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CEO pay gets back to basics with hard cash

By Monica Soto Ouchi and Luke Timmerman
Seattle Times business reporters

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Among the Northwest public companies surveyed by The Seattle Times, median pay for CEOs fell 9 percent last year to $539,561, but a larger chunk of that pay came in the form of cold, hard cash.

Thank the current, intense focus on CEO pay — a movement underscored by shareholder backlash against stock options, the once-coveted tickets to prosperity used by companies to lure and retain CEOs.

Shareholder watchdogs have maligned company boards for treating options like blank checks, arguing that large awards have both diluted shareholder value and driven executive pay to illusory heights.

Firms last year began replacing options, or rights to buy stock at a pre-set price, with bigger bonuses and stock. This comes as the organization that sets accounting rules moves toward requiring public companies to treat options as an expense — a mandate that would squeeze the bottom line.

"It's politically more feasible to pay hard cash," said University of Washington accounting professor Terry Shevlin. Companies are choosing bonuses because they are "linked to performance for the year," he said.

Options make a difference

Getty Images CEO Jonathan Klein, who topped this year's list with $9.5 million in compensation, saw his pay package double after converting $8 million worth of options into stock. His compensation picture, however, has evolved over time.

Klein received 2.5 million options over a six-year period as one of the founders of Getty Images. His Internet startup was similar to others — both executives and employees were awarded large stock-option grants in lieu of higher pay.

By the end of last year, Klein had 1.5 million options remaining; they were worth an estimated $37.7 million, according to regulatory filings.

As Klein's option grants have gone away (his last award came in 2001), the board's compensation committee has given him more cash. In February, the committee reduced Klein's base salary from $1.1 million to $950,000, but increased the bonus he is eligible to earn each year from 30 percent of his base salary to 70 percent.

In 2003, he received a $325,000 bonus. This year, he's eligible to receive up to $665,000.

The trend was visible at other Northwest companies. Salary and bonus represented 57.6 percent of a CEO's total pay package last year, up 18.2 percent from the year before.

Getty Images spokeswoman Deb Trevino said the change further ties Klein's compensation to company performance. Twenty percent of his bonus depends on his personal performance, which is determined by the board's compensation committee. The remainder is based on the company's operating margin.

"Options are clearly not a big component of his compensation," Trevino said.

That Klein topped this year's list underscores the shifting landscape for CEO pay. A year ago, Klein's $9.5 million pay package would have put him sixth on the list of highest-paid CEOs here.

Starbucks CEO Orin Smith was first in the 2002 rankings with a total pay package of $38.8 million after exercising $36.3 million in options. Former Expedia CEO Rich Barton was second with $24.4 million — the vast majority of which came from exercising options.

Graef Crystal, a San Diego-based executive compensation expert, said that executives also soured on options after a lengthy bear market drove down stock prices.

In many cases, an executive's strike price — the pre-determined price at which he or she can convert options into stock — was higher than the actual stock price, rendering the options worthless.

"A lot of people got burned when they had enormous paper profits, watched them evaporate, and basically said, 'I don't want those options anymore,' " Crystal said.

Pay for performance

While the CEOs of Getty Images and Starbucks received the most generous compensation packages in the past two years, their investors shared in the bounty. Getty Images' stock price has nearly doubled in the past 24 months, giving the company a market capitalization of $3.33 billion. Starbucks' stock has risen 75.3 percent during the same period; its market cap is roughly $17 billion.

But an executive's pay doesn't always align with a company's performance. And shareholder discontent has intensified as the gulf continues to widen between what a CEO earns when compared to the average worker.

Albertsons' CEO Lawrence Johnston saw his salary and bonus rise 68 percent last year to $3.3 million when compared with the year before. Add in restricted stock awards, and Johnston earned an average of $16.4 million a year since becoming CEO of the Boise-based retail grocery chain in April 2001.

