When a high-level executive brings home an outsized paycheck these days, chances are there will be stock options and bonuses associated with it. But the process by which corporate boards agree to those extras can be a dizzying one.
It’s a far cry from the old days when a chief executive who was often the chairman as well might have had a cozy pay arrangement with other board members, usually heavy on straight salary and laden with perks. But with changes in SEC rules, and the increasing power of institutional shareholders, the clubhouse atmosphere is long gone.
“The board, and the compensation committee, is not an old boys club anymore,” said Raymond Fife, director of compensation consulting at Coopers & Lybrand LLP in downtown Los Angeles. “They devise pay plans with incentives.”
That, in turn, has led to a much greater role by the board’s compensation committee in determining executive compensation. And in this era of independent advisers and third parties to provide “objective” opinions, compensation committees are more often turning to consultants before settling on pay levels.
“In the past, (consultants) might have been hired by the chief executive, but with most of my clients today, it has shifted to the compensation committee of the board, or the chairman of the compensation committee,” said Don Segolla, regional partner in the Los Angeles offices of KMPG Peat Marwick LLP.
After the compensation committee has hired a consultant, that person or group will attempt to set a pay plan that aligns management’s financial rewards with those of shareholders and that will be competitive in the marketplace.
“Are the pay levels and compensation package appropriate, and how do we know? Those are the two most provocative questions you can ask,” said Segolla.
Typically, compensation consultants will scour the proxy statements of other, similar public companies.
“Many times we will develop a peer group of companies, and we will give (a compensation committee) a bench marking, based on proxy statements, of what the competition is paying,” said David Leach, managing director at Compensation Resource Group Inc. in Pasadena.
The all-important stock options are given a careful going over. Some compensation committees seek an estimated value to the options, so that they can demonstrate that the CEO is being fairly compensated. These values are determined by looking at current interest rates and estimated future performance of the stock, said Leach.
Some committees are also asking that “relative performance” ? that of a company’s stock compared with similar public companies, or the S & P; 500 ? be the basis for options.
In such cases, some portion of the stock options would not be granted if the company merely kept pace with others in the industry, said Robin Ferracone, president of SCA Consulting LLC in downtown Los Angeles, an executive compensation consulting service.
After getting an opinion from a consultant, a compensation committee may go ahead and make an offer to an executive. But the dance of determining an executive’s pay does not stop there. Most top executives, by their very nature, are not the passive types.
As they enter negotiations, and before they sign complicated contracts, most will retain legal advice. In concert with their lawyers, chief executives might not be able to bump up a base salary very much, but they can often wangle additional perks or protection against a sudden firing.
The “exit strategy” is a critical component.
“Our role is to ensure that our client receives a compensation package which has solid terms and conditions, in terms of cash, and equity incentives,” said James Ukropina, a partner at O’Melveny & Myers in downtown Los Angeles. “Among other things, we will look to see that duties and authority are clearly defined, and that grounds for termination are reasonable, and that severance pay is competitive. With regard to change of control (at a company), we want to be sure the executive is adequately protected.”
A signing bonus should be sought, particularly if an executive is leaving a favorable situation and he is being hired as a “fireman” to help a troubled company, said Ukropina. “There should be a minimum bonus for going into a hot spot,” he said.
The process of negotiations can be long. Ukropina has found that “the first proposal is not the last and best proposal, and you have to negotiate to get the best proposal.”
Complicating matters is that a CEO’s lawyer often finds himself dealing directly with institutional shareholders, which was unheard-of in years past. “In one case, there was one large equity investor who had a large stake in the company and was concerned about how the executive was going to be paid,” said Ukropina, who could not be more specific because of confidentiality agreements. “It doesn’t happen often, but I talked with that investor directly.”
In general, large equity investors insist that executives be paid more in stock, and less in salary, said Ukropina.
Even when the compensation committee, the lawyers, the consultants and large shareholders are finished, and it appears the dust has settled on an executive’s package, it sometimes hasn’t.
Often, new CEOs develop tremendous leverage after they have been with a company for a few months and have already inked a contract. Sometimes they decide to use this leverage by demanding that the “old” contract be torn up and a new, richer contract brought in, according to Robert Apfelberg, founder of Commerce Partners Inc. in Woodland Hills and an executive compensation expert.
At that point, the new chief executive may have gained the confidence of some board members. Moreover, board members don’t want it to look as if they hired someone, just to have him leave after three months. For a public company, that would create the perception of instability even more so if the executive were brought in to stabilize a troubled ship.
In the mid-1990s, Apfelberg sat on the board of troubled, publicly held thrift in Los Angeles, which hired a new chief executive for $300,000 a year, plus stock options. After three months, the CEO demanded a 400 percent raise and improved stock options (options that were eventually worth $8 million, when the thrift was sold).
Fancy studies, the recommendations of consultants, the carefully negotiated contracts vetted by lawyers all that was worthless in the face of the reality: The chief executive, publicly identified as the man selected to head a turnaround, was threatening to bolt, and even looking to take other top managers with him. “The board gave him what he wanted,” said Apfelberg.
