Executive Compensation Climbs Into Stratosphere

If the message got any clearer, you’d hear “Fire me!” echo from the helipads atop downtown Los Angeles. After all, if you want to get rich, there’s no better way than getting fired--at least if you’re a top officer at a top company.

The latest ranking of the most highly compensated chief executives in Southern California serves only to underscore the point. The three highest-paid executives--Robert Annunziata of Global Crossing Ltd., Mark Willes of the former Times Mirror Co. and Jill Barad of Mattel Inc.--made the grade because they were essentially canned. (Technically, they all “resigned,” either under pressure or because their jobs were eliminated.) Between them, they were paid more than $146 million.

If those three simply put their pay in bank deposits earning 6% interest, they could employ more than 150 average American wage earners for a year--without ever dipping into the principal of their savings. They could purchase the entire gross domestic product of the Marshall Islands--for a mere $98 million--and still have enough left over to buy company cars for each of those 150 potential employees. Their pay packages amounted to more than the total of U.S. aid to Ethiopia in 1998.

Willes’ pay amounted to about 25% of the annual earnings of Times Mirror in 1999, although the company’s stock more than quadrupled on his five-year watch, including a 20% run-up last year. It is impossible to make a similar comparison with Annunziata and Barad’s pay because neither of the companies they ran were profitable last year.

“There are two ways to make a ton of money,” says Graef Crystal, a compensation expert and columnist for Bloomberg News.

“One is to be the chief executive officer of a very successful company. The other is to screw up royally and get fired. The guys at the run-of-the-mill companies apparently don’t understand that, if they’d just stop trying, they could get canned and make a lot more money.”

Of course, plenty of executives who still work for a living earned stunning amounts, too, according to a ranking of top-paid chief executives in Southern California. The list, compiled by the national benefit consulting firm of Watson Wyatt Worldwide, shows that 14 of the Southland’s most highly compensated chief executives earned more than $10 million each. Among the top 25, no one earned less than $5 million in current pay, which includes salary, bonus and the present value of stock options granted during the year.

Less than a decade ago, earning $1 million put you near the top ranks of the most highly compensated. But today that would be well below the average--and substantially below the median--pay of chief executives at 197 Southern California companies.

The companies examined range in size from multibillion-dollar multinationals such as Walt Disney Co., worth $23 billion at year-end 1999, to companies such as WD-40 of San Diego, which was worth just $146 million.

The average pay of the chief executives in this group was $3.02 million. The median pay, which is the midpoint, indicating that half of the executives earned more and half earned less, was $1.13 million. And that figure measures only what these executives got in total pay for the year. It does not include the windfalls that some reaped by exercising stock options granted in previous years.

In that arena, Disney CEO Michael Eisner continued to dominate. In 1999, he generated a $49.9-million profit by exercising stock options. Amgen Inc.’s Gordon Binder was a close second, with stock gains amounting to $45.2 million. Broadcom Corp. CEO Henry Nicholas III exercised options worth $31.6 million, while Northrop Grumman Inc.’s Kent Kresa took home $18.9 million in stock options gains.

Even consultants, largely inoculated to high pay, are clucking about the latest compensation packages.

“There is a comparative greed,” says Ron Bottano, partner in the Los Angeles office of SCA Consulting. “These [CEOs] see somebody who is 25 or 30 years old making millions overnight [at a “dot-com” company], and they complain that here they are, a seasoned manager at an established company, making much less. I think it has moved the bar. The expectations are staggering.”

The bulk of the money is long-term compensation and, specifically, grants of stock options that are not yet exercisable, notes Don Sagolla, director of the compensation practice at William M. Mercer Inc. in Los Angeles. A recent Mercer study found that while cash salaries were rising by steady but unremarkable amounts, long-term compensation, which is primarily stock-based, had doubled over a three-year period.

“It just blew us away,” Sagolla says. “When you start to look at the spike long-term compensation has made, it’s not just noticeable, it’s staggering.”

The bulk of long-term compensation is made up of stock options, says Daniel M. Wetzel, executive and incentive compensation consultant at Watson Wyatt. That reflects company efforts to compensate managers in a way that is commensurate with their performance. If the company’s performance is strong, its stock price will presumably rise over time. Both managers and shareholders benefit. Stock options also provide companies with certain tax advantages.

The value of stock options is estimated using a formula that establishes a rough value for what the options will be worth when exercisable, and then discounts that value to the rough value of those options today.

Part of the reason options get discounted is because they are normally lost if you change jobs or are terminated before they fully “vest” and become yours without any strings attached. Yet, if recent experience is any guide, if these executives were to be fired in the next few years, their company boards would not only allow them to keep their unvested options, they might forgive their company-provided loans and hand them the keys to their company cars, too.

That is what ought to happen if you’re fired without cause, says Nell Minow, a shareholder activist and editor of the Corporate Library, a Washington-based firm that posts chief executive employment agreements on the Internet (https://www.thecorporatelibrary.com). After all, if you are performing well and are ousted through no fault of your own, you ought to get some parting reward.

However, what shareholders find disturbing is that you can be ousted for incompetence and still not “for cause,” Minow says.

