First, options were the problem.
Now, in some eyes, the solution is the problem.
Amid a backlash against corporate excesses and the move to have them count as an expense against the bottom line, options have been losing favor with more and more companies as a way to reward chief executives.
More often than not, however, that's not translating into lower CEO pay: They're being replaced at least in part by good old cash and by restricted stock--full-value shares that typically become available to sell after a specified period of time.
Companies like them because they don't have to award as many shares, decreasing dilution. Many executives like them because they typically have at least some value regardless of performance--unlike options, which become worthless if the stock price falls.
And that, to some, is the issue with restricted stock.
"I still believe that options are the best incentive-compensation vehicle available," said Jonathan Michael, CEO of Peoria-based insurance company RLI Corp.
Options only have value if stock prices go up, he noted, while executives can benefit from time-vested restricted stock regardless.
"It's my belief you should get nothing if your stock gets cut in half," Michael said. "Restricted stock, on the other hand, only time makes those [shares] valuable to the executive."
Any concerns aside, companies continue to ratchet up restricted stock awards: Among the 100 biggest publicly traded companies in Illinois and northwest Indiana, for example, half the CEOs in 2004 received restricted stock, with a median value for those receiving grants of $1.24 million--more than twice the previous year's $552,000.
That, along with sharply bigger bonuses thanks to higher earnings and solid stock returns, helped to push their median overall compensation up 26 percent in 2004, to $4.4 million.
With growing demands that companies craft plans that emphasize pay for performance, more shareholders are pushing firms to include hurdles based on results to make options or restricted shares have any value.
Labor unions, for example, have filed more than 40 shareholder resolutions at U.S. companies asking them to include performance-based vesting requirements on options or restricted shares.
"Unfortunately, too many companies are using the time-vesting shares, which reward tenure and not performance," said Brandon Rees, an executive-compensation expert at the AFL-CIO. "You don't see enough performance requirements being attached."
`Pay for pulse'
Restricted stock usage is up sharply, though experts say most awards simply have time-based vesting, which critics deride as "pay for pulse."
"People are joining the bandwagon," said Jeffrey London, a partner at the Sachnoff & Weaver law firm in Chicago who works with boards on compensation issues. "I have not joined that bandwagon that restricted stock is better than options. I've always been against restricted stock if it's only time-vesting."
Nationally, a Mercer Human Resource Consulting study of 350 of the nation's largest public companies showed a 60 percent increase in the number of CEOs who received restricted shares from 2002 to 2004. The number of CEOs who received options, meanwhile, fell 7 percent.
Overall, the Mercer study found total median CEO pay--cash plus long-term incentives like options and restricted stock--climbed 17 percent last year, to $7 million. Bonuses increased 20 percent, to $1.5 million, reflecting the sharp jump in corporate profits last year, while salaries rose nearly 4 percent, to $975,000.
John Biggs, former chairman and CEO of the giant TIAA-CREF retirement system and a Boeing Co. board member, called the double-digit pay increases "pretty discouraging" in a forum last month sponsored by the Glass Lewis proxy advisory service.
In fact, a survey of major institutional investors by North Barrington-based Clark Consulting's Pearl Meyer & Partners found that three-quarters of respondents said CEO pay is too high. None said that it was too low.
Use of options declines
Options, the old whipping boy, are making up a smaller portion of the pay mix, several studies show: The Mercer data showed options declined from 76 percent of the value of long-term incentives in 2002 to 57 percent last year.
Locally, according to data provided by Aon Consulting's eComp Data Services, bonuses posted a 37 percent increase, to a median figure of $745,000. Total cash pay was up nearly 20 percent, to $1.62 million. Bucking the national trend on options, however, their median value, based on the 5 percent appreciation model, rose 30 percent, to $1.9 million.
Meanwhile, the median total shareholder return for the companies that were traded for the full year was 21.3 percent, revenue growth was 13.2 percent, and earnings growth was 23.5 percent.
The highest-paid CEO was Motorola Inc.'s Edward Zander, with a package of cash, restricted stock and options valued at $38.8 million, much of it awarded to attract Zander to the job in January 2004. The cash component was $6.5 million, including a $4 million bonus he has deferred; most of the restricted stock and options are not yet available to him.
In 2004, Zander's first year on the job, Schaumburg-based Motorola had sharp jumps in revenue and earnings from continuing operations, plus total shareholder return of nearly 39 percent.
Motorola spokeswoman Jennifer Weyrauch said the company believes it is misleading to lump the compensation awarded to sign on Zander with his regular annual compensation, and she said the company's directors believe the package "is appropriate to help ensure that he has incentives to create value for our stockholders."
In a statement, members of the compensation and leadership committee said: "Mr. Zander's compensation recognizes the exceptional performance of the company during 2004 under his leadership. The board unanimously believes that Mr. Zander's compensation is appropriate to help ensure that he is rewarded for effectively leading this company and is in line with other CEO packages."
The largest restricted stock award went to Navteq Corp.'s Judson Green, at $13.6 million. He received no options. Spokeswoman Kelly Smith said the restricted stock award, which contains both time- and performance-based vesting, was part of a renegotiated employment agreement for Green. His previous agreement expired in April 2004.
