HOW CEO PAY GOT AWAY

By Daniel Kadlec

It's springtime, which means shareholder activists and Big Labor have taken up their favorite pastime: railing against runaway CEO pay. This year's batch of proxy statements provides plenty of ammunition. The corner office of a typical Fortune 500 company comes with annual total compensation of $7.8 million, an increase of roughly 50% over last year. CEOs make a good 200 times more than the average factory worker, even if you throw in the 3% raise that working stiffs gained in 1996. The pay disparity is five times greater than it was 30 years ago--and it's growing. You can almost hear the proletariat sharpening the guillotine.

But wait. The packages that give astronomical amounts to CEOs are exactly the deals that critics were clamoring for in the late 1980s. Then the bigwigs were pulling down huge salaries, out of proportion to company results. The solution? Link pay to stock performance. It seems to have worked like a charm. Corporate profits are at a record high, a task that is, after all, the CEO's job. Those lush profits have helped the stock market soar, as anyone with a mutual fund plainly knows. And it is that bull market that has turned millions upon millions of stock options into pure CEO gold, in cartloads unforeseen by anyone.

So why are shareholders so sore? Because, as usual, corporate America has a taste for excess, particularly in the sheer number of stock options being granted. With nearly half the Fortune 500 companies reporting, about 6% granted their CEO at least 1 million stock options last year. (An option gives the holder the right to buy stock at a preset price within a specific period of time, regardless of what happens in the market.) You don't need to take off your socks to figure that a stock gain of merely $1--a slam dunk for any company that is not soundly asleep--mints an instant $1 million for each of those CEOs. That's pay for showing up, not pay for performance. A growing number of CEOs get so-called megagrants, which are grants of stock options valued at more than three times the CEO's annual salary and bonus. Such grants are an increasingly large and irksome cost shared by all stockholders. The value of existing shares is diluted when new shares are created to hand over to the boss.

Most visible in the land of megagrants is Walt Disney chief Michael Eisner, who was just given options on an astounding 8 million shares, a value compensation experts fix at $196 million. Like most options packages, Eisner's cannot be cashed out all at once. They must be used over a period of years, and their true value will be determined by how well the stock does in that period. So, in a sense, it's misleading to put a value on them now. (Corporations are required to provide the value of the options either at the date they are granted or project their future worth.) On the other hand, by the time he fully cashes out these options--a mere year's worth--they could be worth more than half a billion dollars. And that is in addition to salary, bonus and free rides at Space Mountain. Counting the options, his 1996 compensation comes to $204 million. While Disney stockholders have done well under Eisner's long reign, Eisner himself has done even better. "Shareholders are starting to wonder whether it is just too much," says David Leach, executive vice president of Compensation Resource Group, a consulting firm based in Pasadena, California.

Another lavishly rewarded CEO last year was Lawrence Coss of little known Green Tree Financial, a company based in St. Paul, Minnesota, that finances mobile-home purchases. He was paid $102 million in salary and bonus. He was also given 2 million stock options valued at $35 million, presumably as an incentive. In his case too, shareholders have had much to cheer. They enjoyed a 47% return on their investment last year. But the huge numbers have people edgy. Could Green Tree not recruit a first-rate executive for, say, $50 million? "How much is too much?" asks Patrick McGurn, director of corporate programs at Institutional Shareholder Services. "Even if it's tied to performance, $102 million is outrageous."

More galling is exorbitant CEO pay at companies with laggard stocks. Gil Amelio, the new CEO of struggling Apple Computer, received total compensation valued at $23 million last year while Apple shareholders lost 40% on their investment. Nolan Archibald, CEO of Black & Decker, received total compensation of $6.5 million even though shareholder returns were a pathetic negative 13%. To be fair, in the case of Amelio, $16 million of his package was in stock options. That will prove vastly overstated if he can't fix what ails Apple, and if he does fix it, he's probably worth every penny. Archibald is an unusual case in that his compensation is all salary, bonus, long-term incentive pay and a special dispensation of $2.8 million to help pay his taxes; no options grants. Maybe he knew the stock was going nowhere.

The CEO-pay issue is beginning to feel like the start of a class war. Two weeks ago, the AFL-CIO launched a Website www.paywatch.org detailing CEO pay packages, producing an instant cyberjam among those trying to log on to feed their fury. There are now a dozen Websites devoted to executive pay. "It takes thousands, literally thousands of years to earn what your CEO takes home in a single year," fumes Richard Trumka, secretary of the AFL-CIO.

CEOs are never going to come cheap. The market for their skills is tight. Kodak's George Fisher got a two-year contract extension and 2 million stock options earlier this year when word leaked that he was under consideration for a job as president of AT&T. Kodak had poached Fisher from Motorola. Companies that choose to cut options grants will end up paying more in some other form of compensation, or losing their CEO.

So what's the answer? Shareholder activists had better think it over carefully because, as with stock options before, they just might get what they ask for. Cutting options grants today in favor of other incentives might prove to be a case of bad timing. The stock market is a self-correcting mechanism, even though it hasn't seemed that way in the 1990s. The market may finally be entering a long overdue cooling period, which would naturally fix some glaring excesses in CEO pay--so long, that is, as companies resist the inevitable CEO pleadings to revise their pay deals in a flat or falling market.

One solution embraced by the likes of DuPont and BankAmerica is to grant CEO stock options that can be cashed only after the stock has risen a specified amount. That way a CEO doesn't make a killing unless the stock really zooms. An even better answer is to devise stock options that are indexed to the market or some peer group. They would remain worthless unless the stock outperforms its competitors. Some have suggested the CEOs be required to buy stock above the market price, but that incentive could hurt workers, since a time-honored method of making the stock price jump is to slash jobs. But something has to give, and the CEOs know it. Shareholders will continue to reward extraordinary performance, but being at the helm in a favorable tide doesn't qualify.

--Reported by Bernard Baumohl/New York

With reporting by Bernard Baumohl/New York