Confused? You wouldn’t be if you read the employment agreements that today’s top executives are signing when they take their jobs. The definition of “fired for cause,” has little to do with whether the executive is able to perform the work, Minow says.

“Cause is most often defined as felony, fraud, embezzlement, gross negligence or moral turpitude,” she says. Some contracts allow firing for “willful refusal” to follow the direction of the board.

In many instances, the definition of “cause” is even further restricted. At Toys R Us Inc., for example, former CEO Michael Goldstein could not be fired for cause unless he engaged in a “felony involving moral turpitude.” A simple felony was not enough. Richard Kogan’s contract at Schering-Plough Corp. says his own interpretation of bad faith would prevail if he challenged his firing, unless there was a non-appealable judgment by a court stating otherwise.

“The whole justification for these huge salaries is that these are high-risk, high-reward positions,” Minow adds. “But provisions like this can make the position risk-free, as departures by CEOs at Mattel and Global Crossing so clearly demonstrate.”

It’s not just shareholders who suffer when a manager gets richly rewarded for failure, Sagolla says.

“There is a quiet outrage . . . with the people who remain,” he says. “They are an often-ignored constituency. But they are the ones who have to stay and fix things that got messed up.”

Yet, while parting pay certainly makes headlines, consultants are equally concerned about the rapidly rising pay levels of run-of-the-mill chief executives who remain on the job, says Bottano.

Pay-for-performance was supposed to reduce total compensation in years when shareholders or profits got savaged. But in today’s world, pay just keeps on rising. Indeed, the way things are set up, continuous hikes are nearly guaranteed.

The reason: Companies review pay for their top officers every year, normally by commissioning compensation consultants to study the pay of their peers. Typically, companies say that they want to set pay scales at either the top 25% of pay in the survey, or in the middle, says Crystal. No one ever says they want to set their CEO’s pay near the bottom, he adds. As a result, the averages keep bumping up every year, as compensation committees continually shoot to pay their executives more than a constantly rising average.

It is not the executives themselves who set salary levels, Minow adds. It’s the compensation committee on the company’s board of directors.

Something has to give, many consultants say.

After all, there is only so much cash a company can pay out before earnings are negatively affected. Likewise, every share of stock that managers get costs shareholders something, even if it’s an indirect cost through “dilution.” If, for example, a company has $10 million in shareholder equity and 1 million shares outstanding, each shareholder would suffer a 50% dilution if another million shares were issued at no cost. In other words, the equity standing behind each share would have dropped to $5 from $10 in that exaggerated example.

In the case of stock options granted managers, the dilution is usually small on a year-by-year basis, but it builds up over time. And with multimillion-dollar stock awards becoming more common, it is increasingly becoming an issue of concern.

“I think we are reaching some of the limits of what you can do with equity compensation,” says Bottano. “There is only so much stock to go around.”

Shareholders may not have noticed the negative effect of stock options because the markets have been rising so rapidly over the last decade, Bottano says. But he adds, eventually the market will cool and the impact may begin to hurt.

“As the market starts to slow down, I think investors are going to start asking harder questions,” he says.

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* SWEET SORROW

Mark Willes of the former Times Mirror Co. heads a list of ex-CEOs who departed much the richer. C3

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Southern California Executive Pay

The executive pay list is based on a study conducted for The Times by the West Coast offices of Watson Wyatt Worldwide, an international consulting firm that specializes in compensation and human resources. The information was drawn from proxy statements and annual reports that companies whose stock or bonds trade in public markets are required to file each year with the Securities and Exchange Commission and other public agencies.

These companies are required to disclose the compensation packages of the chief executive officer and four or more other highly compensated executives, but not necessarily the highest-paid employees. Privately held companies are not required to file such reports. The total cash figure is the sum of an executive’s annual base salary and bonus and includes payments that may have been deferred to future years.

Total compensation includes the total cash figure, plus any other type of compensation an executive received. It includes such things as car allowances, insurance premiums, retirement benefits, housing allowances, moving expenses, forgiveness of loans and the present value of stock options granted during the current year using the Black-Scholes valuation method. It also includes the total value of restricted stock awards, including those that vest in future years. It does not include realized and unrealized gains from stock options.

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What They Made

The top three earners in Southern California in the latest survey all got the big bucks because they were fired. The rest of the Top 10 all made at least $12 million. Among the 25 most highly compensated Southland executives, none earned less than $5 million. The average pay of 200 executives surveyed was just over $3 million.

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1. Mark H. Willes

Times Mirror (resigned)

$64.5 million

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2. Robert Annunziata

Global Crossing (resigned)

$40.5 million

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3. Jill E. Barad

Mattel (resigned)

$38.5 million

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4. Henry Yuen

Gemstar International

$24.1 million

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5. Jeffrey C. Barbakow

Tenet Healthcare

$22.5 million

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6. Dirk I. Gates

Xircom

$19.1 million

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7. Frank G. Mancuso

Metro-Goldwyn-Mayer

$17.0 million

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8. Leonard D. Schaeffer

Wellpoint Health Networks

$16.7 million

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9. David E.I. Pyott

Allergan

$13.5 million

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10. Ray R. Irani

Occidental Petroleum

$12.7 million