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Shareholder Revolt Is your CEO Worth $39 Million

January 1, 1999
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Related Topics: Finance/Taxes, Compensation Design and Communication, Strategic Planning, Featured Article
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Charles Collins refers to the Washington Monument as a measuring stick. As co-director of Boston-based United for a Fair Economy (UFE), he focuses public attention and action on economic inequality in the United States. Whenever he’s asked to speak, he invites the audience to imagine the following: "If the Washington Monument is 555 feet tall and reflects the average 1997/1998 CEO paycheck, guess how tall the average worker’s paycheck would be?"

Answer: 21 inches. Yes, in 1998, CEOs were paid approximately 326 times the pay of factory workers, according to UFE. "[Years ago], it would have required a pick-up truck to transport the workers’ equivalent of the Washington Monument. By 1996, you could carry it on an airplane and put it in the overhead luggage bin. Today’s model fits easily into the little space under the seat," he says.

It’s no wonder that corporate shareholders increasingly are voicing their outrage at runaway CEO pay. Shareholder resolutions dealing with executive pay have become vociferous ways for shareholders to stir debate within the corporations. And it’s all happening with greater visibility—and media attention—on the corporate board level.

Indeed, within the last several years, resolutions dealing with executive pay have steadily increased. In 1997, shareholder action reached an all-time high of 127 executive compensation-related resolutions. By March, more than 70 resolutions already had been filed by shareholders, according to Washington, D.C.-based Investor Responsibility Research Center.

One of the resolutions was filed by Franklin Research and Development and UFE at Fairfield, Connecticut-based General Electric Inc. (GE). The resolution asked General Electric to set its own cap on executive compensation as a multiple of the pay of the lowest paid worker. The resolution was prompted when GE’s CEO John F. Welch became the 15th highest paid CEO in 1996. He was ranked number 11 in 1997 with a total compensation package of $39 million.

It’s like a domino effect that clearly impacts HR: Savvy shareholders monitor their investments and look to the board of directors to protect their interests. The board of directors looks to the CEO to lead the company and ensure shareholder profits. But when the CEO fails to raise stock prices, very often the board either fires the top executive or forces him or her to resign.

Therefore, today’s movement for responsive corporate governance is further challenging HR to sharply align CEO recruitment, compensation and succession planning with shareholder interests. These issues might not register on your radar screen, but you’re certain to feel the effects. "With downturns in the stock market, we predict a faster turnover in top CEO ranks during the next year," says Jeffrey E. Christian, president and CEO of Christian & Timbers, an executive search firm based in Cleveland.

So all you HR executives out there, be prepared. A CEO’s departure is just the beginning of a personnel nightmare. Your next level of managers may lose confidence and seek greener pastures in the competitor’s front yard. By paying more attention to the big picture, you’ll be better able to ensure your CEO’s expected accountability to the board—and measure HR’s executive recruitment and compensation practices against shareholders’ interests. If shareholders seemed to you like a faceless entity in the past, don’t be fooled. Whatever pressures they bear on the board will affect your CEO—who, in turn, will depend on you to provide timely, wise and useful input about these hot corporate governance issues.

How has corporate governance changed?
Being a shareholder of an American corporation not only entitles one to a stake in the firm’s financial rewards through dividends and stock appreciation, but also a stake in the way the corporation is governed. Most shareholders are aware of their right to such things as election of directors and increases in the number of shares the corporate issues. Shareholders also have the right to introduce resolutions for all shareholders to consider and vote upon at the annual shareholders’ meetings.

Such resolutions have been actively used for nearly four decades to raise issues of corporate responsibility—issues that often get short-changed in the management of modern business, according to UFE.

In order to file a shareholder resolution, a shareholder must own at least $2,000 worth of the company’s stock for a period not less than one year as of the filing date of the resolution. The proponent of each resolution (or the proponent’s representative) also must be present at the annual meeting to introduce the resolution. Each shareholder may only introduce one resolution per company per year. The resolutions must be filed by a prescribed date that’s usually four months before the first anniversary of the previous year’s annual meeting.

By definition, corporate governance is the effective balance of obligations and responsibilities to different constituencies: customers, employees, the community and the environment. The movement—or revolution—has come into its own in the last decade. Three social forces have propelled changes in the way today’s corporate boards are expected to be structured and function: the movement toward a global market economy; the growth in stock ownership by institutional investors (those of public and private pension funds); and the change in legal regulations of proxy solicitations.

