SURVEY OF CEO COMPENSATION
Terminated?  Who Cares?
Severance-pay packages for CEOs appear to be coming down.  But slowly.
By Perri Capell
The Wall Street Journal
Monday, April 14, 2008

Shareholder fury over oversized severance-pay packages awarded to chief executive officers is causing boards to begin to whittle them down.

But don't weep for the CEO yet.  It is a slow process, as these packages are still sacred cows at many firms.  And even at companies that have reduced potential severance payouts, CEOs stand to become multimillionaires if they are terminated without cause or following a merger.

Still, pay consultants say that in boardrooms across America, directors are giving severance policies a closer look.  A 2007 review of proxy statements by consulting firm Mercer, a subsidiary of Marsh & McLennan Cos., shows that 60% of 182 U.S. companies, with median annual revenue of $3.3 billion, altered change-in-control provisions because of shareholder pressure.

"Severance pay is coming down," says Ira Kay, a New York pay consultant at Watson Wyatt Worldwide, a consulting firm based in Arlington, Va.  Shareholder pressure on this issue "is an irresistible force that companies are going to have to respond to."

Covering Taxes

Alvarez & Marsal Taxand, a New York-based group of tax professionals, studied 2007 Securities and Exchange Commission documents from the 20 largest companies in each of 10 industries and found that 82% of CEOs and 78% of other named executive officers are due to receive cash severance pay if they are terminated following a change in control.  Coupled with stock awards, deferred compensation and pension payouts, the average value of change-in-control benefits for CEOs is $38.4 million, while the average total for other named executive officers is $13.2 million, according to the study.

In 1984, Congress slapped an extra tax on "golden parachutes," the payments promised to executives if their companies are taken over.  The law imposed a 20% excise tax, which is in addition to any federal income tax owed, on awards valued at more than three times an executive's average compensation over the previous five years.  The law also spawned a new form of compensation:  payments to cover the new tax, known as a "gross-up."  These payments have become particularly vexing to directors.

Currently, two-thirds of CEOs and 60% of other named executive officers are entitled to have their severance pay increased to cover the extra taxes, reports Alvarez & Marsal Taxand.  The gross-up payments themselves are subject to both income and the excise tax, so to ensure an executive receives the promised change-in-control benefit, companies typically have to raise the initial gross-up to more than two times the original amount.

Union Pressure

The American Federation of State, County and Municipal Employees, known as AFSCME, is taking aim at gross-ups at 2008 annual meetings, introducing resolutions to ban them at five companies.  The union contends that gross-ups are ineffective pay vehicles.  "They have no performance link at all," says Rich Ferlauto, the union's director of corporate governance and pension investment.

Some pay consultants say they are urging boards to reduce the size of change-in-control payouts to amounts below the federal excise-tax threshold, so they won't need to pay gross-ups.  In other cases, partial gross-ups are recommended.

Even the original intent of severance pay -- to help bridge terminated executives until they find new jobs -- is being questioned.

"The idea behind cash severance is that executives need the money to bridge them until they find a new job," says Watson Wyatt's Mr. Kay.  "That's hilarious because most of the time they don't work again, or it doesn't take them long to find a new job."

If fired without cause, most executives walk away with accelerated vesting of large option and other equity grants, deferred compensation and other benefits, which may make cash severance pay unnecessary, says Mr. Kay.

Nevertheless, at two-thirds of large companies, CEOs would receive cash severance worth three times their current base salary plus three times their bonus following a change in control, according to Equilar Inc., an executive-compensation research firm in Redwood Shores, Calif.

Golden parachutes originally were designed to entice executives to stay during a hostile takeover battle by assuring them of a sizable sum of cash in the event they were fired following a takeover.  Now, investors are urging boards to eliminate the cash payouts or add sunset provisions that cause them to expire when executives' equity holdings have built up, says Patrick McGurn, special counsel of RiskMetric Group Inc.'s ISS Governance Services unit, which advises shareholders on governance proposals.

"The provisions were put in for good reasons, but there are all these perverse developments," he says.  "Why work hard for 10 years to earn the money when you can make a huge payout quickly by selling the company?"

Most equity awards vest over time, but many companies allow immediate vesting if a change in control -- a so-called single trigger -- takes place.  Since this is seen as a windfall for executives, many boards are now requiring a second trigger, such as a job loss, before allowing immediate vesting in equity plans, says Diane Doubleday, global leader of executive remuneration services for Mercer.

Scaling Back

The Mercer study indicates that 64% of surveyed companies that altered change-in-control provisions added double triggers and 56% put conditions on gross-ups for top executives.

Last year, directors at General Mills Inc. approved a new plan that reduces potential severance pay for its senior executives, including CEO and President Ken Powell.

The plan reduces cash severance to two times from three times their annual base salary and bonus and requires a double trigger that includes both an ownership change and the executives' termination before long-term stock awards vest.  The plan also requires that some severance payouts be reduced if they trigger the excise tax.

Mike Peel, General Mills' executive vice president of human resources and business services, says Chairman Stephen W. Sanger initiated the new plan, which covers about 130 executives.  Mr. Powell stands to receive $10 million if dismissed following a change in control, according to the company's latest proxy.  Mr. Sanger, Mr. Powell's predecessor, is retiring in May.

Among other firms that have reduced severance packages:  Ciena Corp., a Linthicum, Md., networking company, and UnitedHealth Group Inc., a Minnetonka, Minn., health insurer, say they have eliminated some gross-up provisions for executives, while XTO Energy Inc. of Fort Worth, Texas, says it has done so for its chairman and CEO.

Companies where boards have voted to cut back the size of severance payouts include Rimage Corp. and Gander Mountain Co. of Minneapolis and FirstEnergy Corp. of Akron, Ohio, according to their proxies.

Still, changes like these have yet to be embraced across the board.  One reason is that it isn't easy for directors to renegotiate agreements governing severance pay several years after an executive is hired, says Dan Moynihan, a principal with Compensation Resources Inc., a Saddle River, N.J., pay consultant.  "The current changes are typically for new people coming in the door," he says.

That isn't stopping AFSCME and other shareholder-activist groups from pushing for change.  Boards at Nabors Industries Ltd., Textron Inc., CVS Caremark Corp., Northrop Grumman  Corp. and Clear Channel Communications Inc. all face resolutions this year asking them to eliminate tax gross-ups for senior executives following a change in control that aren't provided to management employees generally.

Eugene Isenberg, chairman and CEO of Nabors, a Houston-based oil-drilling company, would receive $329 million in cash, stock and other benefits following a change in control, the latest proxy indicates.  Nabors also has agreed to provide a gross-up payment of $146 million, according to the documents.

Nabors officials didn't return calls seeking comment.

--Ms. Capell is a writer in Idaho. She can be reached at reports@wsj.com.

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