Well-Paid L.A. CEOs Lag Top National Chiefs

THE EXECUTIVE PAY CRISIS & #150; Big Bucks, Mixed Results

By ANTHONY PALAZZO
Staff Reporter

How much is a chief executive worth? In Los Angeles, it looks to be 5 percent of net profits.

That's the aggregate amount the CEOs of L.A. County's 50 largest public companies took home during 2001, according to data compiled by the Business Journal. The calculation took into account salary, bonus and other cash compensation, restricted stock grants and stock options exercises.

Surprisingly, there is no rule of thumb to measure the 5 percent figure against. National studies tend to compare changes in CEO pay to changes in earnings or total stockholder return, said Paul Hodgson, senior research associate at the Corporate Library, a corporate governance research firm in Portland, Maine.

Nevertheless, the number seemed high to Hodgson, and to others.

"I think the owner of a small business who takes home 5 percent of net income is fine, but when you're talking about large companies with thousands of employees, it's more troubling," said Scott Klinger, co-director of Responsible Wealth, an executive pay watchdog organization in Boston.

In terms of overall pay levels, L.A. CEOs compared favorably to their counterparts at some of the nation's elite companies.

In 2001, the chief executives of L.A.'s top 50 companies (ranked by market capitalization) took home an average of $4.9 million each, or $247 million total. The companies they run earned a total of $4.9 billion (see list page 18).

Their pay was less than the $14.5 million average CEO pay at the nation's largest 200 companies, according to a recent study by Pearl Meyer & Partners that took into account compensation and stock-option exercises.

Chief executive pay, in fact, has moderated only slightly nationwide after a decade of run-ups despite a precipitous decline in earnings. According to another study, this one by Mercer Human Resource Consulting, CEO pay fell by 0.8 percent at 350 of the largest U.S. companies in 2001, while median net income fell by 17.8 percent.



Accountability issues

With earnings falling across the board and recent charges filed against the former heads of ImClone Systems, Tyco International and last week, Adelphia Communications, CEOs are certain to be under additional scrutiny for performance, pay and accountability.

"The overall pie was growing so quickly (in recent years) that people didn't care how big a slice the CEO took," said Klinger, whose group has filed 40 proxy resolutions over the past four years, most seeking to limit CEO pay. "Many more investors are paying attention to this issue and we expect it to become a major issue in the coming proxy season," he said.

To measure CEO effectiveness, the Business Journal divided chief executive take-home pay by reported net income, and ranked them most effective to least.

At the top of the list were Charles Munger of Wesco Financial Corp., A. Jerrold Perenchio of Univision Communications Inc. and Bradley Wayne Hughes, of Public Storage Inc. each of who took home nothing or next to nothing in pay.

At the bottom was Henry Yuen, who took home $19.9 million at Gemstar International, while the company lost nearly $600 million last year.

In between were CEOs like Richard Handler, chairman and chief executive of Jefferies & Co. During 2001, Handler took home $11.9 million, about one-fifth of the company's net income of $59.5 million. Jefferies, which quietly moved its headquarters to New York from L.A. in February, has 1,200 employees.

Last year, L.A.'s highest paid executive was KB Home Chairman and Chief Executive Bruce Karatz, who took home $44.5 million, including $23.4 million in value realized through stock-option exercises. However, KB Home said in its annual proxy statement that Karatz exercised more than 800,000 options in connection with the settlement of his divorce, and some of those option grants date back to the late 1980s.

The Business Journal's ranking system, like any other numerical measurement, doesn't take into account myriad variables that may come into play when assessing CEO performance.

For instance, the CEOs who took home nothing aren't working for charity. Each has a substantial direct or indirect ownership interest in the company, and their wealth rises when the company's stock rises.

Others near the top of the list run very large companies, so while pay can be substantial, it makes up only a small percentage of net income.



Different measurements

To fully evaluate a performance, other factors need to be considered. A CEO brought into a turnaround situation shouldn't be measured against one leading a start-up company, or one making a transition from growth to stability.

"You need to look at the industry, the business model (of the company) and where they are with respect to the business model," said Don Sagolla, principal with Mercer in Los Angeles.

But the rankings provide a starting point in determining how CEO pay should be set.

"This has really got a lot to do with corporate governance," said Pat Byrnes, president of Actuarial Consultants Inc. in Torrance. "The boards of directors who are really supposed to be protecting the interests of shareholders have not done a credible job in certain settings of restricting the behavior of some CEOs or other executive officers."

Typically, board compensation committees hire a consultant to study pay levels at competitor companies, then set a series of incentives for the CEO that might include stock options, bonuses and long-term incentives such as restricted stock grants.

But as pay levels ballooned over the past decade, the math became "voodoo," Byrnes said. "That's the disquieting piece here."

In Los Angeles, a number of boards are quietly reassessing their pay policies, Byrnes said. "They're in the groaning stage."

One local client he declined to name is in the process of reining in an internal system that used "complicated schemes to award options," he said. Another local company is trying to figure out how to reload options that are underwater without upsetting shareholders.

"Boards have got to start challenging executive officers. Some of them don't think it's their role, some are already big shareholders in those companies, and may have been responsible for bringing (the CEO) in," Byrne said.



Still lofty levels

Some boards have taken high-profile steps to show they're responding. At Walt Disney Co., Chairman and Chief Executive Michael Eisner did not receive a bonus for the year ended September 2001 after net income, before an accounting change, fell to $237 million from $1.2 billion. His pay was a flat $1 million, compared with more than $12 million in total compensation the previous year, including an $8.5 million bonus.

Meanwhile, CEO pay at other local companies remains at lofty levels, despite performance that is termed "mixed," even internally.

At Jefferies, Handler has pushed the brokerage resolutely toward a goal of $1 billion in annual revenues while rising up senior executive ranks. (He was made chairman earlier this year.) Yet while revenues have risen, net income and earnings per share have been falling, to $2.28 a share last year from $2.80 in 1997 and $3.04 in 1998.

In a report, the compensation committee of Jefferies' board said that while earnings per share and return-on-equity fell short of targeted goals during 2001, they exceeded the minimum threshold to qualify Handler for a bonus.

Handler was granted $5.9 million of the targeted $7 million bonus for the year the lion's share of Handler's $12 million payout.

By comparison, Chairman and Chief Executive Raymond A. Mason of Jefferies competitor Legg Mason Inc. took home $11 million in 2001. Legg Mason is about double the size of Jefferies and reports similar levels of profitability.

A Jefferies spokesman declined to comment on Handler's pay. In its report, the compensation committee said it sought to motivate Handler while aligning his interests with shareholders.

Another tricky question facing corporate boards involves stock options. Companies are waiting to see what, if any, pronouncements are issued about whether to treat options as an expense. In the meantime, they've seen that many of the options issued in previous years are underwater as stock prices have fallen.

They're being pressured to reprice the options, but face resistance from shareholders, who often see repricings as a lowering of the bar. In addition, option repricings are counted as an expense against company earnings.

A few companies, including Korn/Ferry International and Computer Sciences Corp., have reissued options to satisfy employees while avoiding an earnings hit. Doing so requires a six-month waiting period between when the old options are recalled and the new ones are priced. Vesting status on the new options is maintained.

Sagolla said he expects more companies to begin issuing restricted stock as an incentive to executives. Many companies have avoided restricted stock grants, because unlike options, restricted stock grants count against earnings. However, the company can amortize the cost of grants over time, and with the accounting treatment of options in dispute, restricted grants are showing more appeal, he said.

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