"Corporate decision making has become more accountable to the true owners of every company: the shareholders," says Richard Koppes, former general counsel of the California Public Employee’s Retirement System (CALPERS) and co-director of the executive education programs at Stanford University Law School in Palo Alto, California. "There are too many boards that overlook more than they oversee."

But institutional investors (large state and municipal employee and teachers retirement plans), such as CALPERS, are wielding their political clout and have become among the most visible leaders in corporate governance issues. That’s because pension holdings, for example, account for more than $5 trillion.

Therefore, today’s directors must assume heavier burdens than before. They have a more complicated legal duty and moral mandate to be the shareholders’ representative. Whereas in the past it was enough for board members to simply attend quarterly meetings, today demands are greater.

Directors must review and approve mergers and acquisitions, answer the demands of institutional investors, and hire and fire executives and set their compensation based on targets that constantly shift. All the while, they’re being scrutinized by the media and three basic groups: religious investors, activist unions and economic fairness organizations, such as UFE.

For example, a landmark resolution was filed in 1997 at Basking Ridge, New Jersey-based AT&T Corp. by U.S. Trust Company of Boston and the Women’s Division of the United Methodist Church, according to UFE. It asked the company to freeze executive pay during periods of downsizing. The resolution garnered 14 percent of shareholder votes, representing 150 million shares, the largest vote ever on a resolution of this type. Although the resolution didn’t pass, AT&T’s new CEO Michael Armstrong acknowledged the importance of this vote by freezing the salaries of the top 450 executives when AT&T announced a new round of layoffs one year ago.

Another shift in corporate governance has been the balance of power within the boards. According to recent proxy statements, boards are made up largely of independent outsiders who provide oversight of corporate strategy and are empowered through executive evaluations, compensation reviews and management succession plans to work as an effective body with the CEO, as opposed to their just rubber stamping recommendations made by management, according to Craig L. Fuller, chairman of global board services practices at New York City-based Korn/Ferry International, an executive search firm.

The average U.S. board today is dominated by outside directors who hold 9 of 11 director seats—leaving only two seats for inside directors. Last year, U.S. corporate boards comprised CEOs and COOs from other companies, retired executives, investors, former government officials, academicians and bankers.

In terms of diversity, women and minorities have been making slight gains in the corporate boardroom. In 1973, virtually all directors were white and male. Fifty-five percent of all boards now report an ethnic minority member, up from 7 percent in 1973. Ten years ago, 31 percent of the companies reported a minority board director. Moreover, 72 percent of all boards report at least one woman director, up from only 11 percent 25 years ago, and ten years ago, when 58 percent of the boards reported having a woman on the board.

"A major board reformation is underway," says Richard Ferry, chairman of Korn/Ferry International. "Board nominating committees have been important factors in the shift from insiders to more independent outside directors."

But keep in mind, once the board is in place, the top priorities of any board is the selection, evaluation and succession of the CEO. HR can play an important role in this process by working with executive recruiters to articulate and balance the company’s management needs and the board’s interests.

Executive recruitment is going through the roof.
CEOs have always been accountable for the overall performance of an organization. But their feet haven’t been held to the fire as much as they are today, says Robert C. Muschewske, senior vice president, executive services of Minneapolis-based Personnel Decisions International. So it’s no surprise to read about the forced resignation or firing of a CEO on any given day. The increased risks attached to a CEO position today is a headhunter’s dream. "Executive search firms are a growing field," he says.

During hot economies, many CEO blemishes are covered up. Problems can’t be seen so it’s easier for a board to put up with the negative qualities and impact a CEO may have on the company. That’s not so when the numbers aren’t there. Boards are then faster to fire or force resignation of the CEO. Like never before, a no-tolerance policy is in effect right to the top, says Christian. "There’s been a 6 percent CEO turnover in the Fortune 100 within the last year."

Therefore, HR executives are likely to call upon executive recruiters more than in the past. Executive Recruiter News projects the industry will grow at an average annual pace of 13 percent through the year 2000. Executive recruiters will work with HR to articulate the job requirements, and identify and scrutinize potential candidates.

However, one of the major problems with executive recruitment is the shallow pool of executive candidates who have a grasp of emerging technology, global issues and the necessary leadership qualities to orchestrate the varied interests, ranging from shareholders to employees. Whether you’re replacing a CEO, searching for new board directors or hiring for other top executive posts, HR can facilitate these searches by clearly establishing the job descriptions, the interview process and protecting the corporate culture.

