The House Financial Services Committee has scheduled a hearing on executive compensation for March 8, 2007. U.S. Rep. Barney Frank, D-Mass., organized the hearing, which will focus on legislation designed to give shareholders more power in setting executives' compensation. Political pressure to increase oversight in Corporate America hit a high recently after shareholder outrage against Home Depot and Pfizer CEOs combined with President Bush's speech earlier this month demanding that companies tie pay to results. Notably, however, Bush stopped short of calling for either new federal rules or fresh congressional action; but, Barney Frank said he plans to go ahead with his plans to move legislation that would greatly expand shareholder powers in the Board room. On the topic, he said, "I agree with President Bush that excessive executive compensation has become a problem, but disagree with his view that we should do nothing about it." No witnesses have been listed yet; however, the hearing is scheduled for March 8th of this year.

The SEC's new executive compensation disclosure rules may have a new set of flaws after an accounting loophole for stock options and an 11th hour rule change may cloud the compensation of top executives. The loopholes, which were discovered by compensation analysts hired to draft these new filings, may undermine the SEC's ultimate goals and end up simply costing company's more money without seeing results. How so? Let's take a look...

The problems stem from a stock options accounting rule known as FAS 123R, which changed the way company's reported stock options expenses. Previously, stock options were not reported as expenses. FAS 123R changed this by saying that if companies gave stock options to executives, they had to subtract the total value of those grants from their earnings that year. This would obviously result in a huge windfall for companies issuing a lot of stock options - particularly in healthcare and technology. To avoid the huge windfall, some 900 companies changed their options vesting dates to occur before the rule went into effect. This enabled the companies to erase an estimated $8 billion of future expenses from their books - they could award these options without cost. Then right before Christmas, the SEC changed the rules again. Now allow companies to report the amount of stock options that vest per year rather than the total value of the options granted to an executive. Without the total value being reported, the summary tables on the new compensation disclosures can be extremely misleading, often changing the order of executives by compensation significantly. Since the new rules require only the top five executives in each company to report in the summaries table, there is room for many top executives to completely hide their compensation from shareholders.

One of the most popular executive perks during mergers and acquisitions is the so-called tax gross-up, which is a payment made by company's to cover taxes on an executive's severence package. Given today's tax law, these gross-ups can end up costing shareholders almost as much as the severence packages themselves! For example, when SBC boughtout rival AT&T in 2005, CEO David Dorseman received not only a $29 million severence package but an additional $11 million gross-up to cover taxes. These gross-ups often go under the radar, unnoticed by the majority of shareholders. Many shareholder rights groups call these gross-ups the most costly part of a golden parachute and an extremely inefficient use of shareholder money. Consequently, it will likely be a popular topic during this years proxy season.

Gross-ups first gained their popularity during the 1980's merger frenzy after the government imposed new tax penalties on executives aimed at preventing them from cashing out million by quickly selling their companies and unloading all of their shares. Companies then began offering gross-ups as an incentive to help keep and retain executives. According to an article on BusinessWeek, only 10% of companies in 1987 had gross-ups compared to about 77% now. It is becoming increasingly apparent that government regulations intended to help reduce executive compensation are simply costs that are passed on to shareholders...

Aflac, Inc. (NYSE:AFL) became the first company to offer shareholders a non-binding vote on executive compensation packages. The move came in response to a 2006 shareholder proposal aimed at increasing corporation transparency and accountability. "Our shareholders, as owners of the company, have the right to know how executive compensation works", commented the company's CEO. "The board's action is in keeping with Aflac's longstanding pay-for-performance compensation policy and our commitment to transparency at all levels."

The company created an offer last week that will give shareholders the ability to cast their votes on the company's 2009 proxy. While the shareholder vote on pay packages serves only as an advisory vote as of now, it creates an important venue for shareholders to communicate on the issue of executive compensation. And with over forty companies are facing shareholder resolutions on executive pay this 2007 proxy season, this may become a new trend to help satisfy the increasing concerns over compensation packages.

A new study by the University of Texas has found that CEO’s at companies whose directors sat on numerous other boards were paid 13% more than CEO’s whose directors did not sit on other boards.  The study is a reflection of sorts of outside directors, most of whom often sit on several boards.

There are several possible explanations.  Some argue this is evidence of the power of "friend of friend" networks that facilitate mutual back-scratching.  Others argue that it is evidence of a viral spread of self-serving practices.  Simply put, it allows a board member, with a reputation for supporting CEO’s, to get other jobs.  An outside director that is friendly to CEO’s on one board gets selected by other CEO’s for other board positions. 

