Executive Pay

While the CEO gravy train may be slowing down, it hasn't jumped the rails. In 2000, despite weakening returns, U.S. company chieftains bagged on average a princely $13.1 million

Joseph M. Magliochetti watched helplessly last year as his market crumbled. The CEO of auto-parts maker Dana Corp. (DCN ) saw North American heavy-truck production tumble, the Big Three Detroit auto makers scale back production, and demand for replacement parts weaken. Despite his best efforts, sales at the Toledo company fell 6%, profits plummeted 44%, and Dana's stock lost more than half its value, turning most of Magliochetti's stock options into so much worthless paper.

By almost any measure, Magliochetti was still rewarded handsomely. The Dana board gave him the $850,000 salary it had promised him in December, 1999, based on strong sales and profits for that year, and an option grant to bring him in line with his peers. But it stripped him of his bonus and stock grant, awards that had brought him a cool $1.8 million in 1999. The board cited his failure to beat goals for net income growth and return on invested capital. In all, Magliochetti's pay in 2000 came to $948,363, down 63% from 1999, making him one of only a handful of top executives to bring home less than $1 million. That's right: In setting Magliochetti's pay, the board in effect said: "The company failed to prosper, and we're holding you accountable."

Makes sense, right? Not in the world of executive compensation. In fact, Dana's actions are extraordinary compared with the way most corporations responded to sluggish performance in 2000. While shareholders got hammered, many compensation committees scrambled to cushion their chief executives from feeling any real pain, granting massive blocks of new stock options in some cases and in others forgiving corporate loans. The average CEO, riding a still-hot market for top management talent, earned a stupendous $13.1 million last year, according to the results of BusinessWeek's 51st annual Executive Pay Scoreboard, compiled with Standard & Poor's Institutional Market Services, a division of The McGraw-Hill Companies. Cash compensation for the CEOs at 365 of the largest U.S. companies increased 18% in 2000, while total pay increased 6.3%. That far exceeds the 4.3% pay hike that salaried workers got last year, and it widens still further the yawning gap between the boss and the rank and file.

As usual, compensation committees handed out perks like candy. Retirees were showered with the standard gifts: lucrative consulting jobs, company cars, and hefty pensions. John F. Welch of General Electric Co. (GE ), who is set to retire at the end of the year, got a pay package valued at $122.6 million in recognition of his "20 years of outstanding service as CEO." And you didn't have to leave to be generously rewarded. Apple Computer Inc.'s (AAPL ) Steven P. Jobs landed the mother of all bonuses after three years of working for free: his own $90 million jet, a Gulfstream V.

IN TEARS. But while the CEO gravy train hasn't run off the rails, it is slowing down. The increase in total compensation was the smallest in five years, and 2000 was the second consecutive year of slower executive pay growth. The reason had little to do with anything decided by boards of directors, though: The same market crash that had investors in tears made many executives' stock options worthless. An analysis by compensation consultants Pearl Meyer & Partners Inc. found that the five hardest-hit lost a total of $62 billion in paper wealth. And with far fewer executives able to cash in, overall CEO pay growth slowed. Still, there was some evidence that more boards, like Dana's, were toying with the notion that CEOs should suffer along with their shareholders. Last year, 26% of CEOs saw their cash compensation decline, compared with 19% in 1999. Schering-Plough's (SGP ) Richard Jay Kogan, Whirlpool's (WHR ) David R. Whitwam, and Texas Instruments' (TXN ) Thomas J. Engibous all lost portions of their bonuses.

All of which raises an interesting question: Will compensation committees wield a carrot or a stick as they meet to calculate CEO rewards in 2001? Some boards are building tough performance goals into future stock and option awards, raising the possibility that some big-name executives who don't meet the goals could walk home with much less this year. With the Nasdaq more than 50% off its high by the end of last year, and the Dow Jones industrial average and Standard & Poor's 500-stock index both well off their high-water marks, many options will take months, maybe years, to recover. And if corporate profits continue to slide, few companies will be able to justify giving out big bonuses for great performance in 2001. Says Peter Chingos, head of the executive compensation practice at consultants William M. Mercer Cos.: "We're seeing a more conservative movement in compensation increases, largely because of what happened with stock prices. I don't think this is going to go away overnight."

For now, though, pay cuts remain theoretical for most CEOs. The 20 highest-paid earned an average $117.6 million, up from $112.9 million in 1999. The biggest pay package went to John S. Reed, the former co-CEO of Citigroup (C ). Reed, who left the firm in April after a power struggle with co-CEO Sanford I. Weill, brought home $293 million, almost entirely by exercising options. As a group, the 20 highest-paid CEOs were almost evenly divided between Old Economy and New. Among those making repeat appearances: John Chambers of Cisco Systems (CSCO ), Welch of GE, and Michael D. Eisner of Walt Disney (DIS ).

Some hard-hit companies caved in when it came time to get tough with their underperforming CEOs. Walt Disney Co., for example, gave CEO Eisner a salary increase, 2 million stock options in Disney Internet Group valued at $37.7 million, and an $11.5 million bonus--after three years in which net income fell by more than half from $1.9 billion in 1997 to $920 million. Other executives exchanged worthless options for new ones, or benefited from repricings. At Compaq Computer Inc. (CPQ ), which saw shares tumble by nearly half last year, Michael D. Capellas had a $5 million loan from the company wiped off the books. He borrowed the money, which will be forgiven over three years, to buy Compaq stock. Still others, stuck with huge tax bills from unprofitable options exercises, had those transactions canceled. The Internet service provider now known as Telocity Delaware Inc. did that for 75 employees, including a director and six top executives. The company declined comment.

