Gerald Herbert  /  AP file
Merck's board awarded CEO Raymond Gilmartin the same $1.38 million bonus as in 2003, and lowered the performance targets used to gauge his pay for next year.
updated 4/15/2005 4:50:20 PM ET 2005-04-15T20:50:20

CEO pay is climbing again, rewarding top executives with the biggest gains many have seen since the stock market bubble.

The executives piloting U.S. companies pocketed substantially more in 2004 than in the previous two years. Those gains come even as more corporate boards — responding to sustained criticism about excessive pay — rethink the way they award compensation, trying to more closely tie CEO pay to performance.

Chief executives' pay increased by an average of 12.6 percent last year, according to an analysis of nearly 180 corporate proxy statements by compensation consulting firm Pearl Meyer & Partners. That figure does not include the profits many CEOs reaped by exercising stock options.

The jump in pay takes the average CEO's compensation to $9.97 million, resuming a long-running rise in pay after two years of little movement.

But that overall figure pales compared to the pay netted by individual CEOs. Directors at Merrill Lynch awarded chief E. Stanley O'Neal with $31.3 million worth of restricted stock. At Wells Fargo & Co., CEO Richard M. Kovacevich pocketed stock options valued by the company at $20.4 million, on top of a $7.5 million bonus.

The surge in what for many CEOs were already huge pay packages, contrasts sharply with an overall slowing in pay for rank-and-file workers. In the past year, the pay of the average U.S. worker rose by just 2.6 percent, an increase more than offset by inflation.

The increase in CEO pay is rekindling debate in corporate governance circles. The argument focuses not just on how much CEOs deserve, but also the extent to which boards of directors control compensation and whether they're doing enough to make sure shareholders get their money's worth.

Some observers see great strides being made to that end.

“I really think compensation committees on boards are getting the message with respect to the relationship between pay and performance,” said Pearl Meyer, president of the firm bearing her name. “We're seeing the beginning of, hopefully, a transitional transformation, with the restructuring of executive pay so that it's more closely attuned to long-term results.”

But the bigger pay packages this year are already drawing fresh criticism from shareholder advocates and others. They are glad to see many companies moving away from the stock options that were a primary source of excessive pay in the late 1990s. But companies' shift to giving executives restricted stock — shares that can be sold after a set amount of time has passed — has just replaced options with shares whose worth is largely guaranteed, critics say.

“We're probably seeing pay packages as rich as they've ever been before because a lot of the risk has been removed from the equity portion of the package,” said Patrick McGurn, executive vice president of Institutional Shareholder Services.

CEO pay packages soared in the late 1990s, as companies granted huge numbers of stock options whose value mounted with the run-up in the financial markets. And while many firms have edged away from options — which give executives the right to buy stock at a set price, then turn around sell if they choose — they are once again netting huge returns for some CEOs.

The leader of that pack is Yahoo! Inc. CEO Terry Semel, who last year pocketed $230 million by exercising options. Semel — paid almost entirely in options — was awarded 7.2 million new options last year.

Companies soon will be required to count options as an expense. So a growing number of firms are rewarding CEOs with restricted stock. A much smaller number are partly paying CEOs with “performance shares” — restricted stock that vests only after an executive steers a firm to meet stated targets.

“There is less of a reliance upon stock options in recent years than there has been in the past,” said Tracy Davis, a compensation consultant for Hewitt Associates. “I think we'll continue to see that kind of trend, where it's more of a balance between options and other vehicles.”

That change is evident in the pay of executives like Edward Whitacre Jr., the CEO of SBC Communications Inc., whose pay totaled just under $16 million last year. That payout is partly the product of a change in thinking by the company's directors, which passed on awarding Whitacre and its other executives the large grants of time-vested restricted stock they received the previous year, in favor of smaller grants of shares they receive only when performance targets are met.

“While stock options and time-based restricted stock are linked to the interests of stockholders, they do not have a performance component or measure,” SBC explained in its proxy statement. The new arrangement “ties managers' interests directly to those of the stockholders.”

But critics say the link between pay and performance will only be meaningful when directors at more companies set targets high enough, and stick to them. Shareholder advocates single out companies like Merck & Co., whose earnings fell sharply last year after it was forced to withdraw its Vioxx pain relief medication.

Despite that, Merck's board awarded CEO Raymond Gilmartin the same $1.38 million bonus as in 2003, and lowered the performance targets used to gauge his pay for the current year. Gilmartin also made $34.8 million from exercising options, and received a new grant of 250,000 options.

“The disparity between Merck's performance and its compensation levels is pretty stark,” said Paul Hodgson who analyzes executive pay for The Corporate Library. “If you have companies out there that continually reset the targets throughout the year because of an unforeseen problem then CEO pay is never likely to go down.”

Directors at a relatively small group of companies have moved aggressively to not just restructure, but rein in CEO pay they judged to be out of control.

At MBNA Corp., the board pared CEO Bruce L. Hammonds' direct pay by 34 percent, following a 24 percent reduction the previous year. The resulting changes still left Hammonds' pay at $9.2 million, reflecting lower base pay, a smaller bonus, a smaller grant of restricted stock and no options.

The board “believes these actions will further align our compensation practices for senior management with those of the market,” MBNA said its in proxy.

While companies like MBNA have moved to make its pay practices more transparent, getting a handle on CEO compensation is as challenging as ever. Unlike the salary or wages most workers count on, CEO pay packages amount to a complex mix of incentives, and companies are not always straightforward in laying out details.

Proxy statements filed by companies show that base salaries are continuing to decline as a portion of most CEO's take-home pay.

CEO salaries, which are set in advance and awarded regardless of corporate results, rose last year by about 4 percent. That partly reflects boards' increased focus on paying for results. It also shows company's attention to tax law, which heavily penalizes companies for paying their top executives more than $1 million in pay that is not tied to performance. Not surprisingly, the average CEO's base salary now hovers right around that $1 million figure.

The surprise, though, is that with many boards stating a desire to move away from straight pay to performance-based pay is that many CEOs continue to make considerably more that that average figure.

At Cendant Corp., for example, Chairman and CEO Henry R. Silverman's base salary was unchanged in 2004. But he still made $3.3 million in salary, along with a bonus of $15.3 million and well over $5 million in other compensation.

At the same time, the average CEO bonuses surged by 21 percent for last year, rising to nearly $1.9 million, according to an analysis by compensation consultant Equilar Inc. of nearly 300 proxies issued by companies whose chief executives have been in place at least three years.

More than nine of every 10 CEOs netted a bonus for the year, the company found.

Both bonuses and long-term incentives like restricted stock were particularly large for CEOs at some Wall Street firms, reflecting a rebound in their companies' fortunes in a resurgent economy.

For example, at the American Express Co., CEO Kenneth Chenault netted a $6 million bonus for last year, up 71 percent from the $3.5 million payout the previous year. His total pay package of $21.9 million also included $3 million in restricted stock, up from $887,000 the previous year.

Many companies justify the large pay packages by noting the demand for qualified CEOs.

“There is a very tight market for proven executive talent,” Meyer said. “It's definitely inflationary.”

But shareholder advocates are skeptical, ridiculing the notion that only a relative handful of executives are capable of running companies.

“The primary argument against reform (in CEO pay) has always been we need to attract, retain and motivate these guys,” said Rosanna Landis Weaver, an analyst for the Investor Responsibility Research Center. “One always wonders why they require quite that much motivation.”

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