Compensation experts Don Delves and head of the North American compensation consulting practice at Hewitt Associates Ken Abosch talk about how companies are dealing with the threat of greater government oversight of executive pay
On many fronts, 2009 is shaping up to be one of the worst years for aligning pay with performance in Corporate America. After bringing the world to the brink of economic disaster, major investment banks are planning to pay their people 30% more than last year in salary plus bonus. "Some [payouts] will be even higher," says Wall Street compensation expert Alan Johnson.
Some CEOs, like Michael Jefferies of Abercrombie & Fitch (ANF), are taking home more pay, despite the fact that their businesses have done so badly that their stocks have tanked and they have laid off many employees. And for the first time, many companies have slashed the salaries of rank-and-file employees. "That's historically been taboo," says Ken Abosch, head of the North American compensation consulting practice at Hewitt Associates.
The impression that Corporate America's pay practices are out of control has become so strong that the government has made the business of paying people its own responsibility. By the middle of October, the government's so-called "pay czar" will rule if the top pay packages for seven firms receiving significant amounts of federal rescue funds—including Citigroup (C) and General Motors—are inappropriate. The Federal Reserve is considering measures to curb pay at all financial firms to rein in risk taking. And members of Congress are asking companies that haven't received federal funds to reveal pay package details.
Talking to the Experts
Some smart companies have started to modify their compensation policies to get ahead of all of the negative attention. Already, "CEO compensation has fallen significantly," notes David Chun, CEO of compensation research firm Equilar. Sixty-four percent of the country's 100 largest companies have also implemented "clawback" provisions, requiring executives to return part of their pay under certain conditions such as malfeasance. This is up from only 17.6% in 2006.
But a lot more could be done. Consider this one telling metric: After the tech meltdown in 2001, CEO pay shrank by 14% in 2002. By contrast, in 2008 CEOs were paid only 8% less than they had been paid in 2007—during the grips of a much more severe and broad-based recession. By contrast, the pay schemes for average professionals have been altered in unprecedented ways. For example, many companies are abandoning base salary increases to rely more on individual bonuses as a cheaper way to encourage performance.
To better understand how the recession has transformed the pay landscape across the nation, BusinessWeek senior writer Emily Thornton recently spoke to two compensation experts: Don Delves, founder and president of executive pay consulting firm the Delves Group, and Ken Abosch, head of the North American compensation consulting practice at Hewitt Associates.
Below are edited excerpts from their conversations:
DONALD DELVES, FOUNDER AND PRESIDENT OF THE DELVES GROUP:
Have we seen any improvements in executive pay?
Corporate governance doesn't change overnight, so I don't want to rush and say that nothing has changed. There are some course corrections happening. Major money center banks and investment banks are at the center of the storm. But that group is very different and separate from the rest of the world. Most of Corporate America has taken the public's concern about executive pay very seriously. Ever since Sarbanes-Oxley, boards have been consistently improving their independence and oversight of executive pay.
Given that, I've been surprised that the rest of Corporate America hasn't been more vocal in its criticism or outrage about what the major money center banks are doing. Recently, Goldman Sachs (GS) CEO Lloyd Blankfein said there should not be guaranteed bonuses. That's like saying you should have indoor plumbing.
There is virtually no such thing as a guaranteed bonus in the vast majority of companies and bonuses in the tens of millions of dollars are unheard of. The last major guaranteed bonus that existed in Corporate America was the bonus Bob Nardelli received for running Home Depot (HD). [For most of] Corporate America, there has been significant change.
What about executive golden parachutes?
Instead of paying three times an executive's annual salary and bonus when there is a change of control, many companies are now paying only two times that amount or one time. There are also a number of companies that are getting rid of excise grossups [which compensate executives for the taxes they must pay on their payouts].
Companies are reducing the number of people covered by change of control agreements and they are reducing or eliminating perquisites, like the personal use of corporate aircraft.
Has the Great Recession had any impact on executive salaries and bonuses?
Salaries for executives are generally flat. But in many companies, like Molex Corp., CEOs have taken a larger salary cut than anyone else.
Bonuses paid in 2009 for 2008 performance were only down by 10%-15% on average. This seems like a small reduction in such bad times, but many companies were not severely affected by the downturn until the last two months of the year, and they still hit their numbers. Keep in mind that bonuses paid in 2008 for 2007 performance were also down. So there is a cumulative reduction of at least 20%.
So where have you seen the biggest change in executive pay?
