For a growing number of corporate executives, the standard paycheck is becoming as anachronistic as carbon paper or ticker tape.
Instead, executives’ salaries increasingly are linked to the performance of the companies they lead, with shares of stock and stock options forming the basis for elaborately structured and lucrative compensation packages.
To get the latest word on executive pay, the Business Journal spoke with four local compensation experts David Leach, managing director of Compensation Resource Group in Pasadena; Diana Peterson-More, president of Organizational Effectiveness Group in Pasadena; Jim Hughes, practice leader for compensation within the human capital services group at Arthur Andersen LLP in Los Angeles; and Carl Jacobs, senior vice president of Woodland Hills-based Carl Jacobs & Associates/Aon Consulting.
Question: What are the main trends driving executive pay these days?
Leach: Stock is really where it’s at, primarily stock options. We’re also seeing a lot of companies asking people to hold on to the stock. They’re giving stock options, but asking executives to hold on to the stocks.
Jacobs: What you really see over the last 10 to 15 years is the tremendous emphasis on the creation of shareholder value. The go-go stock market has really enabled executives to cash in on compensation levels never seen or anticipated before this period of the 1990s.
Q: Which leads to the question: Are there actually executives out there who get eight-, and sometimes even nine-, figure salaries?
Leach: It’s a market-driven system, like free agency in sports. There just needs to be someone there who’s willing to pay the money. Whether the market’s right or wrong is immaterial. That’s the way the free-market system works. It’s a value judgment. It’s like saying, “Is Michael Jordan worth $30 million or $40 million?”
Jacobs: Some people are beginning to feel that (compensation packages) are overinflated. Institutional investors are concerned and are much more carefully scrutinizing the kind of compensation packages that are developed.
I don’t think they’re trying to cap the packages, but they’re trying to control the way stock option grants are determined by assessing the value of the grants. One of the ways organizations develop the desired level of stock options is to look at competitors, see what they’re granting and try to equal it. As the level of grants has accelerated, so does the race to stay even. If stocks cool down, the grants will be worth far less and you won’t be seeing those levels of compensation.
Peterson-More: To me, if what’s taking them into the eight figures is stock performance or something else that’s directly linked to the success of the company, theoretically I think it’s a fair, rational way to compensate people. If the person’s base pay were millions of dollars while the company’s performance is declining, that’s a horse of a different color.
The question is, how much is this individual’s (compensation) really linked to their management, and how much has been a result of the robust economy and stock market’s dramatic growth?
Q: Are there any new wrinkles in the equation?
Leach: There’s increased use of stock options not only at the top, but also throughout the organization. Companies are setting aside more shares for use in stock-option plans than what they previously had. Because they’re going lower into the organization, we’re seeing more and more employees receiving stock options.
Peterson-More: The tendency is to tie compensation with achievement of business goals. In non-profits, it’s tied to achievement of goals and objectives to support the mission. About a third of non-profits have introduced incentives, in terms of bonuses or non-monetary incentives like payment for education or training. There’s a lot of creativity going on.
Hughes: In general, we’re requiring greater and greater performance from the executives. Some historic programs have been deemed giveaways, so we’re seeing some more leading-edge vehicles, like indexed options.
An indexed option is an option to buy stock of your company, but the price you have to pay is indexed by some market rate. A normal option is typically tied to the market price on the day of grant. An indexed option says we’re going to index the price you pay compared to the market. So if I tie it to the S & P; 500, for instance, the only way I get any value is if the price of my stock exceeds the return that’s being perceived elsewhere. Otherwise you’re just being carried along with the market.
Q: What about that? Are executives complaining about the use of these indexed options?
Jacobs: I don’t know that they are. Certainly boards of directors are not. The indexed things could take a bite out, but the way we’ve drawn them, if (the executives) can really outperform the market, then they get a big chunk. If they don’t, the options are of little value. I wouldn’t say they aren’t complaining, but in the final analysis, executive compensation consultants need to be responsible to the shareholders.
Leach: You’re not seeing (indexed options) that much that there’s resistance. Some are reluctant, sure. The argument is that if you want to align (executives) with shareholders, you treat them like shareholders.
But many times when you do see these indexed options, they’re in larger grants. If they’re going to index the options, they’re going to have to do larger grants. It’s greater risk and greater reward.
Peterson-More: I personally haven’t heard anything about it directly. I would imagine any new twist on compensation that could potentially reduce someone’s pay will be resisted. That’s human nature. But if you’re really trying to link compensation to performance, it’s fairer than some of what we’re seeing now, in that you can’t necessarily assign a strong relationship between the dramatic increase in the stock price and the performance of the individual who’s the CEO or president.
Q: Are executives worried at all that the bull market on Wall Street may top out, and are they building their concerns into the pay packages they negotiate?
Jacobs: There is a definite concern that the market may not go this way forever. But people always think, “My company is going to continue to do well.”
Hughes: I haven’t dealt with a lot of companies doing that. Part of it may be that everyone wants to ride that wave as long as it’s there.
Q: What would you expect to see if, in fact, the market tops out?
Peterson-More: If the market were to have a downturn over a sustained period of time, there would be a rethinking of the system. There’d probably be less of a reliance on stock options and more emphasis on monetary incentives and/or increase in base pay.
Hughes: When the wave stops, when the availability of getting tremendous value out of the marketplace diminishes, we may see a trend in the other area, moving back toward more guaranteed or fixed compensation.
Q: What about the large, institutional investors? Are they playing a bigger role in determining executive compensation?
Jacobs: In the last few years, the boards of directors are being far more conscientious about their role. The executive compensation committee of one of my clients has been much more diligent in recent years in reviewing compensation. They feel the pressure from shareholders, especially the big ones. Directors and audit firms have also been sued more often in recent years (by shareholder groups unhappy with compensation plans).
Leach: Institutional investors are playing an increasing role, and companies are paying more attention to them. Many times, we’ll counsel our clients, the companies, to talk with their major investors ahead of time if they’re doing something their institutional investors might not approve.
Peterson-More: I think you’re starting to see a process that’s going to lead to that. You’re starting to see institutions show up at stock meetings, challenging various things directors are doing, including compensation. CalPERS has led the way in many respects here in California.
I don’t know that there’s acknowledgment of a direct relationship. There are often instances when shareholders raise issues and behind the scenes have an impact, but the company may not acknowledge it openly.
Q: Are there any trends in compensation for any of L.A. County’s major industries, such as the entertainment, aerospace, high-tech or oil industries?
Jacobs: The entertainment industry is becoming more corporate-like. It used to be more emphasis on cash compensation, but the structure of the packages is becoming more typical. Cash bonuses are tied to operating results. The use of stock options has become more broad. In tech companies, the other thing you see is granting of significant numbers of (stock) options beyond the executive group. You see it in sales and other positions. You see it in companies in general much more than in the past.