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In 2000, when Intuit Inc. wanted to hire Stephen Bennett, then an executive vice president at General Electric Capital Corporation, as Intuit’s new chief executive officer, the board wooed him with a heaping chunk of stock: 800,000 nonqualified stock options and 150,000 restricted shares. Offered at $67 a share, the options were “underwater” at press time, with Intuit stock valued at $49. But the restricted shares are currently worth some $7.35 million. Intuit says the new CEO was worth every penny. Bennett had expertise that Inuit wanted badly, says Jim Grenier, Intuit’s vice president of total rewards, who oversees the company’s compensation process. “In the 23 years he was at GE, Steve acquired extensive experience in both short-term and long-term strategy, and with improving customer service,” says Grenier. “And those were the areas, we believed at the time, in which we needed tremendous help.” To lure an executive of Bennett’s caliber from a major corporation like GE, the company had to make a compelling pitch, says Intuit chairman Bill Campbell. “It was a higher-risk job opportunity, so there had to be the opportunity of a higher reward,” he says. But when Bennett’s contract came up for renewal in 2003, the Intuit board took a different tack. This time Bennett didn’t get any options. Instead, he’s taking home 225,000 shares of restricted stock, worth a hefty $17.9 million as calculated on the company’s 2003 proxy, but worth a mere $11 million at the software company’s current stock price. Bennett isn’t the only CEO getting his pay package overhauled these days. For directors at Fortune 1000 companies, executive compensation is shaping up as one of the hot-button issues of 2004: Last year nearly 40 percent of shareholder resolutions dealt with compensation-related matters, and the same intense focus on executive pay is showing up in shareholder proposals in this year’s proxies. Compensation committees at companies across the nation are taking notice, taking stock, and taking action. Top executives at blue-chip businesses are still being generously rewarded for their work. But boards are doling out compensation in more restrictive ways, including grants of restricted stock (full-value stock subject to restrictions on vesting and sale), revised bonus structures, smaller severance packages, and an increased attention to performance metrics. Compensation committee directors “are beginning to face it now,” says veteran director Margaret Zagel, a director of medical device company Atrion Corporation before resigning to take up her current position as general counsel of accounting giant Grant Thornton early this year. “First the regulating bodies were looking at companies’ financial and audit committees, but everyone saw that it was going to be the comp committee next. So [directors] have started to look at compensation proactively.” Last year New York Stock Exchange, Inc., chairman Dick Grasso’s $147 million pay package ignited a firestorm of negative publicity and resulted in the mass resignation of NYSE board members. If that’s not enough to give directors pause, consider the pending shareholder suit against board members of The Walt Disney Company over former CEO Michael Ovitz’s $140 million severance package. The complaint paints a picture of an alarmingly passive board that didn’t even see a copy of Ovitz’s employment agreement and took no action when directors discovered Ovitz’s severance had been set without their approval. In May 2003 a Delaware judge allowed the case to proceed, finding that the board’s inactivity, if true as alleged, was valid grounds for a claim of breach of fiduciary duty. (The board members have argued that the terms of Ovitz’s employment represented a reasonable exercise of their business judgment.) As a result of the increased pressure and risk, compensation committees are taking pains that were virtually unheard of a few years ago. Too often, says compensation consultant Claude Johnston of New York’s Pearl Meyer & Partners, executive pay decisions are made in isolated snippets. “Often the comp committee members are only presented with a small element of the pay package at any one time,” he says. “Each decision made in isolation might feel reasonable. But they don’t take the time to step back and evaluate the entire package. The members are often surprised to see that when you add all the pieces up, it comes to a very substantial sum of money.” Out: Stock Options. The standard compensation currency of the previous decade � stock options � has become decidedly less popular, particularly to investors. And companies are listening to their complaints. “A significant minority appear to be moving away from the sole use of stock options,” says Paul Hodgson, a senior research associate at The Corporate Library in Portland, Maine, a corporate governance research group. “Companies are trying to show investors that they are now in control.” Furthermore, it’s likely that very soon options will no longer be a free lunch on a company’s P&L. The Financial Accounting Standards Board is expected to propose new rules requiring all public companies to expense stock options by 2005. For many executives, anyway, the bloom is off the stock option rose. Many of the options that companies bandied about in the 1990s are trading below their strike price today, despite the market rebound. “People don’t place any value in them anymore,” says Robert Profusek, a partner at Jones Day in New York. “I’ve heard even CEOs say that options are worthless in their minds. But that’s silly, because options usually have ten-year tails [allowing the options to be exercised at any point during that period] on them. CEOs should be smarter than that.” But don’t expect every U.S. company to wean itself entirely off stock options anytime soon, especially in the tech sector. “When you’re limited in terms of cash, stock options can be very useful,” points out Intuit’s Grenier. In: Restricted Stock. Compensation committees have been scrambling for a more investor-friendly mode of equity compensation, often finding it in the form of restricted stock. Last year Verizon Communications Inc. made a shift away from stock options by introducing performance share units, which senior employees can earn on the basis of the company’s total shareholder return compared to its telecom peers. One of the avowed aims of the new program is to reduce the number of stock options granted to executives. Microsoft Corporation and General Electric Company have also backed away from stock options. “Five years ago, if you brought up restricted stock to a comp committee, they would have loudly run you out of the room for suggesting a giveaway item,” says Pearl Meyer’s Johnston. “Now there’s a lot more interest, but there’s also the concern that companies don’t create more guaranteed compensation. There should always be a performance condition, either performance-contingent vesting or performance-accelerated