Commentary: Smoke, Mirrors, And The Boss's Paycheck

It's not every day that a corporate chieftain offers to give up a full year's salary if his company fails to meet an earnings target. By making that pledge, Union Carbide Chairman and Chief Executive William H. Joyce raised eyebrows and made headlines last week. News reports indicated that Joyce, who earned $2.1 million last year, would forfeit his base salary--currently $850,000--if his company does not earn at least $4 a share in 2000. An additional 16 senior execs will give up 65% of their salaries if the target is missed.

Before anyone anoints Joyce a pay-for-performance hero, however, a closer look at his pay plan is in order. Chalk this one up to clever public relations. Although it's unlikely to dent Joyce's wallet or stoke up Union Carbide Corp.'s performance, as a PR ploy, it worked like a charm. Joyce garnered favorable headlines in major newspapers and cheers from investors. "People are so cynical about executives having their snouts in the trough that anyone who raises his head for a few moments is considered a hero," says Graef "Bud" Crystal, the executive pay consultant and critic. "No one expects an American CEO to give back anything."

But will it make much difference in how the company does? Union Carbide, of course, argues it will. Although Joyce declined to comment, a spokesperson says he made the move in the face of skepticism by investors that Carbide will make $4 a share in 2000, when an industry down cycle is expected. Criticizing most incentive plans, Carbide's vice-president of human resources Malcolm A. Kessinger says: "Pay for performance is a carrot without a stick. You don't get rewarded for missing a target, but you don't lose anything either."

Carbide's new pay plan is far more nuanced than initial reports indicated, however. Rather than giving up his entire salary in the year 2000, for example, Joyce will give up a third of his base pay in each of the next three years. It's worth noting that his base pay has jumped nearly 55% in the past two years, from $550,000 in 1995, when he became CEO. So what he's putting at risk is less than the raises he has already racked up.

If Carbide misses its target, Joyce will lose that money. But in return, he stands to gain far more. Joyce will get "additional incentive compensation" up to eight times the salary he is forsaking if earnings hit $4.75 a share in 1999 and 2000. And the payoff could be even higher because that pay will be converted into "phantom shares" of stock--at current prices. If he delivers the goods, he'll benefit from any uplift in the market.

Moreover, on the face of it, Joyce hasn't staked this bet on a very tough hurdle. Sure, analysts foresee a downturn starting in 1998 for Carbide, which earned $3.90 a share in 1996 and is expected to make $4.40 a share this year. But linking pay to earnings per share is not a good idea, since it's one of the most manipulable of all accounting measures. To hike EPS, a CEO could sell assets, slash marketing costs or research and development expenses, defer investment--or simply buy back shares. "When you have a compensation arrangement based on a single profitability measure, it's almost certain it can be manipulated to get the desired result," warns Howard M. Schilit, president of the Center for Financial Research & Analysis in Rockville, Md.

WHAT STICK? It's also far from clear that Joyce's pay will really take a hit. Union Carbide concedes that his pay packet each year will be balanced out by "variable compensation." In other words, Joyce could more than make up any salary loss with cash bonuses and stock plans. Last year, these alone paid him $1.4 million, not including options on 130,000 shares. If Carbide stock rises by 10% a year over the 10-year option term, they would be worth $9.5 million.

Under a meaningful plan, a CEO would no longer be paid millions simply for riding the cyclical wave of an industry upturn or a bull market. Such a plan would base compensation on goals set against an industry peer group over multiple years. Every cent beyond his base salary would then be paid only if he outperformed Carbide's main rivals on key targets such as return on equity or assets. Even option gains would come only after the shareholders have reaped their rewards and only after a company has done better than its peers.

Don't hold your breath. Few boards of directors and still fewer CEOs want to put that much on the line. Until then, we'll have to do with gestures that have more public-relations value than real impact.