The Seven Payparazzi More Than Just Gadflys, a Compensation Reform Swarm Seeks Change
Indeed, this coming proxy season could be as crazy as a Fellini film. In the case of executive compensation reform, the agenda-setters could be called the payparazzi, after the Fellini character who inspired the name for celebrity-swarming photographers who are sometimes likened to a swarm of buzzing insects.
Interviewing investors, investor relations pros and governance experts, FinancialWeek has identified the seven players most likely to have an impact on compensation policies this year. To be sure, there are way more than seven members of the payparazzi posse, but the ones profiled here could have the biggest influence on compensation policies this year.
The payparazzi include:
|Ralph Whitworth, head of Relational Investors, the San Diego-based hedge fund that forced the hand of the Home Depot board.|
|Richard Ferlauto, director of pension and benefit policy at the American Federation of State, County and Municipal Employees.|
|U.S. Rep. Barney Frank, D-Massachusetts and chairman of the House Financial Services Committee.|
|John Wilcox, head of governance at pension fund giant TIAA-CREF.|
|Richard Moore, treasurer of North Carolina and head of the state’s $70 billion pension fund.|
|Nell Minow, co-founder of governance watchdog the Corporate Library.|
|Gretchen Morgenson, Pulitzer prize-winning financial reporter and columnist at The New York Times.|
Other leading pay pests include Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware; Rob Feckner, president of the board of administration at the $228 billion California Public Employees’ Retirement System; and Jack Ehnes, CEO of the $156 billion California State Teachers’ Retirement System.
Institutional shareholders don’t mind when companies they own pay CEOs big bucks, as long as they’re also getting paid by a rising stock price and maybe even increasing dividends.
It’s all about performance, and these days, it seems, pay and performance are linked—but not the way many shareholders want. That’s because in many cases, while the CEO’s pay has been skyrocketing, the stock has been stagnating. When that happens, the payparazzi kick it into high gear.
Last week, Christianna Wood, who works for Feckner as senior investment officer of global equities at CalPERS, sent a letter urging shareholders of Shaw Group to approve a new bylaw that would let them have final OK over severance packages that are about three times the amount of an executive’s base salary plus bonus.
"The adoption of this bylaw amendment, in CalPERS’ opinion, still allows the company the flexibility it needs to attract qualified individuals to serve in officer positions," Wood wrote. "If management delivers performance, why wouldn’t shareowners approve payouts that reward them for this performance?"
As a group, institutional investors are moving more slowly. Their trade organization, the Council of Institutional Investors, has yet to come up with a policy regarding executive compensation, but executives see a problem, according to deputy director Amy Borrus.
"There’s a huge gap between pay and performance at too many companies," she says. "The feeling now is that companies police themselves or they will be policed."
Relational Investors’ Whitworth is known as an activist shareholder; he raised Cain last year over Santander Bank’s deal to acquire a big stake in Sovereign Bancorp, arguing, ultimately fruitlessly, that the deal was being shoved down shareholders’ throats.
At Home Depot, he led the charge, agitating for a board shake-up. He is still hoping to nominate at least two directors to the retailer’s board at this year’s annual meeting.
The quickness with which Whitworth’s campaign worked in toppling Nardelli (he bought $1 billion of the retailer’s stock, or 1.2%, in December) highlights just how much clout the Georgetown-educated lawyer has.
"Investors like Ralph Whitworth are going to force the changes," says David A. Nadler, CEO of Mercer Delta. "He can get a lot of attention, and he has the resources to make a difference."
Another one who has been getting a lot of attention is Ferlauto, who oversees $850 million for the AFSCME pension fund.
Long a critic of exorbitant executive pay, Ferlauto has clearly taken a lead on the issue: Over the past month alone he has commented on executive compensation in print several dozen times, made TV appearances and given a speech to industry pros.
This year Ferlauto plans to file shareholder resolutions with as many as 75 publicly traded companies demanding that shareholders be allowed the right to vote on executive pay packages. The proposals would give shareholders an advisory, or nonbinding, vote on executive compensation, similar to the current practice in the United Kingdom.
"Experts in the U.K. say this vote is the single most powerful tool that they have to align pay with performance," Ferlauto says.
His target: corporate boards of directors and, more specifically, compensation committees. "Shareholders need to hold directors’ feet to the fire," he says, "because in most cases they are not willing to stand up to the CEO and demand real performance."
In many cases, Ferlauto says, it will require major board changes to fix rigged compensation policies. Many companies have installed majority vote programs, which require directors to receive 51% of the votes to stay on the board, while shareholders can currently submit proposals to create proxy-access procedures for future elections ("We can run directors for election who pledge to clean up the pay problem," Ferlauto says).
Also advocating that shareholders have the ability to vote on pay packages is freshly minted House Financial Services Committee Chairman Barney Frank. The Massachusetts Democrat has long been a vocal critic of CEOs’ ever-bulging paychecks, which fits into his larger agenda of lessening the nation’s wealth disparity, and he said last month at the National Press Club that he plans to "work out the details" on legislation to give shareholders more say on the issue.
