEO in the Bloomberg survey, earning $43.2 million in 2009. Photographer: Jonathan Alcorn/Bloomberg
In a study for Bloomberg News, Crystal examined the compensation of 271 chief executive officers and found the average slipped 4.7 percent last year to $9.95 million, with extremes ranging from $43.2 million for CBS Corp.’s Leslie Moonves to $245,322 for Google Inc.’s Eric Schmidt.
Using formulas he developed over 30 years in the business, Crystal crunched the numbers to see whether higher shareholder returns, the gold standard of performance for investors, led to higher pay, and vice versa. No matter how he sliced the data, the answer was no.
“The return explained none of the variations,” said Crystal, 76, in a telephone interview from his home in Las Vegas. “Simply put, companies don’t pay for performance.”
If CEOs were paid according to shareholder return, Moonves would take a $28 million pay cut under a model that Crystal developed.
At CBS, “more than 85 percent of Mr. Moonves’s compensation is keyed to performance-based measures” and is “closely aligned” to shareholders’ interests, Dana McClintock, a spokesman, said.
$9.29 Million Overpaid
Crystal’s model reapportioned pay according to a formula based two-thirds on shareholder return, and one-third on company size, measured by its sales.
Among those who would lose money in the redistribution were CEOs who received raises in 2009, when most of their peers took pay cuts. After a 61 percent boost to $12.6 million, Eastman Kodak Co.’s Antonio Perez made $9.29 million more than the Crystal model said he should.
AT&T Inc.’s Randall Stephenson -- up 85 percent to $29.2 million in 2009, primarily from an increased pension contribution -- deserved $20 million less, according to Crystal.
The CEO who would receive the most if shareholder return ruled in board rooms: Ford Motor Co.’s Alan Mulally, 64, who would move up to $19.6 million from $17.9 million.
Ford, based in Dearborn, Michigan, was alone among U.S. automakers in avoiding bankruptcy last year. Ford boosted U.S. market share through March to 17.4 percent, up 2.7 percentage points from a year earlier. Its shares rose more than fourfold in 2009 and about 310 percentage points more than the Standard & Poor’s 500 Index.
Eight Times Value
The CEO whose actual pay was most out of line in the Crystal model was Cephalon Inc. founder Frank Baldino Jr., 56. He took home $11.1 million, more than eight times the $1.34 million allotted him by the formula.
Tying Baldino’s compensation to stock price wouldn’t appropriately reflect his value to the biotechnology firm, or the strength of the company, said Sheryl Williams, a spokeswoman for Frazer, Pennsylvania-based Cephalon. “We don’t pay our executives based on changes in the price of the stock,” she said. “We pay them based on growth in sales and earnings.”
The drugmaker reported net income last year of $342.6 million, a 78 percent gain, on $2.19 billion in sales. Shares were off 19 percent for the year as the company had more research and development failures than successes, Williams said.
‘Angers Main Street’
Crystal’s model was devised amid rising concern that executive pay is too high and calls from President Barack Obama and others that CEOs should suffer when companies mess up.
“It angers Main Street when it sees what executive pay looks like, especially on Wall Street,” Feinberg, 64, the U.S. paymaster, said in an interview.
Warren Buffett, CEO of Berkshire Hathaway Inc., said in his shareholder letter this year that he wants to see “meaningful sticks” tied to the “oversized financial carrots” that are part of CEO and director pay packages.
Shareholder return is a “much better barometer of performance than any type of guaranteed salary,” Feinberg said.
Ira T. Kay, an independent compensation consultant in New York, said Crystal and Feinberg are talking about the wrong performance gauge. Eighty percent to ninety percent of CEOs’ bonuses in 2009 were tied to earnings growth, which is highly correlated to stock price appreciation, according to Kay.
“It’s a mythology among the American public and media that there is no pay for performance,” he said. “If measured properly, there is tremendous pay for performance.”
‘Too Many Influences’
Stock prices can move at the whim of the market and aren’t the best way to evaluate CEO performance, said Tim White, a partner at Dallas-based Kaye/Bassman International, an executive search and recruitment firm. “There are far too many influences on stock price that the leader can’t control,” White said.
Crystal acknowledges his model isn’t perfect. For one thing, he said, it assumes that the aggregate $2.7 billion that CEOs in the study received represents the appropriate level. If it were up to him, CEO compensation would be reduced across the board, he said.
Shareholder return is the best determinant of pay because it’s the only gauge of success that’s external and can’t be manipulated by accounting tricks or shifts in performance targets, Crystal said.
Throughout his career, which began in 1959 after he saw an ad for a wage and salary analyst in the Los Angeles Times, Crystal said he noticed that CEOs rarely saw their pay packages docked when their companies’ stock plummeted.
‘Bargain’ CEOs
“On the down side, it’s never the CEO’s fault,” he said. “Yet if the company has a good year, guys gather around him like he’s Julius Caesar.”
For his study, Crystal included companies in the S&P 500 that had filed proxy statements for their 2009 fiscal years by April 16. Only CEOs who were in the position in 2008 and 2009 were included, for accurate comparisons.
He found that 159 of the 271 CEOs would get raises if the total CEO payroll last year were redistributed according to his return-heavy formula.
The most underpaid of the “bargain” CEOs, Google’s Schmidt, received $245,322 last year, 99 percent below pay adjusted for shareholder return. Schmidt owns 9.4 million shares of the Mountain View, California-based company, according to a company filing. His restraint contrasts with other CEOs who have fortunes in stock and still take big packages, Crystal said.
Oracle Corp.’s Larry Ellison, 65, who owns shares worth about $30 billion, was paid $56.8 million in the company’s latest fiscal year.
