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Sunday, October 23, 2005

How to Slow Runaway Executive Pay

October 23, 2005
How to Slow Runaway Executive Pay
By GRETCHEN MORGENSON

WHILE investors have railed about skyrocketing executive pay, lo these many years, the response from executive suites has been a confounding silence. Even directors, who have a fiduciary duty to put shareholders' interests before those of managers, have been unwilling to stop the insanity.

Last year, the average pay package for chief executives at big companies came in at $10 million, up 13 percent from 2003. In view of the pension and health insurance givebacks being forced upon lower-level workers, this surge is especially obscene.

That the people on the receiving end of these enormous transfers of shareholder wealth want them to continue is no surprise. What's-in-it-for-me is the way we live now. Still, letting excessive pay escalate every year hurts the already battered reputations of American executives. From that standpoint, the silence has been baffling.

Finally, however, a C.E.O., albeit an emeritus one, is talking tough about outrageous pay and pliant boards. In a taped speech - aimed at directors - that will be shown at a compensation conference on Oct. 31 in Chicago, Edgar S. Woolard Jr., the former chief executive of DuPont and the current chairman of the New York Stock Exchange's compensation committee, debunks the main myths of executive pay.

Mr. Woolard, 71, does the debunking with style. He has one word, for example, to describe the notion that chief executive pay is driven by competition: "bull." And to the idea that compensation committees are independent, he says "double bull."

What about the doctrine that chiefs are owed stupefying amounts because they create wealth for shareholders? "A joke," Mr. Woolard says.

"I honestly don't understand why more C.E.O.'s aren't concerned about the image of business leaders in general," Mr. Woolard said in an interview. "They don't seem to have the same perception I do that business leaders are beginning to be thought of as politicians and labor union leaders and other types of individuals who don't have the right respect. So I'm speaking out because I would like to encourage other current C.E.O.'s to provide the leadership to begin to make the change to more rational compensation."

For example, he said, most people do not know that compensation committees are not independent of the chief executive. He described the workings of these typically close relationships:

"The compensation committee talks to an outside consultant who has surveys that you could drive a truck through and pay anything you want to pay, to be perfectly honest," Mr. Woolard says. "The outside consultant talks to the H.R. vice president, who talks to the C.E.O. The C.E.O. says what he'd like to receive. It gets to the H.R. person who tells the outside consultant. And it pretty well works out that the C.E.O. gets what he's implied he thinks he deserves, so he will be respected by his peers."

Mr. Woolard said directors should solve this problem by barring compensation consultants from discussing pay with anyone inside the company. Rather, the consultant should offer pay ideas to the company's compensation committee, which should discuss the matter only with human resources people. "At the New York Stock Exchange our outside consultants do not get any comments or sense of direction from the C.E.O. or H.R. person," he said.

While executives often contend that their pay is driven by competition, Mr. Woolard counters that the outside consultants are in control. If the consultants want to be rehired in future years, they will not want to hurt their chances by suggesting that a chief receive less than his or her peers do.

"Boards have been led to accept the logic that if 'our C.E.O.' is not in the top half, it implies to employees and to the general public that the board may not have confidence in the C.E.O.," Mr. Woolard said in the interview. "For some crazy reason it's been translated to, 'If you paid me at the bottom quartile, people would think you're about to get rid of me.' All that is honed by these outside consultants; they've gotten rich by providing this framework and the logic of the top quartile, and the boards have accepted it."

A solution, Mr. Woolard said, is a strategy known as internal pay equity, which he put into practice at DuPont in 1989. It starts with an examination of the average pay given to the handful of senior managers running a company's divisions; the chief executive's compensation is then based on a premium set to those pay levels.

"We took the level of the senior v.p.'s, the people who make very major decisions about the businesses underneath them," Mr. Woolard recalled. "And we asked the outside consultant to make a survey of how other companies pay people at that level, which is not escalating greatly. Then we put a cap on the C.E.O.'s total compensation not exceeding 50 percent of that." The chief executive, therefore, is taken out of the peer-group horse race that propels pay into the stratosphere.

Finally, Mr. Woolard knocks down the notion that chief executives deserve their riches because of the shareholder wealth they have created.

"During the 1990's with the stock market bubble and the major temporary wealth created for shareholders, this philosophy that 'I am doing so great for my shareholders, I certainly deserve a fairly significant portion of the benefit,' permeated across companies and boards," Mr. Woolard said. "Now, my concern is that the stock market bubble burst and many shares declined significantly but the base of C.E.O. compensation that was built during that artificial period is a base that is still used today. Because the surveys of the outside consultants are primarily built on compensation for the last five years, there's no way for those surveys to decline."

In other words, a lot of these emperors have no clothes.

Jesse M. Brill, a securities lawyer who is chairman of the National Association of Stock Plan Professionals, a sponsor of the Chicago conference, said the video of Mr. Woolard's speech should be required viewing in every public company's boardroom. Mere mortals can view it, too, at www.compensationstandards.com/nonmember/EdWoolard_video.asp.

"It all goes back to accepting that this is a significant problem," Mr. Woolard said, "and thinking very carefully about it at the compensation committee and the board, and not allowing the C.E.O. to have any input into the process."

Won't it be interesting to see if any of Mr. Woolard's peers join him in battling chief executive greed or if directors start to take up this fight? It would be a shame if the silence from the corner office just continued.

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