Tie CEO Pay More Tightly to Performance
Options Grants May Depend On Meeting Financial Goals;
Moving Beyond a 'Pulse'
By Joann S. Lublin
The Wall Street Journal
Tuesday, February 21, 2006
More chief executive officers are finding strings attached
to their free lunch.
Amid rising complaints about excessive executive
compensation, an increasing number of corporate boards are
imposing performance targets on the stock and stock options
they include in their CEOs' pay packages. Such targets are
the latest strategy in a decades-long effort to tighten the
link between top executives' bank balances and their
Last year, 30 out of 100 major U.S. corporations -- ranging
from ConAgra Foods Inc. to Peoples Energy Corp. -- based a
portion of the equity granted to their CEOs on performance
targets, up from 23 in 2004 and 17 in 2003, according to an
analysis of proxy statements filed since July 1. The
analysis was done for The Wall Street Journal by Mercer
Human Resource Consulting.
Peter Chingos, head of the U.S. executive-compensation
practice at Mercer in New York, predicts half of the
nation's big companies will use such awards by the end of
this year, as they seek to tie CEO pay more tightly to
The expanded emphasis on performance targets is designed to
keep executives from reaping rich rewards for reasons
unrelated to their leadership skills. Stock options, which
became a popular form of compensation in the 1990s, can gain
value in a rising stock market, enabling executives to
pocket windfalls even if their own companies' earnings
growth is modest. Some critics also say big options grants
encourage executives to seek short-term gains in their
companies' share prices, without creating long-term value.
Restricted shares, which have replaced stock options at many
companies, typically aren't linked to corporate
performance. They often are derided by critics as "pay for
pulse," because the restrictions on selling the stock
disappear over time, even if the executive does little more
than just show up for work.
As alternatives, companies are turning to a variety of
performance goals in hopes of promoting greater
accountability. Some companies make grants of stock or
stock options contingent on the company achieving financial
goals, such as earnings or revenue growth. Others set the
exercise price for stock options well above the stock's
then-current market price. That means the CEO can't profit
from those options unless the stock's price rises
significantly, benefiting other shareholders as well.
Performance targets, however, don't necessarily make it easy
for shareholders to tell if the big boss is really earning
his or her big bucks. That is because companies aren't
required to divulge numerical goals and won't be required to
do so even under tougher executive-pay disclosure rules
proposed last month by the Securities and Exchange
NCR Corp., which wasn't included in Mercer's analysis,
recruited William Nuti as its chief executive last summer
partly by offering him a $1 million salary and $500,000
guaranteed bonus for 2005. But he loses 400,000 of his
650,000 options unless the Dayton, Ohio, maker of
automated-teller machines and other products reaches an
undisclosed level of cumulative net operating profit by Dec.
NCR directors embraced the idea of performance-linked
options months before they recruited Mr. Nuti because they
felt a CEO only "should win when shareholders win," recalls
Linda Fayne Levinson, head of the board's compensation
committee. With conventional stock options, she says, "if
you stay long enough and your board doesn't fire you, you
can weather bad periods and ultimately get value."
In another sign of the harder line some boards are taking
toward CEO compensation, Mr. Nuti's contract allows the
board to fire him for cause if he and his family fail to
relocate to Dayton by Aug. 1 from their home on New York's
Long Island. Until then, NCR is paying Mr. Nuti to fly home
weekly in the corporate jet.
Like most companies, NCR doesn't divulge the profit goal
that Mr. Nuti must achieve before he can exercise his
options. To do so would create "a competitive
disadvantage," Mr. Nuti says.
By contrast, Tyson Foods Inc., which settled an SEC
complaint last year over allegedly inadequate disclosure of
executive perks, tells shareholders plenty about specific
hurdles that CEO John Tyson must clear in order to profit
from a performance-based equity award.
The nation's biggest meatpacker, based in Springdale, Ark.,
handed Mr. Tyson 150,000 "performance shares" in the year
ended Oct. 1. How many shares Mr. Tyson keeps will depend
on improvements in Tyson's stock price and return on
Half are tied to how Tyson's shares fare against those of 12
other food companies in the three years ending in September
2007; the more companies that Tyson outperforms, the more
shares Mr. Tyson retains. He forfeits 75,000 shares unless
Tyson's stock price outperforms at least six of its peers.
Mr. Tyson keeps the other half only if the company's return
on invested capital, which was 10% in fiscal 2005, hits
13.25% over the same three-year period. Directors believe
that level "would reflect very strong performance," says
spokesman Gary Mickelson.
Performance-linked equity targets "need to be meaningful,"
with targets an investor can understand, says Read Hudson,
Tyson's corporate secretary. Members of Tyson's
compensation committee put the performance-linked shares in
Mr. Tyson's 2003 employment contract after concluding that
"this is the way the world is going," Mr. Hudson says. The
deal guarantees the CEO grants through the current fiscal
year with a maximum annual value of nearly $2.5 million, but
specifies that all must be earned through some performance
measure. Tyson first disclosed the SEC investigation in
March 2004. Mr. Mickelson, the Tyson spokesman, says there
isn't any connection between Mr. Tyson's contract and the
subsequent disclosure of that probe, which involved perks
given to his father Don Tyson while he was its senior
Tyson was among the 16 companies tying at least 40% of their
leader's 2005 equity awards to performance targets, the
Mercer analysis found. Others include: ArvinMeritor Inc.,
Briggs & Stratton Corp., ConAgra, Franklin Resources Inc.,
Peoples Energy, Intuit Inc. and Ruddick Corp.
Other companies are taking a similar tack. Directors at
Freescale Semiconductor Inc., for example, plan to give
executives "a significant dose of performance-based
restricted stock for 2006," says B. Kenneth West, chairman
of the board compensation committee at the Austin, Texas,
chip maker. Until now, none of the equity Chief Executive
Michel Mayer received since Freescale's 2004 spinoff from
Motorola Inc. came with strings attached.
Some executives have forfeited stock or options because
their companies didn't hit performance targets. At Eastman
Kodak Co., which wasn't included in the Mercer study, former
CEO Daniel A. Carp didn't earn any out of a potential 30,000
performance-linked shares in 2004 because the Rochester,
N.Y., photography and imaging company fell short of its
goals for shareholder returns from 2002 through 2004.
Mr. Carp stepped down in June. Now, his successor, Antonio
Perez, is at risk of losing out on 120,000 shares, unless
Kodak hit unspecified operational earnings-per-share targets
for 2004 and 2005. Kodak posted a net loss of $1.37 billion
last year but didn't divulge operational per-share
earnings. Kodak will disclose whether Mr. Perez received
any of the shares in its annual proxy filing in the next few
months, according to a company spokesman.
Write to Joann S. Lublin