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Boards 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 employers' success.

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 performance.

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 Commission.

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. 31, 2008.

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 invested capital.

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 chairman.

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 at joann.lublin@wsj.com

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