A say on pay

Shareholders seek input on executive compensation, which, as our annual ranking shows, doesn’t mirror performance.
By Frank Maley

After the lackluster year Bank of America Corp. had in 2007, Kenneth Steiner figured it was time shareholders had a say in executive compensation. Nothing binding — basically an annual opinion poll — but it would give him a chance to express his displeasure with how the company was being run. “We weren’t making money, and earnings were starting to decline. Meanwhile, executive pay was still in the stratosphere. I thought it was unwarranted, and I thought the directors were being irresponsible.”

He got his proposal on the ballot for last year’s annual meeting. The board of directors opposed it. “Stockholders already have effective avenues for communication with the board,” BofA’s proxy statement said. “In addition, the proposed advisory vote would not provide the board with sufficient information to address stockholder concerns and may impede our ability to attract the most qualified executive talent.”

It was defeated but won 44.9% of the vote. “It’s very difficult to get 50% in the first year or two of proposals,” Steiner says. So the Great Neck, N.Y., resident submitted it again this year. Only 40% of the proxies cast supported it — even though net income and shareholder return were worse in 2008. His initiative might have been hurt because BofA already had its executive-pay package on the ballot: As a recipient of funds from the federal Troubled Asset Relief Program, it was required to. Shareholders ratified the plan 72% to 28%.

But it might not be long before BofA has to put executive compensation before the shareholders each year, TARP money or not. Indignation at high CEO pay, combined with economic turmoil and taxpayer bailouts of struggling companies, have turned up the heat on lawmakers. A bill passed by the U.S. House of Representatives just before its August break would force publicly traded companies to hold annual nonbinding votes. A similar bill cleared the House two years ago but stalled in the Senate. This one stands a better chance, observers say, noting that it’s a question of when, not if, shareholders get a say on CEO pay.

The chief executives of North Carolina’s 75 largest public companies did little last year to assuage concerns about pay and performance. Shares of many took a beating their latest fiscal year, with a median loss in value of 31.7%, according to data derived from the ranking that starts on page 38. But CEOs of most made more money, a median increase of 3.1%. Of the 59 in the job at least two fiscal years, 30 got more cash compensation — salary and bonuses — and 31 increased total compensation. Of those, 19 ran companies that saw a decline on the bottom line. “When you look at this, you start worrying what is the cause and effect, because frankly I can’t see it,” says Hank Federal, principal and Southeast practice leader of Findley Davies Inc., the human-resources consultancy that compiles the ranking for Business North Carolina.

The say-on-pay provision in the House bill is part of a larger package of reforms broadly aimed at reining in compensation practices that encourage excessive risk-taking at the expense of shareholders, employees and — in extreme cases — taxpayers. The median percentage of pay from base salary fell from 35.3% to 31.7% for Tar Heel CEOs, while that from bonuses, stock, options and long-term cash increased slightly to 61.1%. “If you believe that part of the financial problem we’re in today is because our financial markets paid executives to take unrealistic risks to get that level of pay,” Federal says, “then you have to say, OK, we have to change the paradigm and maybe we need to take some of that risk out.”

Few CEOs have a pay package as performance-based as BofA’s Ken Lewis. But last year, it became less so. In 2007, 93% came from bonuses, stock, options and long-term cash. That shrank to 85%. He didn’t get a bonus, which in 2007 totaled $4.25 million. His compensation from stock awards fell 61.5%, and his option grants dropped more than a third. Overall pay was slashed 54% to $11.7 million. The decrease was the largest, in percentage terms, of any CEO in BNC’s ranking.

Equity pay is supposed to align a CEO’s interest with shareholders’, but the hefty package of stock-based pay Lewis received in 2007 didn’t prevent BofA from getting caught up in the nationwide financial maelstrom of last fall and seeing its shares lose 60% of their value. Nor did it prevent net income from plummeting 73%.

Lewis’ shrunken pay package was still fat enough to rank fourth, but his customary position as North Carolina’s best-paid public-company chief executive went to Martin Orlowsky of Greensboro-based cigarette maker Lorillard Inc. His compensation more than tripled last year, the biggest percentage increase on the list. More than 70% of Orlowsky’s $15.8 million package came from a $10 million bonus associated with the company’s separation from New York-based Loews Corp.