This study, involving 3,000 companies, shows that companies lavishly pay CEO’s even while performing below expectations for such high pay.  This has also been noticed by more than 80% of Americans (evenly divided between the well-off and those making under $100,000-a-year) who agree that CEO’s are paid too much.  The greater the bond between CEO’s and board members creates greater compensation packages, plain and simple.  

Grants of restricted stock are not inherently performance-based. This is due to the fact that the executive may receive compensation even if the stock price decreases or stays the same. A grant of restricted stock is treated like cash and does not satisfy the definition of performance-based compensation, unless the grant of the restricted stock is solely based upon the attainment of a performance goal or standard (set by the compensation committee and/or shareholders). While not overly common, restricted stock is one way in which many executives are "quietly" compensated by effectively tendering stock into cash.

Performance-based compensation is a growing trend among compensation procedures. It is currently being acted upon as "pay for play" theories where compensation accounts for the attainment of one or more performance goals within the company. These performance goals are established by a compensation committee consisting solely of two or more outside directors (not a current or former employee or officer of the corporation,and does not recieve compensation for personal services other than for directorship). The material terms under which the compensation is to be paid, including the performance goals, are then disclosed to and approved by the shareholders in a separate vote prior to the payment. The committee verifies that the performance goals and any other material terms have been successfully met and completed in order for the executive to receive the full compensation.

Performance is based on standards for the individual executive, for a particular branch, or for the company as a whole. Performance standards could include increases in stock price, market share, quarter or annual sales, or earnings per share. Please note that executives are allowed some discretion in their performance-related compensations; as well, their performance may be reevaltuated based on preestablished objective goals and performance formulas.

Two pension funds (one public) said that they would ask an Alaska state court to freeze more than $140 million in retirement pay and other compensation for outgoing BP CEO John Browne, saying it is "excessive and undeserved". The shareholders said they want Mr. Browne's pension fund to be held in a court-supervised trust while they pursue claims against him and the board of directors for environmental and worker safety issues that have beset the oil company. They are also pushing for future executive compensation at BP to be tied to safety metrics in an attempt to curb the recent rise in public health and safety concerns, including fatal accidents at a Texas refinery and maintenance issues at an Alaskan oil pipeline.

The claims, according to estimates compiled by the plaintiff's law firm, seek to temporarily bar Mr. Browne from collecting approximately $40 million in pension benefits and $54.5 million in long-term performance pay while the plaintiffs pursue their claims. They also want the court to freeze about $30.7 million in stock options and want about $18.3 million in previously awarded cash bonuses to be returned and put into the trust. Finally, the group demanded company accounting records that they could use to calculate the exact total of his compensation. While BP refused to comment on the matter, we already know that the CEO announced that he would be stepping down on at the end of July, a full year-and-a-half earlier than expected.

Deferred compensation is exactly what it sounds like: compensation that is deferred until a later date. Why would someone defer their compensation, especially given the time value of money? Well, it turns out that the government offered many tax benefits for those who did defer their compensation. Consequently, executives sought to defer large amounts of compensation as a way to avoid paying taxes. Recently laws have reversed this trend, however, by placing a $1 million cap on all deductions.

Under the new laws, a corporation may deduct compensation expenses as an ordinary and necessary business expense for its employees. However, the otherwise acceptable deduction for compensation paid or accumulated to a covered employee of a public corporation is limited to no more than $1 million a year. A person is considered a covered employee if they are the CEO of a corporation (or the individual acting in such capacity) at the close of the taxable year; as well, the four highest compensated employees are also taken into account for the limitation's rules.  

The deduction limitation is applied even in the case of an emergency resulting from transfer of property in connection with the performance of services. The deduction limitation applies to all compensation for services, including cash and the cash value of all remuneration (including benefits) paid in medium other than cash. There are a few factors that are not included in the deduction limitation. Such factors not included are remuneration based on commission; remuneration payable solely on account of the attainment of one or more performance goals if certain outside director and shareholder requirements are met (performance-based compensation); payments to a tax-qualified retirement plan (including salary deduction contributions); and amounts that are excludable from the executive's gross income (such as health benefits and miscellaneous fringe benefits). 

Executives are covered by a wide range of compensation arrangements, which will be discussed in our new series. These arrangements may include agreements between several employees or it may consist solely on individual agreements between the company and one executive. Typical arrangements include nonqualified deferred compensation and stock option programs due to their tax benefits. There is, however, a limit on a company's deduction for compensation of certain employees in excess of $1 million - a limitation that applies to the chief executive officer and the four other most highly compensated employees. However, performance-based compensation is not subject to the deduction limitation. Studies have indicated that the deduction limitation may have led to some substitution away from salary compensation toward performance-based compensation, but that growth in overall executive compensation has not been reduced.