During that same three-year period, the company has undergone tumultuous change. Johnston led a major restructuring in which the company closed 95 stores, two distribution centers and laid off 1,300 employees. The grocery chain also endured a four-month labor dispute with retail employees in Southern California that ended in February. And, the company's stock has fallen 5.4 percent over the three-year period ending in Dec. 31, 2003.

The average grocery worker in the Puget Sound area makes $18,000 per year, according to Geralyn Lutty, vice president and regional director for the United Food and Commercial Workers.

Put another way, it would take the average grocery worker 911 years to equal Johnston's average salary for one year.

That disparity far exceeds state and national trends.

On a national level, the CEOs of the country's largest corporations were paid more than 300 times the average factory worker, according to Business Week, which has conducted an annual CEO pay survey for 54 years.

The median total wage for individuals in Washington was $35,256 in 2002, the last year for which statistics were available. This figure includes bonuses, sales commission, exercised stock options, overtime and any other form of compensation.

For a CEO in the Northwest, where the list of public companies is dominated by smaller companies, median total pay in 2003 was $593,010 — or 16.8 times that of the average worker.

However, the gap between CEO and worker pay is most visible at the Fortune-500-company level. At Washington Mutual, for instance, CEO Kerry Killinger made $7.5 million in total pay last year. That's 214 times the median total wage for state residents.

Reform needed?

Scott Klinger, Responsible Wealth Co-Director for United For a Fair Economy, said executive-pay trends won't change until there's meaningful reform in the board room. In Europe, where boards have designated spots for employee representatives, CEO pay is 30 to 40 times the pay of the average worker, he said.

"(The boards in the U.S.) are largely made up of peer or retired CEOs," he said of U.S. company boards. "They're part of the same system. Until we start getting directors with different backgrounds, different experiences and different interests, I don't think we'll see any meaningful changes."

Pay expert Crystal said he was a consultant to oil giant Mobil in 1973 when the board decided to double its CEO's pay because the company's profits doubled during the oil crisis. The following year when profits returned to previous levels, one prominent board member wanted to cut CEO pay back to where it had been. He was kicked off the board.

The CEO said it wasn't his fault the profits declined, it was the global economy, and he didn't deserve a pay cut. He didn't get one.

"In good times, the CEO comes before the shareholders wearing the wreath of Julius Caesar, saying how he brought about these good times," Crystal said.

"In bad times, they switch costumes and become Pontius Pilate, with washing pans and soap, saying, 'I'm sorry, it's not my fault, it's Greenspan or fuel prices, and I'm just as much a victim as you, so I shouldn't get a pay cut. Plus, I have to work harder in bad times.'

"We really don't say that when you have a crappy performance, you have to take a pay cut," Crystal said. "Most people, even on boards, don't have the guts to do that."

Looking for answers

Fred Whittlesey, a consultant with Aon Compensation Consulting in Seattle who drafts executive-pay plans, said that executive pay is increasing, no matter how the numbers are sliced.

Whittlesey said he's working on executive pay plans that are less reliant on stock options, more linked to company performance, more complex and more scrutinized by company directors.

He said he's being asked questions from directors he's never heard from before, such as: "Which companies are we comparing ourselves to? Is this really the right peer group? What are the best measurements of performance? What's the right ratio between cash and stock?"

Most of this new scrutiny will be applied to 2005 pay plans.

But Whittlesey predicts it will be 2009 or 2010 before shareholders really see what kind of impact the new attitude has on executive pay. And, he thinks it won't show any downward pressure on the dollar amounts.

"Pay rates for executives are not really driven by market conditions, and won't be," Whittlesey said. "It's driven by supply and demand for executive talent. If you want a hard-charger to take a company to the next level, they have to be given some upside."

Monica Soto Ouchi: 206-515-5632 or msoto@seattletimes.com

Luke Timmerman: 206-515-5644 or ltimmerman@seattletimes.com

Copyright © 2004 The Seattle Times Company

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