Michael Nieset, of Christian & Timbers, says he often works closely with HR professionals in conducting executive level searches. His interaction varies from project to project.

Typically, HR plays a leading role to ensure that the recruiting process is successful. "Great HR executives can, and often do, make the difference between a good search and a great search," he says. HR’s ability to monitor the organization, to advance the process and select the candidates until they’re hired is a very important task.

CEO compensation—what’s enough?
Recruiting aside, if there’s any one area that ignites debate, it’s the topic of how much executives are paid. One of the greatest challenges facing today’s boards is striking balance between CEO compensation packages with the pressures from outside to cap CEO pay. Labor unions, in particular, have drawn public attention to the pay gap.

In fact, the AFL-CIO has a Web site called Executive PayWatch. Employees can click onto a site that will post the compensation package of a particular CEO. One page devoted to Boston-based Fleet Financial Group, for example, says that CEO Terrence Murray receives an annual compensation of $6 million. In addition, he receives $16.4 million in stock option grants, $3.7 million in stock option exercises and $22.2 million in unexercised stock options.

Below the figures is a brief narrative explaining that "although Terry Murray has served as president and CEO of Fleet for 16 years, the compensation committee awarded him 825,000 additional stock options in 1997 as part of a retention strategy. Apparently, the $22 million worth of unexercised stock options he holds was not sufficient to motivate Murray to stay at Fleet."

The story goes on to explain that while Murray has garnered millions as the CEO, Fleet customers and government regulators have been less than happy with the financial-services company. Fleet reportedly agreed to settle with the U.S. Justice Department over allegations that it had charged blacks and Hispanics excessive fees or interest rates.

Examples such as the one above illustrate why today’s compensation subcommittees of a board are perceived as running amok. "There’s been a lack of accountability on their part," says Collins. There’s no question that in terms of the industrialized world, there’s no country that comes close to the disparity in top CEO pay and average worker pay. In countries such as Germany, the ratio is much less—around 21 to 1.

Of course, corporate leaders deserve a unique compensation package—above and beyond the average manager and employee. But the HR question is how can a board do this while satisfying the usual critics, such as shareholders, board members, rank-and-file employees and the media?

In an article published in Solutions magazine in October 1996, authors Thomas E. Miller and Kenneth G. Gibson say the challenge of building an effective compensation program lies in a company’s ability to establish a balance between short- and long-term compensation in concert with the corporation’s performance standards.

It’s no wonder that compensation committees have become one of the most important standing groups on today’s corporate boards. Executive compensation generally includes base salary, short-term incentives (annual bonus), long-term incentives (stock options), executive benefits (insurance, deferred compensation) and perquisites (company car, special parking privileges, club memberships).

The committee’s role—along with HR’s input—is to provide a compensation package that attracts and retains the best executives or CEO in a highly competitive market.

Ask Ed Walsh, director of HR at Camden, New Jersey-based Campbell Soup Company. Walsh worked directly with the board’s compensation and organization committee to appoint a successor to the company’s retired CEO, David Johnson. Walsh helped design the compensation package that intended to attract the new CEO and also accommodate the board’s interests.

Corporate boards such as Campbell’s are moving toward a pay-for-performance mentality that ties compensation closely to the performance of the company. The thinking is that if a CEO owns stocks in a company, he or she will have more personal stake in making the company’s stock go up in value.

Miller and Gibson also say CEOs and executives need to hear this message: "We want you to stay, we want you to contribute, and we want you to be compensated well. If you choose to stay until retirement, we want you to approach that transition with confidence and dignity. But rewards will come only to those whose contributions are consistent with the corporate mission and objectives, not to those who merely render services."

They offer the following guidelines to develop compensation and benefit plans that not only silence critics, but convert them to be advocates of the issues they now target:

  • Develop a corporate-executive compensation statement.
  • Examine the current statement to the newly articulated one.
  • Begin exploring alternatives.
  • Explore financial impact.
  • Ask what financial result will be obtained, and how those results relate to short- and long-term costs.
  • Assemble the puzzle.
  • Present the statement to the compensation committee, owner and partners.
  • Communicate with all participating executives.

Clearly, no company will survive the next decade without a proper focus on executive compensation. However, HR can help balance short- and long-term compensation in concert with the corporation’s performance standards by working closely with the board compensation subcommittee. Once the CEOis selected and hired, pay attention to how you develop the CEO’s job description, and measure his or her performance.