Our series will primarily explore the various types of stock-based compensation, which includes stocks, stock options (right to purchase shares by a certain date), restricted stock (stock with restrictions tied to them, such that can't be sold for a certain amount of time, etc.), stock appreciation rights (the right to the gains of the stock as if you owned it), and phantom stock (artificial shares that the company values at the going market rate).

Regulatory filings yesterday showed that Toll Bros. CEO Robert Toll's salary slumped along with the rest of the housing market. The filings revealed that the housing sector CEO received only $29.3 million in salary, options, and benefits this year compared to $41.3 million in 2005 and $50.2 million in 2004. The executive, who ranked among the nation's highest-paid CEOs, agreed to the pay cut after the board felt it was "too big of a number" given the slowing of the economy for home building. Many investors continue to criticize the executive, however, as the company's shares were cut in half earlier this year before making a slight recovery during the past few months. Are these complaints justified? Well, let's take a look at Robert Toll's pay versus performance...

ExecutiveDisclosure.com reports reveal that the Robert Toll is still being paid far more than his peers. The actual numbers show that during 2003-2005 he was being paid 273% more than other in the housing industry. Here is a chart from ExecutiveDisclosure.com comparing Toll's salary to that of his industry peers:

If there is a problem, who is to blame? Ultimately, it is the board of directors that is responsible for executive compensation. The most important function in today's compensation environment is tying executive compensation to stock performance, giving management a "stake in the success" of the company. ExecutiveDisclosure.com can also make these comparisons via a compensation vs stock trend chart:



It appears as if the company's board of directors has done an excellent job of tying compensation to performance. So, the real question becomes whether this compensation "premium" over other industry executives is justified given Toll Bros.'s market positioning and Toll's influence on the company...

The chief executives of America's 500 biggest companies, measured by a composite ranking of sales, profits, assets and market value, received a combined 6% pay raise last year, which is minimal in comparison to their 54% pay raise in 2004. In total, America’s top CEO's earned a healthy $5.4 billion in 2006. 

The average paycheck for last year for each boss works out to $10.9 million. For the group of 500 as a whole, aggregate stock gains accounted for 51% of total compensation, versus 53% a year ago. The average boss took in $5.6 million from exercising options last year. When calculating a chief executive’s total pay, salary and bonuses, and other compensation, such as vested restricted stock grants, long-term incentive payouts and perks, are all taken into calculation. 

Who were the top earners? Richard D. Fairbank, chief executive of Capital One Financial, was the top earner in 2005, as he earned $249.3 million in total pay, which came almost entirely from exercised stock options. The same goes for the next four top-paid CEO's: Terry S. Semel of Yahoo! with $231 million, Henry R. Silverman of Cendant with $140 million, Bruce Karatz of KB Home with $136 million, and Richard S. Fuld Jr. of Lehman Brothers Holdings with $123 million.

Most people are now aware of the new laws aimed at curbing executive compensation by limiting the amount of money that can be put into their deferred compensation plan to $1 million (the rest incurring a 20% penalty). Democrats hail this as a final victory over a tax loophole that has allowed many executives to channel millions through a tax-free venue - which is true. The problem is that there are additional loopholes that these new regulations fail to address - loopholes that will be exploited by future executives. Consequently, these new regulations might end up hurting middle management and others while executives are free to get their money in other ways.

The main problem in corporate America is the power that most executives have over their own compensation. Ironically, in a market where shareholders are supposed to elect members of the Board to oversee management, CEO's serve as chairmans' of their own board in over 50% of all companies! This enables them to set their own pay in many cases, as management compensation is something that the board sets. Now, the problem lies in the fact that while these new regulations may limit the amount of money put into a deferred compensation account, they do not impose other limits on compensation. Therefore, executives can simply re-channel the money from these accounts to stock options, restricted stock grants, or a multitude of other venues. Meanwhile, middle management - who has very little control over their compensation - may end up paying more as a result.

Regulators made a similar mistake back in 1993, when they imposed a $1 million limit on tax-deductible CEO salary that wasn't tied to performance. This ended up being on of the major factors leading up to the explosion in the number of stock options granted to executives - a practice that was not as common before the regulations originally went into effect. In the end, the middle class ended up with a tax hike while executives ended up with more stock options. The laws we are seeing drafted today may turn out to be the same thing. Perhaps the old saying is true: history repeats itself.