Behind him was Doug Lebda of Charlotte-based Tree.com Inc. Lebda founded LendingTree Inc. in 1996 and continued running the online loan marketplace after New York-based IAC/InterActiveCorp bought it in 2003. He became CEO of Tree.com when it was spun off in August 2008. Most of his pay last year came in stock and options. The company reported stock awards to him of $4.8 million in 2008, most from grants IAC made in previous years that were accelerated by the spinoff. The other CEO to finish higher than Lewis was Richard Noll of Hanesbrands Inc., a Winston-Salem-based apparel maker. His pay jumped 39% — mostly from a major options grant — in a year the value of his company’s shares fell 53%. Hanesbrands did manage a slight increase in net income during bleak economic times in an industry long buffeted by foreign competition.

While most CEOs get the lion’s share of pay from salary, bonus, stock and options, a few receive significant amounts in other ways. Some are hard to figure. Charlotte-based Coca-Cola Bottling Company Consolidated reported $935,304 in income-tax reimbursements for J. Frank Harrison III. It didn’t return phone calls seeking comment. Charlotte-based Duke Energy Inc. recorded $385,626 for Jim Rogers’ “personal use of airplane,” though he reimburses the company for direct operating costs. The figure represents tax deductions Duke missed on the aircraft’s use as business expense.

While stock and options might not qualify as what the House bill calls “perverse incentives,” they change behavior in ways that sometimes carry more risk. “It’s a balancing act,” says Laura Thatcher, head of the executive-compensation practice at Atlanta-based Alston & Bird LLP. “If all you have is base salary, there’s very little risk. It’s pay for a pulse, basically. On the other hand, if you have a very low salary and you know that 90% of your pay is based on meeting performance hurdles, you’re going to be very driven to reach those performance hurdles. And depending on what they are, it could be a material risk to the company.”

Experts can disagree on what the right balance is — and it varies from company to company and business to business. Writing recently in a Harvard Business Review blog, Roger Martin called for elimination of equity-based pay in favor of compensation based on such measures as earnings per share, return on invested capital and market share. “Those are things over which executives exert significant control,” the professor of strategy management at the University of Toronto noted, “and if they improve those real results, stock price will follow.”

But Henry Oehmann, director of national executive compensation services for Chicago-based Grant Thornton LLP, says the median pay mix in North Carolina, with its emphasis on bonuses and equity, isn’t unusual. “To see two-thirds of the package in something other than base salary is fairly typical, and I don’t think it’s problematic unless you haven’t done your homework with respect to the way in which your company performance drives the pay packages.”

Whether a CEO is being given the right incentives is often hard to tell from what’s disclosed in proxies, Federal says. “One of the issues the SEC and governance watchdogs have been concerned with is the lack of clarity in the description of executive compensation. This will take on additional importance when say-on-pay legislation is passed for all public companies.”

Though board members might resent being second-guessed by shareholders — who often know little about operations or the difficulty of finding and keeping the right CEO — say-on-pay might not be such a bad thing. Even nonbinding votes can be effective. “Even though they’re only advisory, they can provide a warning signal to wayward directors, who might actually rethink future actions to avoid being voted out,” says Omari Simmons, a law professor specializing in corporate governance at Wake Forest University.

The reach of the reforms under discussion might extend beyond publicly traded companies into privately held ones — even nonprofits. Many of the Sarbanes-Oxley accounting rules applied to public companies in 2002 have established standards widely viewed as best practices for a variety of entities. “Even though the banks that got TARP money are in a separate regulatory category right now, where they have to include some of these elements — say-on-pay and that kind of stuff — there have already been some public companies that have voluntarily adopted a nonbinding say-on-pay vote, so you’re already seeing the needle move,” says Patrick Bryant, a lawyer who handles corporate-governance matters at Robinson, Bradshaw & Hinson PA in Charlotte.

But Congress can be unpredictable. If it can’t deliver an annual say-on-pay for stockholders and companies don’t volunteer one, shareholders who want one will have to demand it. If nobody else steps up, Steiner, who owns about 3,000 BofA shares, says he will probably try to get it on the ballot again next year — “assuming I’m still a shareholder in a few months.”