Ensure executive development and succession planning.
Very often, finding the right CEO is just the beginning. With closer scrutiny and tougher standards by which to judge performance, CEOs can be fired or forced to resign within months of hire. The key is to evaluate CEOs fairly and to establish clear guidelines for doing so.

According to Korn/Ferry International’s 25th Annual Board of Director’s study, released last year, 72 percent of 1,020 boards surveyed said they have a formal process for evaluating CEO performance. In 89 percent of the cases, performance is measured against a set of targets to which the board and CEO agree to at the beginning of the year. For 92 percent of the cases, the process includes a formal feedback session with the CEO, often in written form (30 percent). Of the companies that offer written feedback, 72 percent find the process effective.

Muschewske says that he has worked closely with many firms to design a CEO evaluation that works. After reviewing a number of case studies, he developed the following steps—all of which HR can help oversee in one’s own company:

  • Develop a CEO position description.
  • Identify a specific goal for the year.
  • Present the CEO’s self-appraisal.
  • Distribute a CEO evaluation booklet.
  • Prepare a performance evaluation summary by the executive recruitment consultant.
  • Present the evaluation summary at the board meeting.
  • Present the performance evaluation to the CEO.
  • Evaluate the process.

HR managers can conclude the last step by posing the questions: Did the process work and was it effective? Why or why not? If not, hopefully your board has been wise enough to anticipate succession planning. "This should be the first priority for any corporate board," says Nieset of Christian &Timbers.

By succession planning, Nieset isn’t just referring to replacing a CEO. Today, succession planning is more about executive development and keeping your entire board and organization talent rich. Gone are the days of ‘croneyism’ rule. Given today’s competitive market, corporate boards need to be endowed with independent thinkers and proven experts in their respective fields.

"There needs to be someone at the table who challenges the Great Man Theory and asks the questions, ‘How does our overall compensation structure affect teambuilding, efficiency and productivity, or example? What are the down sides?’" says Collins.

Without business integrity advocates, a company could end up like Texaco—making a $175 million mistake ("Don’t Make Texaco’s $175Million Mistake," WORKFORCE, March 1997). Texaco, says Gary Roberts, a spokesman for Atlanta-based Corporate Governance Center, was an example of senior management out of control. "There weren’t any intelligent limits on the managers’ behavior or conversations." (He’s referring to a debacle involving secret tapes and prejudiced attitudes of high-ranking officials.)

Boards of the future need to be invigorated with CEO and board members who grasp technological innovations, change management and global markets, who demonstrate excellent communication skills, and value organizational culture.

One positive example is Cincinnati-based Fifth Third Bank. Two years ago, the bank elected Mitchel D. Livingston to the board. Livingston, vice president of student affairs and human resources at the University of Cincinnati, is one of the few HR experts sitting as an outsider on a U.S. corporate board. He attends at least six to eight board meetings a year, sits on two committees, including one that ensures diversity and community relations between the bank and local residents.

When asked how his HR background adds value to the board, he says: "Organizational culture is more critically analyzed by HR. Sometimes, organizations focus too much on structure and systems and not enough on building horizontal influence and relationship building. This comes out of the HR perspective."

Is there a place for HR on the board?
Even with increased diversity on corporate boards, very few are predicting permanent seats for HR experts. Unfortunately, human resources professionals are still a long way from being considered outside board members.

Short of that goal, however, HR still can become a board partner. Once an HR professional understands how the board works, the first step in building a relationship with the board is through achieving CEO advocacy. This means the CEO is open with the board, feels secure in an interactive relationship, and has respect for and trust in the HR function and its people. "A CEO who understands HR is the CEO to have onboard," says Roberts.

There are several ways that HR can build its partnership with the board. The first step is to ask the CEO to advocate for your direct interaction with the board. Minimally, HR can meet with the board once a year to present an HR report. In addition, HR can advise the compensation committee, seek internal and external resources for technical input and competitive information, and keep up with the trends of outside business practices and legislation.

The good news is that CEOs and boards are a lot more aware of the importance of HR practices. They also are more open to HR’s input on compensation, recruitment, performance appraisal, diversity and corporate culture issues.

"HR professionals can make a real difference," says Jim Dirazdi, acting director of Washington, D.C.-based National Association of Corporate Directors. Short of gaining a seat on the board, let your valuable expertise propel the movement toward responsive corporate governance. Don’t let the revolution pass you by.

Workforce, January 1999, Vol. 78, No. 1, pp. 38-45.

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