The values of long-term incentive grants are down anywhere from 15%-25%. That's the most dramatic downward shift in executive pay that I've seen in the past 25 years. That's happened in part because the value of companies' stock is down. But it's also because most companies have not granted a lot more shares of stock to make up for the shortfall. If they grant about the same number of shares and options as in prior years, the value is significantly less. This is a significant downward shift in pay levels that is likely to be permanent, re-setting the bar at a lower level.
There are also movements afoot to develop principles for executive pay. At least two groups—the Independent Directors Executive Compensation Project, which is focused on the role of board members, and the Center for Executive Compensation, which is led by a group of senior human resources executives from major corporations, are proposing sets of principles and suggesting that companies and their boards voluntarily adopt them. This will give companies the opportunity to take the lead in improving governance of executive pay and in defining the game.
The idea is for companies and boards to voluntarily adopt a set of core principles like accountability, alignment, fairness, and transparency. While companies would also agree to some initial best practices under each principle, they would also be encouraged to develop and share new best practices. The result would be a peer-comparison process where companies challenge and lead each other to consistently improving pay practices. The principles and best practices would also be the basis for communicating to shareholders in annual proxy statements.
KEN ABOSCH, HEAD OF THE NORTH AMERICAN COPENSATION CONSULTING PRACTICE AT HEWITT ASSOCIATES:
How has the Great Recession affected salaries?
The base salary part of the equation has probably been the most dramatically impacted for most employees. Prior to the recession, we saw salary increases tracking just under 4%. We saw the number drop below 3% in 2008 for the first time ever. And it went below 2% and landed this year at 1.8%. This is a catastrophic change in approach to increasing salaries.
The outlook for 2010 is a slight recovery to 2.7% increases for the average professional worker. While some organizations may be breathing a sigh of relief to see that, to put it in perspective, if we had not experienced 1.8% this year, 2.7% would be the worst salary increase on record. So we're not out of the woods.
We don't expect any restoration in salary-increase activity back to pre-recession levels. Three percent is the new 4%. Because of the tremendous pressure that companies are under to cut costs and because base salaries are fixed costs, we don't foresee any recovery back to a 4% environment. Salaries represent for many organizations one of the top three expenses beyond equipment.
What about bonuses?
While we're seeing record-low budgeting for base salaries, we're seeing record high budgeting for bonuses. In 2009, organizations are budgeting 12% of their payroll for bonuses on average. That's the highest percentage we've seen in the 33 years that we've been recording this data. For 2010, the projection is close to 12%. Before 2005, companies budgeted between 9% and 10%. So the percentage has been trending up. What's counterintuitive is that the highest level of funding for bonuses is occurring in the heart of the recession.
We know companies this last year slowed the growth of salaries, froze them, and in some cases cut salaries. Regardless of which category a company was in, we found all of them had full funding for their bonus programs this year. That's indicative of a shift from fixed costs to variable costs, since bonuses are not additive costs. You pay them one time and they go away.
It's also indicative of the fact that organizations have turned to variable pay as the new pay for performance today. A lot of organizations are abandoning base salary increases as a way to incent performance.
Are you seeing other trends in this area?
We're seeing two other trends. One is a movement to include more employees in the program and [the other is] a movement to include individual performance. In the past, a lot of bonus programs reflected company performance. How much an employee feels he or she can control their bonus has historically been low. This movement to include individual performance is a sign that organizations want to move away from an entitlement mentality to a greater perceived control over the outcome.
And it's indicative that companies have shifted their focus to variable pay as the pay for performance vehicle of choice.
Have promotions suffered during the Great Recession?
Promotions got hit hard this last year. About 21% of companies reduced the availability of promotions. That number will be lower this year but [there will still be fewer companies offering promotions] than what we would see in a normal year. We wouldn't see any focus on reducing promotions in a normal year. Companies are still doing what they can to keep a lid on costs.
When employees didn't get a salary increase, a lot of managers try to get their employees promoted. It comes out of different money. There are salary budgets and promotion budgets. Since the bottom line for companies was survival, companies drew the line on promotions this year also.
Overall, what are your expectations for pay for employees this year? Will it be any better?
Better is a relative term. It will be better than last year. But if we didn't have last year, it would look like the worst year we ever had.
We saw almost half of companies freezing salaries last year. This year about 13% of companies will freeze salaries. But in a normal year we would see less than 1%. Companies have never been willing to reduce salaries until this year. And this year we saw 20% reducing salaries for some part of the workforce. It's one thing to slow the growth of someone's pay or to freeze someone's pay. But companies have never been willing to ask them to give back some of their pay, and yet they did that this year.
The good news here is that we don't see any companies planning on reducing salaries in 2010. That's a clear indication that things are getting better.