By James Bristol

This blog is for reviewing trends, developments and breaking news on executive compensation matters. Reader interest will dictate the direction of the discussion.

There have been so many developments in executive compensation in the past couple of years that a quick review of where we were and where we are today is in order.

In the not too distant past, executive pay was given little thought by anyone in the media. Experienced executives with credibility on Wall Street were hard to find and the bidding for talent was intense. No one had heard of “stock option back-dating” and no one could have imagined the shareholder lawsuits and criminal prosecutions taking place today due to equity compensation practices. Lavish parachutes for management were common in the era of corporate mergers and acquisitions. If change in control payments triggered golden parachute taxes under 280G, many companies simply paid the executives an extra “gross-up” amount to cover the tax bill. At the board level, corporate governance on executive pay consisted of compensation committee review and routine approval of a CEO’s proposal for his/her own pay. Significant increases were common if a consultant could be found to demonstrate that the new pay scale was needed to put the CEO in the top quartile of the marketplace. Shareholders typically gave rubber stamp approval to any and all proposals for equity compensation plans.

Eye-popping numbers have appeared on proxy statements for the largest companies even when shareholder returns were minimal. A series of developments has changed the landscape on executive pay, particularly for publicly traded companies. Change has come in the wake of (perhaps in response to) well-publicized corporate failures, such as Enron and WorldCom. In most cases, the impetus for the change was to curb abuses in executive pay that were perceived to have contributed to those failures. Some of the key changes in the past two years:

• Stock option grants result in a charge to earnings like cash compensation, even though the company pays nothing and receives cash on exercise.
• Proxy disclosures of executive pay require a compensation discussion and analysis (CD&A) with extensive financial disclosures of potential payments on termination and change in control.
• Corporate-owned life insurance funding deferred compensation is now restricted.
• Section 409A was added to the Internal Revenue Code to curb perceived abuses:
• All stock options must be granted at 100% of market value (or higher).
• Executives at publicly traded companies must wait at least 6 months after termination to receive most post-employment payments.
• Deferred compensation plans must follow stricter rules on elections and payouts.

The new boardroom landscape is now shaping up to look something like this:

• A compensation committee of “independent directors” has a written charter, much like the audit committee, and meets regularly.

• Independence has different meanings under stock exchange rules, tax rules and SEC rules. Director relationships with the company are closely scrutinized. Comp committee members must be independent under all standards.
• There is less emphasis on stock options. Restricted stock units, stock appreciation rights (settled in stock) and performance based vesting are becoming common.
• Cash bonuses are paid under a 162(m) performance incentive plan approved by stockholders.
• Equity compensation awards are granted under strict procedures to avoid “backdating.”
• Compensation committee directly hires consulting firm. In some boards, the comp committee and the company will have separate compensation consultants.
• Change in control payments are sometimes limited to amounts that are within the golden parachute tax thresholds, although tax gross-ups still exist for some top executives.
• CEO pay is no longer rubber-stamped. Take a look at the Delaware court decision involving the Disney board that approved extraordinary severance payments to Michael Eisner when he was fired.
• Paying compensation at the median, rather than the top quartile, is OK.
• Executive perks are being replaced with performance-based payments.
• Institutional Shareholder Services (ISS) is routinely consulted before requesting stockholder approval of equity compensation programs.

Your personal experience with these issues will vary. Most companies below the Fortune 250 do not make headlines on exorbitant executive pay for good reason. Nonetheless, the medicine for the perceived abuses in executive compensation applies to all companies. The taste of the medicine is the worst for publicly traded companies. Companies that only comply with GAAP financial reporting can avoid ISS, NYSE/Nasdaq and many of the Internal Revenue Code rules and, thus, have an easier time of it. However, even companies that are closely held by friendly shareholders must now give some deference to new executive compensation standards.

Query to readers:

How has your company been affected by the changing executive compensation landscape?  What changes would you like to see rolled back?  What additional changes are needed?