INCENTIVES. Still, after years of paying lip service to the idea of pay for performance, at least a few companies took extraordinary steps last year to link the two. At Coca-Cola Co. (KO ), CEO Douglas N. Daft was granted $87.2 million in restricted shares--but he will get the full amount only if he manages to increase earnings per share by 20% a year for five years, a task analysts say may be difficult, if not impossible. Coke compensation committee Chairman Herbert A. Allen said that management considers the goals "aggressive but realistic," adding, "we'll see in five years." Staples Inc. (SPLS ) CEO Thomas G. Stemberg got 100,000 restricted shares, worth $1.4 million, which vest in 2005--or earlier if earnings goals are met. Says Stemberg: "Our philosophy is one of low pay combined with strong equity rewards." Of course, low pay is a relative term: Stemberg also took home nearly $1 million in salary and bonus. His $2.4 million total pay, while down 27% from 1999, was hardly a pittance.

Lawrence J. Ellison, CEO of Oracle Corp. (ORCL ), took that low-pay philosophy even further. After watching his paper wealth decline by nearly $10 billion, to $41 billion, in 2000, according to Pearl Meyer, Ellison opted to eliminate his salary and bonus through 2004 and take a huge option grant--20 million shares--that is supposed to last him for the next three years. And at Tyco International Ltd., CEO L. Dennis Kozlowski needs to beat tough earnings goals to exercise 900,000 options he was granted last year. But he's not worried. "I have all my eggs in this basket," Kozlowski says. "But I'm watching this basket real closely."

Those were the exceptions. Overall, the link between CEO pay and company performance remained fuzzy. The top spot for shareholder return relative to pay went to David M. Rickey of Applied Micro Circuits Corp. (AMCC ), who delivered a giant 4,751% for a mere $4.5 million in pay from 1998 through 2000--in marked contrast to last year's winner, David S. Wetherell of CMGI Inc. (CMGI ), who was paid $1 million less and delivered returns nearly three times as good. Rickey also sold millions of dollars' worth of stock in December and January, and the stock has since lost 80% of its value. At the bottom of the performance heap, Charles B. Wang of Computer Associates International Inc. (CA ) earned $698.2 million from 1998 through 2000 and produced a dismal shareholder return of -63%, making last year's loser, Eisner of Walt Disney, look like a bargain. Eisner was paid $60 million less from 1997 through 1999 and earned 28% for shareholders during the same period. CA says Wang helped increase shareholder value 901% in the 1990s. He also agreed to return more than 20% of his 1998 pay--2.7 million shares, or $150 million, according to the company--to settle shareholder lawsuits over a special grant of stock to Wang and other top company executives.

CA was among several companies that said their CEOs were worth every penny of their pay. Some complained that it was unfair to count options exercises as compensation, as BusinessWeek does, since most were granted several years earlier. Others said CEOs don't realize options riches unless all shareholders benefit from a soaring stock. Another criticism was that our performance criteria are too narrow, in some cases not reflecting outsized shareholder returns or a company's profit growth. At American Home Products Corp. (AHP ), where former CEO John R. Stafford topped the list of companies with the worst return on equity relative to pay, spokesman Lowell B. Weiner said our analysis is distorted by the heavy costs related to lawsuits filed over the Fen-Phen diet drug controversy. During the same period, AHP logged a 75% return to shareholders. Says Weiner of the analysis: "It makes us look bad, and in reality we've got a lot of good stuff going on."

Compensation consultants say the growing gap between pay and performance is partly the result of companies' using new measures to gauge performance. By using comparisons such as earnings per share and return on equity, a CEO whose stock is going to the dogs can still sometimes come out ahead in pay. Case in point: CMGI. The Internet incubator more than doubled Wetherell's bonus, to $481,400, on the strength of operating income--even though the company ended its 2000 fiscal year in July with a $1.3 billion net loss and with the stock down 18%. CMGI says Wetherell was underpaid compared with his peers and deserved the boost based on the prior year's performance. Says Scott Olsen, leader of the executive compensation practice at consultants Towers Perrin: "If the board likes a CEO, it's likely to do whatever it takes to keep him."

But rewarding a CEO when the stock is plummeting presents its own set of dilemmas. For one thing, option grants have to be bigger: A $10 million grant costs a company only 100,000 shares when the stock is trading at $100, but 5 million shares when it's trading at $2. And few institutional investors are willing to put up with that kind of dilution. A showdown is brewing over the issue. This year, institutional investors have filed more than 50 shareholder proposals targeting executive pay that will be voted on at annual meetings.

At the same time, top executives who have been burned by the market are starting to demand tangible rewards in the here and now: more cash, bigger bonuses, and other perks to offset the risk of options. In a booming economy, options were the incentive of choice because gains could be astronomical, and they belonged to the executive whether he stayed at the company or left. Now there's a new favorite: restricted shares, which typically vest after several years provided the executive remains employed at the company, and are safer than options because they always retain at least some value. A few years ago, says consultant Olsen, executives would hold out for the biggest option grants possible. Cash and bonuses were viewed as positively dowdy. "I don't hear as many people saying that now," Olsen says.

When the economy and stock markets were roaring, CEO pay rocketed along as well. Now that the longest expansion in U.S. history has ground to a halt, though, few companies seem eager to transfer the pain to executive paychecks. If anything, the market for top-flight CEOs is as tight as ever, says Patrick S. Pittard, CEO of executive search firm Heidrick & Struggles International Inc., as troubled companies seek would-be saviors. "It has never been more expensive," he says. Still, if shareholders continue to suffer the kinds of market losses dished out in the first quarter, even the thickest-skinned boards may have a hard time upping the pay for underperforming CEOs in 2001. In that case, look for the gravy train to creak to a halt.

By Louis Lavelle

With Frederick F. Jespersen and bureau reports

— With assistance by Frederick Jespersen

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