updated 5/2/2009 11:54:40 AM ET 2009-05-02T15:54:40

CEO pay fell in 2008, but will the pullback last?

The answer hinges on whether corporate boards make changes now to keep compensation at less stratospheric levels for the long term.

For critics of high executive pay, this is the year when public and political anger has lined up firmly on the side of reform. But those involved in setting pay — directors, lawyers and consultants, among others — face the genuine challenge of retaining and attracting top executive talent without fueling an even greater public backlash against CEO pay.

"It comes down to balancing what is the right thing to do for the company, and having to look over your shoulder at what shareholders and the media think," said Steven Hall, who runs a compensation consulting firm.

Since the start of the year, boards have been huddled with compensation advisers to figure out what is appropriate to pay top executives during the worst economic crisis in decades.

Because of the collapse in corporate earnings and stock prices, many executives won't meet performance targets that help set their pay. That could shut CEOs out of cash or stock bonuses at the same time as their existing stock compensation has lost much of its value.

In fact, 90 percent of the stock options granted in 2008 are considered to be under water, according to an Associated Press analysis of 387 companies in the Standard & Poor's 500 index. Executives could wait years for stock prices to rise enough that they can profit.

Some executives might not see much of an incentive to stay at their companies if they don't expect to claim much of their pay. To retain the top brass, many boards are redesigning their pay programs, especially because no one knows how long the recession will last.

Xerox, for instance, has already disclosed that for the first half of this year it is shifting away from using revenue growth — which tracks sales of a company — as a performance measure. Instead it will focus primarily on cash flows the company generates from running its business, as well in part on earnings per share.

In other words, CEO Anne Mulcahy will be rewarded not for generating new business but for running the existing ones better. In July, it will set its performance measures for the second-half of the year.

Xerox said that in this current economic climate such changes "are the most relevant goals and measures to the company's 2009 performance," according to its proxy statement.

That shift shouldn't necessarily worry investors, but they should watch to see if companies keep changing their goals, said Richard Ferlauto, director of pension and benefits policy for the American Federation of State, County and Municipal Employees, a Washington-based labor group representing government workers.

Ferlauto and other large shareholders are keeping close tabs on whether companies are lowering their performance hurdles so CEOs won't lose.

"We don't want to see less risk and more reward," said Michael McCauley, senior corporate governance officer at the Florida State Board of Administration, which manages assets for the state's pension plans. "We don't like the do-over mentality. We are seeing incentive frameworks getting gutted because stock prices are down so much."

He points to companies that are making bonuses more flexible so that they can still be awarded even if year-end results fall short of pre-established performance goals.

Another thing to look out for: Companies that dole out bigger-than-usual stock and option grants, which have the potential to be very lucrative if share prices rise in the years ahead.

That's especially likely if a company gives out the same dollar amount in stock awards — as opposed to a fixed number of shares — annually. If the stock is down, the executive is granted more shares, and could profit more if the stock bounces back.

"The message to companies: Their programs are biased (toward executives) over the long term," said David Swinford, who heads the compensation consulting firm Pearl Meyer & Partners.

Not every company can afford to tilt pay packages to executives' benefit, though. The more than 400 companies getting government help under the Troubled Asset Relief Program face new restrictions on pay.

Bonuses and retention awards will be curbed so long as the company is getting money from the government. Severance payouts to departing executives will be prohibited, and companies must have in place a provision to recoup bonuses if it is determined the payment was based on criteria later found to be materially inaccurate.

Those companies will also be required to hold a shareholder vote on executive pay, known as "say on pay." While those votes aren't binding, they still allow investors to make themselves heard.

If directors ignore what the shareholders want, they could put their own jobs at risk. That's because investors could then move to oust them from the board.

McCauley, of the Florida investment board, thinks all this could lead to some positive changes in executive pay down the road.

"Executive compensation is like an aircraft carrier trying to change direction," he said. "It won't happen quickly."

© 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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