December 30, 2005

Executive Pay To Be New Year’s Hot Topic; Investors’ Outrage Over Excessive Pay Packages Has Reached Boiling Point

Happy New Year! I close the year with yesterday’s Financial Times front page article:

“Investors plan to make executive pay the number one issue at companies’ annual meetings this spring. New evidence suggesting that executive pay growth is accelerating, coupled with outrage at big severance packages for some bosses, has pushed the issue to the top of investors’ concerns.

The AFSCME union, whose pension fund is worth Dollars 800m, is calling for UK-style votes by shareholders on executive pay at the 2006 annual meetings of US Bancorp, Merrill Lynch, Bank of America, Home Depot and Countrywide Financial.

The union claims to have identified excessive compensation at these companies and warns it might try to oust directors on their compensation committees if they do not take steps to align bosses’ pay with company performance.

Alyssa Ellsworth, managing director of the Councilof Institutional Investors, whose members are pension funds with assets worth more than Dollars 3,000bn, said executive compensation would be the “headline issue” in 2006.

The median total compensation of chief executives grew by 30 per cent in 2004, according to a survey of 1,522 CEOs by the Corporate Library, a corporate governance watchdog. That increase compares with a median rise of 15 per cent in 2003 and 10 per cent in 2002.

The library concluded that of the 10 CEOs who enjoyed the biggest pay growth in 2004, only five could justify their increases based on the companies’ performance. Total compensation includes restricted stock awards and profits from exercising share options, which drove the 30 per cent increase.

Investors’ anger about executive pay boiled over this year at Morgan Stanley, the investment bank. Shareholders were angry that Phillip Purcell, the former chief executive who resigned in June, secured a 45 per cent pay rise in 2004, even though the firm’s net income increased by only 18 per cent. Anger turned to outrage when he departed with a Dollars 44m severance deal plus Dollars 62m in equity compensation and pension benefits.

William McDonough, former president of the New York Federal Reserve Bank, said last month “the American people are still very unhappy about the level of executive compensation” and warned of the risk that lawmakers would feel obliged to intervene. He said the one thing the public did not understand was “paying for failure”.

The Securities and Ex-change Commission, meanwhile, has been clamping down on breaches of its disclosure rules on executive pay. Last year the chief US financial regulator accused GE of failing from 1997 to 2002 to accurately outline the benefits the company would provide Jack Welch, its chief executive, after his retirement in 2001.

The SEC found that Mr Welch received benefits worth Dollars 2.5m in 2002, including use of the GE aircraft, an Dollars 11m New York apartment, a limousine, a Mercedes Benz car, offices and a personal assistant.

GE reached a post-retirement consulting agreement with Mr Welch in 1996, but it only became public during divorce proceedings with his second wife in 2002.

The SEC said GE had previously limited its description of Mr Welch’s retirement benefits to statements that he would have “lifetime access to company facilities and services comparable to those currently made available to him by the company”.

But while the SEC has stepped up enforcement of its disclosure rules on executive pay, they have not kept pace with changing forms of compensation.

A proposal to overhaul the rules will be the first big test for Christopher Cox, who became SEC chairman last August after pledging to stay true to the regulator’s mission to protect investors’ interests. But he risks incurring the wrath of chief executives by insisting on better disclosure of compensation.

Bosses are likely to be nervous about comments he made shortly after becoming SEC chairman that investors had to have sufficient information about executive pay to be able to “discipline” cases of “apparent excess”.

In a speech to business leaders in New York this month, he sought to reassure people the SEC did not want to “interfere in salary decisions” or to “cap salaries”.

The SEC has instead been studying what additional information should be provided to investors about executive pay. It is considering requiring companies to make valuations of bosses’ defined benefit pensions and stock options, potentially huge sources of compensation.

William Donaldson, Mr Cox’s predecessor, hoped that better disclosure of executive pay would help curb examples of big compensation packages at troubled or failing companies.

Mr Cox told the FT it was the job of boards of directors to align “executive pay with executive performance”, and that the SEC proposal “would not directly help with that aspect”.

However, he said the proposal would “assist in providing industry-wide competitive information about executive compensation levels with greater detail than is presently the case.”