Not ‘Entirely Altruistic’
Oracle, based in Redwood City, California, wasn’t included in the Crystal study because its fiscal year ended May 31, before the latest batch of proxy filings covering the calendar year. Google and Oracle officials didn’t return calls and e- mails seeking comment.
Like Schmidt, Jeff Bezos, 46, of Amazon.com Inc. was rated as underpaid with a $1.78 million package, compared to the $18.3 million he would get under Crystal’s model. Stock of Seattle- based Amazon beat the S&P 500 by 136 percentage points in 2009. Bezos holds 92 million shares worth about $12 billion.
Bezos’s decision to take such low compensation “isn’t entirely altruistic,” because it acts to moderate pay demands by Amazon’s employees, said Steve Wallenstein, a professor at the University of Maryland’s Smith School of Business, who studies corporate directors.
A ‘Shared Sacrifice’
On the opposite end of the spectrum was Kodak’s Perez, 64. Kodak, based in Rochester, New York, lost $210 million last year as its revenue fell 19 percent and its shares shed a third of their value. The company, undergoing a transformation from film to digital products, cut 4,100 jobs and has its lowest workforce since the 1930s.
The compensation committee of Kodak’s board approved a 9.8 percent base salary reduction for Perez, which its proxy filing said was larger than guidelines would have dictated, because of Perez’s “desire to lead in the shared sacrifice.” The sacrifice didn’t extend to the rest of Perez’s package -- where directors changed terms in ways that benefited the CEO. The board said it was responding to what it saw as “strong incentive” for Perez to retire this year because parts of his employment agreement were expiring.
Kodak gave Perez an option for 500,000 shares valued at $1.05 million, by amending his employment contract. It accelerated to 2009 an equity payout originally scheduled for 2010, helping Perez get a $6.18 million stock award. The company also retained its 2008 metrics for “target annual variable pay” adding $1.71 million to Perez’s package.
A Successful 2009
Perez’s total pay package was $12.6 million, up 61 percent.
Kodak had a successful 2009 and achieved the profitability and cash generation goals that were communicated to investors early in the year, according to David Lanzillo, a spokesman for the company.
“We have seen a lot of symbolic cutting of cash salaries,” said Brandon Rees, deputy director of the AFL-CIO’s office of investment in Washington. “That’s a tiny fraction of total compensation” versus “the millions of dollars in other forms of compensation.”
Some of the misalignment between shareholder return and CEO pay arises from competition among companies. Compensation committees routinely peg a substantial portion of CEOs’ pay to competitors, often at the 75th percentile. That means that pay flows even when shares fall, so long as CEOs in the selected peer group do well, said Robin Ferracone, executive chair at Los Angeles-based Farient Advisors, an executive compensation firm.
Special Awards
The CEOs of Goldman Sachs Group Inc., JPMorgan Chase & Co., Morgan Stanley and Citigroup Inc. each earned at least 89 percent less than the return-driven pay calculation in the Crystal model. After receiving aid under the Troubled Asset Relief Program during the financial crisis, they heeded coaxing from Feinberg and Obama to restrain executive compensation.
In 2010, Goldman Sachs and JPMorgan reversed themselves and made special awards to their leaders that they attributed to 2009 performance. Goldman Sachs gave Lloyd Blankfein a $9 million all-stock bonus, and JPMorgan’s Jamie Dimon was awarded stock and options worth about $17 million.
An exception to the underpaid bank CEOs was Henry Meyer III, 60, the CEO of Cleveland-based lender KeyCorp. Although the bank was barred under TARP from paying cash bonuses, Meyer’s total compensation rose 21 percent as KeyCorp’s stock fell 34 percent. His $8.15 million package was $5.28 million more than the return model dictated.
CEO ‘Fraternity Club’
In its proxy filing, the company said it changed its performance goals for the CEO and his direct reports last year “as a result of the then-unfolding financial crisis and the uncertainty about the compliance obligations to be imposed for TARP participants.”
Meyer’s base salary, paid in shares, was increased $623,193 to $1.64 million. Citing the need to retain talent, the compensation committee boosted his option award by $1.29 million to $2.14 million. The salary shares can’t be sold until the full repayment of the $2.5 billion TARP investment in KeyCorp stock by the U.S. Treasury.
The compensation committee acted to recognize “substantial efforts of management in strengthening Key’s capital levels, liquidity and funding ratios” last year, said William Murschel, a KeyCorp spokesman. The company’s $1.34 billion loss in 2009 narrowed from a loss of $1.47 billion in 2008.
Metrics can shift quickly to accommodate an elite “fraternity club” of CEOs, said Ron Ashkenas, a managing partner at Robert H. Schaffer & Associates LLC, a management consulting firm in Stamford, Connecticut. He said compensation is “based far more on a mythical sense of competitive pressure than on any real indicators of value.”
‘Negative Bonuses’
As ways to better align pay with shareholder returns, Crystal recommends giving stock options that can’t be exercised for five years with a strike price that’s the average of the last 90 days before being awarded. He said he sees that as a way to avoid “opportunistic” option pricing at advantageous prices and to tie performance to long-term results. He also suggests “negative bonuses” -- or placing a portion of bonuses awarded annually into accounts that could be reduced if executives fail to meet subsequent years’ incentive targets.
Some of Crystal’s former clients have called him a Judas for being a part of the system for so long and then turning on it. His standard rejoinder is that he prefers to be compared to Mary Magdalene in the second phase of her life.
“Maybe I was a hooker,” Crystal said. “But I’m hoping to end my life as a saint.”
(Please click here to view an interactive table containing all 271 cases.)
To contact the reporters on this story: Jessica Silver-Greenberg in New York jsilvergreen@bloomberg.net; Alexis Leondis in New York aleondis@bloomberg.net.
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