"I’ll tell you why things are going to change in terms of executive compensation: Barney Frank," says Nell Minow of the Corporate Library. "He assumes power right as this issue gets traction, and he’s been interested in fixing this for a long, long time. Don’t underestimate Congress, there’s a lot of stuff you can do from there."
At a conference in Washington last month, Frank said he hoped to pass a bill by midyear giving shareholders more say in setting corporate executive pay.
"We need to find some way to legislate greater shareholder involvement in setting CEO salaries," he said.
But many of Frank’s payparazzi cohorts worry about such a move.
Remember the Omnibus Reconciliation Act of 1993, which was meant to curb expanding pay packages, laughable by today’s standards, by setting a $1 million cap? The act contained a huge loophole: The $1 million limit did not include compensation tied to market-based measures of performance, such as stock options. Instead of a ceiling for pay, Congress created a floor.
On the other hand, shareholder proposals alone are unlikely to produce much change, in that they can just as easily be ignored by boards of directors.
"Shareholder proposals look good as public statements of opposition," says Charles Peck, principal researcher and program manager on compensation for the Conference Board, "but they don’t really have a lot of power. It will probably take a real shareholder revolt by a big shareholder, like a TIAA-CREF, to force drastic changes."
Although payparazzo John Wilcox, head of corporate governance at TIAA-CREF, says he is not planning to sponsor any shareholder resolutions on the subject of executive compensation this year, his staff will be combing the new compensation disclosures of its holdings, and meeting with those companies with which they find fault.
"Our strategy in the activist area is to meet one on one with managements," he says. "Quiet diplomacy is the way we work."
Wilcox joined TIAA-CREF in late 2005 after 30 years at Georgeson, a firm that helps companies secure annual-meeting votes and win proxy contests. Seamlessly switching sides, Wilcox immediately voiced his support of majority voting rules to elect directors, one of the pillars of so-called shareholder democracy.
He says TIAA-CREF is currently "weighing up" the advisory vote practice pushed by Frank and Ferlauto. "Our trustees are looking at how effective the vote would be. It’s worth examination."
In North Carolina, Treasurer Richard Moore, who oversees more than $70 billion in assets as manager of the state’s retirement system, has been making considerable noise about executive compensation. Since 2004, Moore, who is a lead contender for the state’s 2008 gubernatorial race, has been pushing for more pay disclosure.
In that year alone, he asked the managements of about 50 of the pension fund’s largest holdings to better disclose the pay of their top leaders. Moore has also requested that some companies, including Home Depot, publish on their Web sites details of senior executives’ pay 30 days before those policies are put in place. All of them declined.
Most recently, Moore withheld votes for five directors (one of them was ex-Pfizer CEO Henry McKinnell, another beneficiary of a big pay package) at ExxonMobil to protest the company’s high pay packages at the same time gas prices were soaring.
"This is an issue that is not going away," Moore wrote in an e-mail. He is currently concerned about the use of compensation consultants who are also hired for other work within the company. "This sets up a conflict of interest similar to what we saw with auditors during Enron and other corporate scandals."
While investors and legislators have the most power to effect change on compensation, Minow, who co-founded the Corporate Library with Robert A.G. Monks in 1999, continues to draw attention to the issue.
Her firm, headquartered in Portland, Maine, rates companies on their governance practices and has long considered executive compensation the No. 1 indicator of a board’s effectiveness. "If the board can’t get executive compensation right, it’s been shown it won’t get anything else right either," she says.
Like Ferlauto, Minow says changing the makeup of boards is the only way to fix the compensation problem. Two ways to do that are through majority voting and shareholder access to the proxy.
"We need to pry the fingers of the CEO off of the process of picking board members," she says, "and if shareholders can get rid of compensation committees who do a bad job, we’ll see some changes."
Also on Minow’s wish list for 2007: Limit stock options to those that are premium-priced (above the market price of the shares) and indexed to a peer group or the market as a whole, or in some other way tied to the company’s performance. "Right now," she says, "70% of option grants are attributable to overall market returns, and we really don’t need to be compensating executives for that."
Finally, where would the compensation issue be without Gretchen Morgenson, the New York Times reporter who has been hammering away at the issue for the past two years?
Morgenson, however, takes exception to the notion that she’s leading a wave of reform: "As a reporter, I’m just observing and commenting."
But she has certainly struck a nerve. Her coverage of compensation was famously called "absolutely loony" by Barry Diller, CEO of Internet media conglomerate IAC/InterActiveCorp. Diller was the highest-paid CEO in 2005, with a $295 million package.
Morgenson doesn’t think legislation is the answer, and could do more harm than good.
"It would be better if shareholders acted and directors responded rather than getting Congress involved," she says.
In the meantime, she foresees no shortage of fodder for executive compensation stories in the coming year.
"This proxy season we’re going to see a lot more information," she says. "Reporters are going to be working overtime."
—Additional reporting by Matthew Quinn of FinancialWeek.