Chief executives of U.S. companies, used to receiving million-dollar bonus checks at the end of the year, should prepare to get by with a lot less this time around.
As corporate boards begin discussing 2008 bonus awards, it is a near certainty that U.S. CEOs will get smaller checks—and many will not get bonuses at all. To blame are the plunge in the stock market, the financial crisis, the downturn in the economy, and also an environment that makes hefty bonuses toxic in the arena of public opinion.
Still, many wonder how much boards will really cut back on one of their favorite ways of rewarding senior executives. A steep drop in bonus awards would be a marked contrast with previous years.
According to executive compensation research firm Equilar, as recently as 2006, 96.6% of CEOs in the S&P 500 received a median $1.9 million in cash bonus compensation at the end of the year. As the financial crisis began in 2007, those figures fell somewhat, with 88.4% of CEOs receiving median bonuses of $1.84 million.
No one knows how low bonuses could go in 2008, or how rare they might be.
The Pressure's On
Nell Minow, co-founder of the Corporate Library, which focuses on corporate governance issues, says institutional investors are watching boards, and their compensation committees, carefully. "There will be very powerful calls for the ouster of comp committee members who do not cut back on bonuses this year," she says.
Board members know they're being watched, say many consultants who specialize in executive compensation. In 2007, bonuses fell mostly on a company-by-company basis, says Steven Hall, managing director of Steven Hall & Partners. "You're going to see everything down this year," Hall says, with "big time" declines in financial services and housing industries.
Many boards have no choice but to slash bonuses. At the start of each year, most boards set and disclose specific criteria for yearend bonuses. If those benchmarks—which might include particular revenue or profit targets—aren't met, no bonus is supposed to be paid.
Even if most benchmarks are met, boards in this environment might use their discretion to limit or cancel a bonus, says Lance Froelich, a compensation consultant and senior director at BDO Seidman. Numbers might still look O.K., he says, "but you can't ignore the cash position of the company [or] the fact that shareholders have been hurt."
"No, Thank You"
It's not just boards that are showing resistance to bonus payouts in 2008. CEOs also may want to limit their own compensation—at least temporarily—for appearance's sake.
Goldman Sachs (GS) Chief Executive Lloyd Blankfein and six other senior executives said last month that they would forego all bonuses in 2008, including both cash payouts and equity awards or options. A spokesman for the investment bank said it was the "right thing to do."
At the end of 2007, it appeared that Goldman was one of the best-run Wall Street firms and might withstand the credit crisis better than many rivals. Blankfein was the ninth highest-paid U.S. CEO in 2007, according to the Corporate Library. His cash bonus was $30 million of his total $76.7 million pay. But Goldman's stock is down 68% in 2008, and, after the collapse of Lehman Brothers, Goldman was forced to turn itself into a bank holding company and apply for federal bailout funds.
Hall says he knows of several other CEOs that have privately told their boards that they don't want a bonus this year. Executives "want to set the right tone," Harris says, adding executives are thinking: "Yeah I'm entitled to a bonus, but how is this going to look to my employees as I'm cutting back on staff?"
Boards and executives are focused on morale and fairness at a time when a vast array of companies have already laid off workers or are planning job cuts in the coming months. "The worst thing that could happen is for executives to get something, and the rank-and-file zero out," Froelich says.
This reluctance to pay out generous bonuses doesn't mean some high-profile CEOs won't get big payouts in 2008—and get criticized severely for them.
Nor would a temporary drop in bonuses satisfy critics who believe boards show far too much deference to executives, and who believe U.S. corporate brass are paid far too much. The debate over CEO pay has spilled over into the political arena. Chief executives at Ford (F) and General Motors (GM) said they would limit their salaries to $1 per year if U.S. automakers get federal help. President-elect Barack Obama as a senator was a sponsor of a federal "say on pay" bill, which would require a shareholder vote on executive compensation packages. Such a proposal may have an easier time passing with Washington dominated by Democrats.
One factor that could keep bonuses high: Boards remain concerned about retaining and motivating talented executives. "The boards [are] walking a tightrope between trying to keep performers in place and shareholder oversight responsibilities," says Kevin Nussbaum of CBIZ Human Capital Services (CBZ). "If you've got a group of superstars, you'd better be worried about what's keeping them at your company."
Equity Loses Charm
Cash bonuses have increased in recent years, but equity compensation has become even more popular as a long-term incentive, with the stock or stock options paid out over many years. Equilar research manager Alexander Cwirko-Godycki notes 60% to 80% of pay packages are typically in stock.
As stock prices plunged in the past year, the value of past years' stock awards has also plunged. Without a huge market rally, many executives now know they may never profit from their stock options.
Without these equity incentives holding CEOs to companies, several compensation experts said boards are seriously worried executives could get scooped up by competitors. Rivals could grant new stock options, priced at the market's current low level.
With perks going away and bonuses canceled, "you have to start worrying how do we keep that person in place," says Don Lindner, a compensation expert at the human resources association WorldatWork. As a way to retain executives, equity is "not near the tool it used to be."
Minow says all this worry about keeping talent is "a little silly." Based on companies' performance in the past two years, CEOs "haven't done so well," she says. "Maybe we'll get people who could do better."
Nowhere to Go
Moreover, though superstars might always have other employment prospects, many executives don't have anywhere to go in this climate. CEOs contemplating a job change "don't know if [they're] jumping from the frying pan to the fire," Hall says, adding that retaining execs could be a bigger issue when the economy recovers in two or three years.
But the biggest compensation conundrum facing corporate boards may not be 2008 bonuses or keeping execs long-term, but what to do about 2009. "How do we design next year's incentive plan to be sure we can get the best performance out of executives in a very difficult time?" Lindner asks.
Almost no one—neither economists, executives, investors, nor policymakers—knows what to expect from the economy and financial crisis in 2009. Set the bar too low and you'll be accused of coddling executives. Set the bar too high, and a bad economy could make your goals impossible to meet.
One way to solve that problem is to judge CEOs by how well they perform compared to competitors, rather than setting specific goals, Lindner says.
After so much went wrong in 2008, many investors would be justified in wondering if any executive deserves a bonus. But companies still need good CEOs, and that's especially true in the current economic environment. The trick for compensation committees: Finding the right level of reward—and restraint—in these tough times.