Directors' Compensation: Cash Laughs Last
from
January/February 2002
by Joseph B. Treaster
In 2000 the median total compensation for directors of public companies burst through the six-figure barrier, surging 11.5%, from $99,198 to $110,648. Lots of directors went into the year expecting far more than that, especially at Internet, technology, or telecommunications companies. Many of those outfits not only dispensed enormous compensation packages, but did so exclusively in stock and stock options that held the promise of huge capital gains. But the face value of such deals—used by consulting firm William M. Mercer Inc. to calculate total director compensation for the year—took a beating as the seasons progressed. Many directors who looked, and probably felt, like multimillionaires in the spring ended up with options that lay deep underwater by winter. In contrast, those with cash-heavy pay packages finished the year like the tortoise, first across the finish line and well ahead of numerous sodden hares.
With the Dow, Standard & Poor’s, the Nasdaq, and other stock indices all down sharply, 2001 won’t be any better for directors whose compensation is heavy on stock. Small wonder that some companies are increasing the proportion of cash in the compensation they pay their boards. Others are even offering directors a choice as to what they’d like that proportion to be. Motorola, among others, permits directors to opt for up to 50% of their compensation in cash. Morgan Stanley Dean Witter insists that its directors take their annual retainers in stock but lets them choose whether they want their committee fees in cash, stock, or a mix thereof.
The punishment that the markets have inflicted on directors mirrors the pain suffered by shareholders—which is exactly what corporate-governance experts have pushed for in demanding that director compensation, along with the pay of top executives, reflect a company’s performance. “This is the way it’s supposed to work,’’ says Charles Elson, who directs the Center for Corporate Governance at the University of Delaware. “If stock prices go up, directors and shareholders feel great. If prices go down, they don’t feel great, and directors have a real incentive to make things go great again.’’
For all that, companies whose investors lost the most also seem to have forked over many of the biggest compensation packages in 2000, according to Mercer. The New York City firm included 390 publicly traded companies in its survey. Among the five top payers, only one, Tibco Software Inc. in Palo Alto, California, made money for its shareholders. It delivered a total annual return of 7%, a respectable figure considering that the S&P lost 9.1% for the year. Tibco’s nine directors collected $3.5 million apiece, which made them the year’s best-paid board. The other four companies on the top-paying list vaporized a lot of shareholder equity. These include Yahoo!, which in 1999 was No. 1 in the Mercer rankings, having paid its directors more than $3.1 million each.
In 2001 share prices fell sharply for all five companies, including the newly merged AOL Time Warner. The stock options granted to Tibco directors in 2000 were valued by Mercer at $55.56 a share, their price on the day of the annual meeting. By October 11, 2001, they’d dropped to just under $9.
In addition to the top five, Mercer found that 12 other companies also gave directors total compensation exceeding $1 million in 2000. Among them: Oracle (which paid its directors $1.75 million each), BroadVision ($1.67 million), and Exodus Communications ($1.03 million). At 51 other corporations, directors received between $250,000 and $1 million. Cisco Systems’ board members collected $848,000 each, and Merck & Co.’s got $250,948. Again, most or all of this compensation was in stock or stock options that are now beneath the waves.
To find directors with smiles on their faces, look for those serving the handful of old-line companies that continue to pay their boards only in cash. Alcoa’s directors got $100,000 apiece, for instance. Gannett’s received $70,000, Winn-Dixie’s $60,000. Companies that dispensed compensation in cash-heavy packages, such as Lucent Technologies and Hewlett-Packard, also had happy directors.
Cash rewards, of course, wipe the smiles off the faces of corporate-governance specialists like Charles Elson. “If you’re paid in cash and the stock falls, you have no real incentive to take action,’’ he complains. “At that point, your interest has diverged from the interest of the shareholder. Your interest is in keeping your job and your cash flow.”
Thanks to the pressure exerted by all kinds of activists to align director compensation with corporate performance, more board members than ever found themselves at the mercy of the markets. In 1996, according to the Mercer research, stock and stock options made up a little over 36% of the average compensation package; four years later the percentage was nearly 60%. Mercer also found that 95% of the companies in its study include some stock in their director compensation, up from 89% in 1996. At dozens of these companies—and not only technology outfits—stock or stock options make up all or almost all of the compensation directors receive.
Such proportions looked great in bullish times, and few directors protested their hefty stock grants. But the bear market has tempered this enthusiasm to such an extent that some experts feel the compensation model needs to be changed. “The pendulum has swung too much toward stock,’’ says Peter J. Oppermann, a specialist in executive compensation at Mercer. “The message here is that the pay for directors is too volatile, simply because you’ve got too much weight on stock.”
At some companies, such as long-established drugmaker Merck, sunken options probably represent nothing more than a soggy patch for directors, says Peter T. Chingos, who heads Mercer’s executive-compensation consulting practice. In time the markets will turn, the stock will recover, and the directors will be in clover once again. “These are long-term plans,’’ Chingos says. “The stock options have a 10-year life. When prices are down, directors get more options. So over the long run, they should be fine.’’
A return to health is more doubtful for many Internet and telecommunications companies. Directors of such outfits as DoubleClick, Internet Capital, and Priceline.com ended 2000 knowing that they’d worked for free, and others may join that club at the end of 2001. This explains why some companies are changing the way director contracts are constructed and are reemphasizing cash as a perfectly respectable mode of compensation. Indeed, around 75 of those in the Mercer study have increased the proportion of cash in their directors’ annual retainers.
That doesn’t sit well with governance experts like John M. Nash, president emeritus of the National Association of Corporate Directors. Not only is Nash a strong advocate of paying directors in stock to align their interests with those of shareholders, he also thinks directors should be required to buy and hold a certain amount of that stock. “To get the directors’ attention, to help them concentrate, to raise the bar of performance, there has to be a risk factor,” he says. “The risk can’t only be on the investors, the institutions, and the little guy. The director has to share in that pain.”
Some companies—IBM, Bank of America, and General Electric among them—already insist that board members meet a minimum stock-ownership requirement. Their number is growing. In 2000, about 19% of the companies studied by Mercer required directors to own shares with a value of three to five times their annual retainers, up from 11.4% in 1996. In most cases, directors were expected to reach the stock-ownership goal within five years of joining a board.
Cash isn’t the only way to protect directors against a stock-market collapse. Another way is to reprice their options—an action that’s sure to stir protest among shareholders, who get no such makeup payments when a stock tanks. Repricing sparks anger among activists. Says Nell Minow, who edits the Corporate Library (www.thecorporatelibrary.com), a website on corporate governance: “We want anything but a softening of the blow. We want the board of directors to be up at night thinking about these things. I don’t want them to sleep soundly.’’
Even as the cash-versus-stock controversy heats up, companies have met with generally good reviews for the various ways they’ve found to cut back on expensive benefits for boards. In 1996, for example, 28% of the outfits Mercer studied provided pensions to directors; last year only 7% did so. (See the box below for more on benefits that have been cut—and one that’s growing.)
Directors who serve on compensation committees clearly face a dilemma. On the one hand, they must continue to align the board’s rewards with those for shareholders. If they don’t, they’ll hear about it. But they must also offer the kind of compensation that will attract and retain the best and most experienced directors, something that’s particularly important in troubled times. Most likely market forces will prevail. Right now the need for good directors is paramount, and companies that offer their directors some kind of choice may be the winners.
