The second in a four-part series on how CEO pay became a national controversy.
Smithfield Foods CEO Larry Pope stands to take home $46.4 million from the sale of the world’s largest pork producer to Chinese interests last September. Once the deal was announced, the fine print revealed the board had authorized more than $18 million in accelerated stock-based payments to the chief executive, including millions of dollars in previously undisclosed incentives.
In January, Wal-Mart Stores CEO Michael Duke retired after five years at the helm, as the world’s largest retailer was about to report lower earnings. Duke relinquished unearned performance shares potentially worth millions, but the board had awarded him $2 million in 2010 for “achieving at least 2.5 percent revenue growth” when unadjusted revenues grew by just 1 percent.
This March, Alcoa disclosed that its board piled new cash bonuses and stock incentives onto CEO Klaus Kleinfeld after having previously “reduced the grant value” of the CEO’s 2012 equity pay by 20 percent “in response to the decline in our stock price.” Offsetting that decline, the directors gave Kleinfeld a 28 percent greater number of stock and option units in 2012 and 35 percent more in 2013 after a further drop in the share value. Granted during two years when shareholders were being hammered, the higher number of units had a market value of $7,228,410 at last Friday’s closing price.
|Part 1: The Man Pushing CEO Pay to the Stratosphere|
|Part 2: How Smithfield Larded CEO's Pay Package|
|Part 3: The High-Stakes Fight Over 'Pay for Performance'|
|Part 4: An Unlikely Champion for Higher CEO Pay|
Three big U.S. companies. Three boards. One pay consultant: Ira Kay.
The Smithfield, Wal-Mart and Alcoa examples demonstrate that how CEOs are paid is as meaningful, and perhaps more so, than how much. That’s where consultants such as Kay, managing director of Pay Governance LLC, come in. Executive-pay specialists and the boards that hire them preside over bulging CEO pay through alternative compensation-accounting methods, amorphous performance targets, opaque disclosures and equity grants that reward longevity rather than results.
“I’m not on the committee. I don’t have a vote. It’s up to the committee to decide whether this is working or not,” Kay said, during a series of interviews last fall. At the same time, he described himself as the “vocal cords” of insider interests on executive pay issues, “not their mouthpiece.”
Until as recently as five years ago, the management teams at many big U.S. companies hired the executive-compensation consultant that advised their boards, and paid them substantially more for additional work such as employee-benefits consulting. Congress, shareholders and regulators all questioned whether the consultants’ ultimate loyalty was to the boards or management.
A Need for Change
The National Association of Corporate Directors, a Washington trade group, had recommended as early as 2003 that boards hire compensation consultants independent from management.
“Make independence a bedrock of compensation-committee governance,” the NACD said in a 76-page report that was explicit and bold for the time. In 2005, a 28-member committee of the Conference Board big business group, including Kay among 15 compensation consultants and nine company executives, took a step back, proposing that boards and management share their consultant, albeit under the administrative control of directors, to avoid “dueling” experts.
Even today, before an independent consultant’s candidacy is passed onto the compensation committee for consideration, the consultants typically are screened by corporate human relations departments and management, says Jan Koors, a managing director of the Pearl Meyer & Partners practice in Chicago. And independent consultants can still work for management so long as payments above $120,000 are disclosed to the Securities and Exchange Commission, under a law that became effective in 2010.
Concerns About Conflicts
Kay says he recognized that a growing perception about conflicts of interest challenged his future. He relates a prospecting trip to Minneapolis in 2007 to meet real estate developer Frank Trestman, then the compensation committee chair of electronics retailer Best Buy. Like most in the industry at the time, Kay's employer, Watson Wyatt & Co., represented boards and management simultaneously, and had a thriving employee-benefits practice that generally received bigger fees from the companies it served than did its work on executive pay, he said in an interview.
“What the f are you doing here?” Trestman asked, according to Kay’s telling. “I would never hire you.” When Kay asked why, Trestman supposedly responded, “Because you work for a full-service consulting firm. I don’t think it looks right.” Says Kay: “I was like, ‘You couldn’t have told me that on the phone?’ And wow, this is my future? I was the first person in our industry who had that thought.”
Trestman refutes Kay’s version of the story, including his use of the f-word, confirming only that after meeting the consultant the board chose another who was “definitely not a self-promoter like Ira Kay.”
On Dec. 5, 2007, Rep. Henry Waxman (D-CA), then chairman of the House Committee on Oversight and Government Reform, called a hearing to examine the “inherent conflict” posed by consultants who “are being asked to evaluate the worth of the executives who hire them and pay them millions of dollars.” Congressional investigators had found that, for 2006, only 33 of 113 Fortune 250 companies that hired compensation consultants with conflicts of interest disclosed the relationships to investors. On average, the companies paid the consultants almost 11 times more for other services, averaging $2.3 million, than the $220,000 for executive-compensation advice, according to the report.
“Waxman that piece of – that guy,” Kay recounted. As head of the compensation practice at Watson Wyatt, he was invited to testify at the hearing and declined, he says, at the request of his employer. On the conflict-of-interest perceptions, he says, “It was preposterous, and frankly insulting to our integrity.”
Soon after, the clubby, insular world of boards, management and pay consultants began to break up.