Many compensation consultants are urging companies to adopt performance-based vesting in their restricted shares.
Matthew Turner, senior executive-compensation consultant with Mercer, said the move toward time-vested restricted shares is really more of a transition from options to more performance-based vehicles.
"My interpretation on this is that it's a relatively easy-to-implement alternative to stock options," he said. "I think companies would be well-served to consider additional performance ties to their restricted stock plans."
Michael Kesner, principal in charge of Deloitte and Touche's executive compensation practice based in Chicago, said the popularity of time-vested restricted stock may not last.
"I don't see that surviving," he said. "I think that's going to shift. If you're going to do stock, make them performance shares."
Simple time vesting, he said, "doesn't make sense to me."
Blair Jones, senior vice president at Sibson Consulting, said time-vested restricted stock has a place as a retention vehicle, but that companies should tailor plans to ensure they accomplish that goal.
"If a company is going to use time-vested restricted stock, I would rarely advocate using it as a sole vehicle," she said. "If you're going to make it about retention, maybe make them stay around longer to get it."
Tom Wamberg, CEO of Clark Consulting, is a fan of performance-based restricted shares.
"The argument with options is if the stock goes down, you lose management's interest," he said. If the stock price falls, because restricted stock still has value, executives are motivated to work to push the shares higher.
"That's an incentive to perform," he said.
The challenge, many experts say, is in defining the criteria for performance-based shares.
"You've got to really be able to outline and define those metrics" and align with long-term shareholder interests, said Judy Thorp, national partner in charge for compensation and benefits at KPMG. "That's not an easy thing to do. ...
"I think it's critical, and yet we find many companies just don't clearly define those metrics, or if they define the metrics, they change them too often or too quickly."
Companies use combinations of different criteria, experts said, with shareholder return, earnings per share, revenue growth and return on equity among the most popular measures.
When adopting pay-for-performance standards, many are urging companies to take a long-term view. In a speech earlier this year, for example, Securities and Exchange Commission Chairman William Donaldson challenged directors.
"Company boards must show greater discipline and judgment in carrying out their fiduciary duties to shareholders to award pay packages that are linked to long-term performance," he said. "I would like to see a much broader definition of performance--necessitating an evaluation that goes well beyond EPS and other financial measures, to identify what management excellence, and hence reward, is all about."
How companies are doing on pay for true performance is a matter of debate.
"We're seeing increasingly tighter correlation between company performance--both financial and stock performance--and the incentive components of CEO pay," Mercer's Turner said. "Compensation committees are seeking a better understanding of pay for performance. They're spending more time getting the measures right."
Charles Schwab, CEO of Charles Schwab Corp., whose company uses performance-based restricted stock, said he believes "executive compensation should be related to performance" but said seemingly large pay packages can be appropriate.
"A CEO is an incredibly responsible job," requiring 20 to 30 years of experience, followed by what is often a relatively brief tenure.
"They're incredibly prepared. They're more prepared than a doctor is to do brain surgery," he said, adding that people don't begrudge a brain surgeon with 30 years' experience a hefty salary.
A `continuing disconnect'
The AFL-CIO's Rees, however, sees a "continuing disconnect" between pay and performance.
"The problem is that during the 1990s, CEO pay exploded in size. Since the stock market bubble popped ... we did not see CEO compensation packages deflate to the extent that shareholders saw their holdings deflate," he said.
"Compensation committee members have been unable or unwilling to stand up to the pay demands of their executives."
Maryann Waryjas, a partner at the Katten Muchin Rosenman LLP law firm who works on compensation issues with corporate boards, said pay for performance has been a buzzword since the 1980s, but it hasn't always worked.
"In some instances, senior management is being compensated at times when the shareholders are not faring as well," she said.
A key issue, Waryjas said, are severance packages for CEOs being kicked out the door.
"What you see is former CEOs left the company with multimillions of dollars at a time when the company is underperforming," she said. "That's very difficult for shareholders to understand."
Clark Consulting CEO Wamberg believes some bad examples are inevitable.
"There's always going to be cases where you have an indirect linkage between pay and performance," he said. "There's no way around it."
But, he and several other experts who work with boards said, directors are more engaged than ever.
"People are trying hard. ... I've never seen people try harder," Wamberg said. "It's a serious issue."
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By the numbers
Value of the total package--cash, restricted stock and options--awarded to Motorola's Edward Zander, which ranks No. 1.
Value of total package awarded to General Growth Properties' John Bucksbaum, the lowest-paid CEO on the list.
Largest value of unexercised, in-the-money options, held by Navteq's Judson Green.
Value realized from options exercised by Illinois Tool Works' James Farrell, the largest of any CEO.
Largest salary, to Calamos Asset Management's John P. Calamos Sr. He also had the largest bonus, at $8.3 million.
Number of female CEOs in the 2004 pay list of Top 100 companies. (Sara Lee's Brenda Barnes was named CEO in February.)
Number of CEOs who received no options last year, down from 22 in 2003.
Source: Aon Consulting's eComp Database