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Pittsburgh Post Gazette, May 15, 2005

Are reforms working? Experts say link between pay, performance is lacking

Sunday, May 15, 2005

By Len Boselovic, Pittsburgh Post-Gazette

Just as Major League Baseball teams enter spring training with eternal optimism, reformers enter proxy season with hope that, one day, there will be less disparity between corporate pay and corporate performance. And there's reason to think that events of recent years would forge a stronger link between the two.

Stricter accounting controls in the wake of corporate scandals have made it harder for executives to cash in on stock options that are based on earnings inflated by accounting sleight of hand. Companies are disclosing more information on how their compensation plans are put together and providing greater detail on perquisites, giving investors more ammunition to use against abusers. And more independent directors have been added to corporate boards, increasing the likelihood that boards will represent shareholders rather than management.

Despite all that, many pay experts who have reviewed the latest executive payouts still found them lacking on the pay-for-performance front.

"There continues to be a high correlation between CEO compensation and bank asset size, and no correlation with three-year [earnings-per-share] growth and shareholder returns," Citigroup banking analyst Ruchi Madan wrote in a May 6 report on bank executive pay.

Of the 10 banks that paid their CEOs the most, Bank of New York reported lower earnings last year while PNC Financial Services Group and Mellon Financial posted below-average earnings-per-share growth, Madan writes.

Performance is just one factor that influences how and how much executives are paid.

CEOs at large companies typically make more than their counterparts at smaller companies because they have much more complex jobs. Then there's the issue of keeping up with the Joneses.

"Compensation practices are very much driven by what other companies are doing," said Steven Huddart, a professor at Penn State's Smeal College of Business who specializes in compensation issues.

The type of business also is a factor.

Some businesses tend to have more predictable results than others. The more volatile an industry, the harder it is to develop a compensation plan.

Diane Posnak, managing director of compensation consultant Pearl Meyer & Partners, says volatility, changing government regulations and other factors are why compensation plans should be reviewed frequently.

Finally, although few doubt the contributions that top executives make to the performance of their company's stock, there are times when other factors can have even more of an impact.

During the bull markets of the '90s, investors feverishly bid up stocks of technology companies that had yet to report a profit. Most of those companies used stock options to motivate executives and reward employees in lieu of cash they did not have -- even though the market's emotion rather than their fundamentals were pushing the stocks higher.

The result: Executives raked in millions of dollars on the options even though the stocks crashed and the companies ended up on the rocks when the tech bubble burst in 2000.

That's one reason why companies are relying less on options and more on restricted stock. While options produce bigger payouts than restricted stock if a stock does well, they can be worth nothing if the stock price fails to rise.

"Even in the worst-case scenario, the restricted stock is still worth something," Huddart said.

Even as various factors complicate the relationship between pay and performance, some are convinced the link is getting stronger.

"CEOs feel a lot more pain from poor performance than they did in prior years," said Robert Daines, a Stanford University law professor who's studied executive compensation. "The use of performance-based compensation and stock-based compensation is up dramatically over the last 15 years."

Consulting firm Towers Perrin surveyed executive pay at more than 1,400 companies and discovered that CEO bonuses at high-performing companies -- based on their return on equity -- grew twice as fast as bonuses of CEOs running lower-performing companies.

Daines and two other professors found that the link between pay and performance is the strongest when a large percentage of an executive's pay is based on incentives and the company has a shareholder who owns a large block of stock.

"The block shareholder is important for the obvious reason that if someone's looking over your shoulder, you'll do a better job," said New York university law professor Lewis Kornhauser, who co-authored the study.

Kornhauser said one other possible explanation was that more skilled executives are more likely to take jobs where much of their pay is based on incentives, while less-skilled executives seek out more stable pay arrangements.

For all the fuss institutional investors, regulators and others are making about linking pay with performance, it's not at all clear how important it is to most investors.

Three-quarters of investment managers recently surveyed by Pearl Meyer & Partners said CEOs were overpaid.

"The survey indicates that money managers are highly skeptical of the rationales behind some key longtime compensation practices," said Chairman Pearl Meyer.

Yet other investors say they're more concerned with a company's growth rate and other fundamentals than what it pays its top talent.

"I wouldn't say it's that high up the list," said Duncan Richardson, chief equity investment officer of Eaton Vance Management.

"The only time it kind of gets your attention is if there's a big mismatch between the pay and performance."

(Len Boselovic can be reached at or 412-263-1941.)


Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 865-0041
(814) 863-8393 fax
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