vesting [for the stock grant].” Specific performance measures include EPS (earnings-per-share) growth, operating cash flow, and TSR (total shareholder return, defined as the total benefit to the shareholder during a particular period of time: stock appreciation plus reinvested dividends). At Intuit, the board began rethinking the company’s use of options after shareholders started voicing concern about the business’s stock option burn rate: the number of options issued in a particular year, divided by the total shares outstanding. (A higher burn rate dilutes the worth of outstanding shares.) In 1999 Intuit’s burn rate stood at about 7 percent. Intuit chairman Bill Campbell says that “at that point, we could always get shareholder support. We were a growing company, and we needed the options.” But Campbell started hearing from investors that the percentage should come down: “When the ISS [Institutional Shareholder Services] and shareholders started paying attention to this, saying it should be at 3.5 percent, we moved down accordingly.” The company’s burn rate for fiscal 2003 was 2.88 percent. How could Intuit continue to compensate CEO Bennett competitively without increasing its dilution? “The board was very insistent on trying to get him locked in for another three to five years,” says Grenier. Campbell says they looked at a number of methodologies, but finally settled on restricted stock units. “We had to reduce the number of stock options, and with restricted stock, we didn’t have to give as many shares,” he says. Because they’re restricted stock units, the shares don’t start vesting for three years, and don’t fully vest until five years out. “We needed to have him complete the journey,” says Campbell. Grenier says the company also considered a variety of long-term cash plans, but always came back to tying the CEO’s pay to Intuit’s stock price. “Long-term cash wound up feeling just like stock without the hard-line connection to stock,” he says. “By using actual stock, if Intuit does very well, Steve Bennett does well.” Under Fire: Golden Parachutes. Big severance packages have become a touchy subject with many investors. Just ask former GE CEO Jack Welch, who had to forgo part of his own lavish retirement package in 2003 when it became the target of shareholder outrage. But GE isn’t the only company feeling the heat. When former Compaq Computer Corporation CEO Michael Capellas resigned almost two years ago as president of Hewlett-Packard Company following the Compaq-HP merger, he received $14.4 million in severance. In response, in April 2003 a slim majority of Hewlett-Packard shareholders approved a measure calling for the company to seek shareholder approval for executive severance packages greater than 2.99 times that person’s salary and bonus. That measure was nonbinding, but three months later, the board voted to follow the shareholders’ lead. The new severance policy that HP adopted in October limits the CEO’s severance to just 2.5 times salary and cash bonus. A similar move came recently at Qwest Communications International Inc. Qwest shareholders passed a resolution giving them the right to approve any severance package worth more than three times an executive’s salary and bonus. Qwest’s management and board supported the change, one of a raft of corporate governance � related shareholder actions filed in response to the revelation that Qwest had overstated its 2000 and 2001 revenue by $2.5 billion. “We agree that there should be reasonable limitations placed on severance arrangements,” Qwest management wrote in the proxy, “so long as these limitations do not impair Qwest’s ability to hire superior management talent.” On The Rise: Bonuses. A decade ago the typical CEO was eligible for anywhere from 25 to 40 percent of his or her salary as an annual bonus, according to Paul Dorf, managing director of Compensation Resources, Inc., in Saddle River, New Jersey. “Today that’s probably closer to 100 percent,” he says. Partly because of the switch away from stock options, short-term incentives are now gaining even more favor. But actual CEO bonus payouts for 2001 and 2002 were down substantially, mostly because of poor financial results. As a result, says Pearl Meyer managing director Edward Archer, “companies are retooling the short-term incentive plans to put hope in people’s souls.” Ruby Tuesday, Inc., a Maryville, Tennessee-based restaurant chain, recently sought and received shareholder approval to increase its executive bonuses. (The company put the matter to a shareholder vote to ensure that the full amount of the bonus would be tax-deductible.) CEO Sandy Beall can now receive up to 175 percent of his $966,000 salary as a bonus, an increase from 125 percent. The company said the change was necessary to stay competitive with other, similar casual-dining chains. However, some businesses are going in the other direction. Last year shareholders and employees of Delta Air Lines, Inc., boiled over when the company announced that it had paid $43 million in executive bonuses in 2002, a year in which the company lost $1.3 billion and eliminated thousands of jobs. This year Delta has said that it will not issue any cash performance bonuses for 2003, and Delta CEO Gerald Greenstein announced in a recent memo that Delta will make changes � still unspecified � in its approach to executive compensation. Businesses are also reconsidering the performance metrics they use to calculate bonuses � and compensation in general. Many compensation experts are counseling corporations to tie pay to the real financial drivers of a company, such as return on assets or growth in earnings per share. At GE the number of performance-share units awarded to CEO Immelt will be based on the corporation’s cash flow. “Companies are . . . waking up and saying that stock price isn’t the be-all [and] end-all,” says Don Delves, president of The Delves Group, a Chicago-based compensation consulting firm. “I encourage them to look at financial performance over stock performance. Financial performance is a lot more under their control. And it’s not management’s job to manage the stock price, but to run the company.” From the investor perspective, the prevailing attitude is one of wait-and-see � although that doesn’t preclude filing some shareholder resolutions along the way. “I think most people in the institutional investor community regard this as the beginning of a long road toward attaining better governance,” says The Corporate Library’s Hodgson. There haven’t been any major revolutions in compensation or the way that boards are run, he says: “But there’s enough of a change in attitude among all the constituents to indicate that more substantial changes may be on the way.”
Christopher Caggiano is a freelance writer based in Boston and a former senior associate editor at Inc magazine. This article originally appeared in Corporate Counsel‘s sibling publication D&O Advisor.

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