CEO pay under the microscope

Scrutiny of CEO pay is likely to increase—especially with a looming SEC requirement concerning what's disclosed on proxies

By Bill Roberts -- EDN, June 1, 2006

How do you know when executive compensation may have rocketed too high? When some shareholders sue the company.

The Hewlett-Packard board of directors can relate to this scenario first-hand. Several union pension funds recently sued the HP board for breach of corporate policy because the directors had given Carly Fiorina, the fired CEO, $42 million in severance and other payments. The lawsuit contends that her severance award violated a shareholder-approved company policy not to give severance packages that exceeded a certain threshold without first seeking shareholder approval. The Fiorina package exceeded that threshold, but was not put to a shareholder vote.

However the lawsuit gets resolved, the H-P board would no doubt rather avoid the bad public relations it is causing.

The lawsuit highlights one of the current CEO pay issues: severance packages. Two other hot-button issues: replacing stock options with restricted stock grants for long-term incentive pay and connecting long-term incentives to precise performance metrics.

The U.S. Securities and Exchange Commission (SEC) is close to requiring that all proxy statements provide more-detailed information for these three areas and much more. Draft disclosure rules are under deliberation and will be made final later this year. (see "Proposed SEC Disclosure Rules," page 48).

The new rules are just one reason board compensation committees spend more time now on CEO pay packages than in the past. Two other factors also drive deeper due diligence: wide negative reaction toward CEO pay when it seems excessive compared to employee gains or shareholder return, and shareholder actions such as the H-P suit. The era of CEO pay scrutiny by the press, the public and shareholders is not over. If anything, the new disclosure rules will intensify it.

"Executive pay is partly about compensation strategy, partly about shareholder relations and partly about public relations," says Stephen Mader, vice chairman and head of the board services and CEO practice at Christian & Timbers, an executive search firm.

How much they make

The question everyone wants to ask is, "how much did the CEO make?" Under the new SEC rules, proxies will have to state a single total compensation figure. Currently they don't, but where proxies pale, the press provides. Like similar lists, the "Electronic Business Highest-Paid Executives" list (see page 46) is an annual scorecard of who acquired the most wealth. A titillating read, it is not a good barometer of CEO pay trends, because it says nothing about average CEO pay.

Another shortcoming: These lists include only publicly held companies, but electronics has a critical mass of privately held startups. According to a survey by VentureOne, which tracks VC financing, the median total salary and bonus compensation for the CEOs of 722 venture-backed companies this spring was $263,000, compared to $252,000 in the spring of 2005. The median amount of CEO equity was 5 percent, about the same as a year earlier. CEOs in northern California, which would include many electronics startups, had a larger median: $275,000 in total compensation. Their equity levels were the same as the overall median.

For large publicly held companies, one gauge of the median comes from a study by Equilar, which tracks executive compensation trends. Based on proxy filings of 197 companies in the Standard & Poor's 500 with fiscal years ending between May 2005 and December 2005, Equilar concluded that the average CEO total direct compensation (salary, cash bonus and long-term incentives) at these high-market-cap companies increased 1.6 percent year to year. The survey included only companies whose CEOs had been in that position for the past three fiscal years. Median total direct compensation grew to $8.37 million, from the 2004 level of $8.24 million.

By comparison, the total direct compensation of Irwin Mark Jacobs, who tops this year's EB list, was $23.5 million in fiscal 2005. Jacobs—cofounder, chairman and until July 2005, CEO of Qualcomm—had total direct compensation of $16.3 million in 2004.

For making comparisons, even the Equilar findings are relevant only for big electronics companies such as Intel, HP and Qualcomm, whose CEO pay practices are likely to have more in common with Fortune 500 companies than with the broader electronics industry. Smaller, publicly held electronics companies typically offer less CEO pay.

Although compensation consultants don't have precise numbers, they don't see huge increases over last year among medium-size publicly held companies. "Salaries are pretty stable, and cash bonuses are a bit higher, due to better performance at many companies," says George Paulin, CEO at FW Cook, a consulting firm. The value of long-term incentives is about the same, but the makeup is starting to look different, because more companies are adopting restricted stock grants.

Coin of the realm

Electronics companies never used to debate long-term incentives. Stock options were the coin of the realm. They typically must be held three to five years to vest, and then they are worth the difference between the issue price and the exercise price. That difference can be huge if the options are held long enough or if the executive exercises them during a bull market. The options also can be worth nothing—under water—if the stock falls below the issue price. Given its cyclical nature, the semiconductor industry is no stranger to underwater options.

Since the U.S. Financial Accounting Standards Board (FASB) changed the rules, more than a year ago, companies must account for options as an expense. This places stock options on the same level accounting field as other stock incentives, including restricted stock, which was already treated as an expense.

With the tax advantage of options nullified, electronics boards are slowly moving toward restricted stock, which other industries have already been using widely. Restricted stock typically must be held for a period of time, and often performance metrics must be met. Once the restrictions are met, the executive can sell the stock at market value. Restricted stock does not have as much risk as options, because the stock will always be worth something, if it is worth anything. Due to this certainty, restricted stock grants tend to be smaller than option grants—one third to one fourth as many. The upside potential of options is far greater than restricted stock, but the downside potential is greater, too.

"The impact of the FASB expense ruling has been that companies are not using as many options and are using more restricted stock," says J. Richard, CEO of J Richard & Co., a Silicon Valley pay consulting firm with many electronics clients. "Not as many employees are eligible for options, and options are not being granted as frequently as they used to be."

Even before the FASB ruling, Microsoft decided that options no longer made sense for a mature company and began to use only restricted stock for all employees. Intel, a vocal opponent of the FASB rule, announced in December 2005 that it would discontinue options and start using restricted stock for most employees. It plans to use both for top executives. Intel's recent proxy shows that the top five executives received only options in fiscal 2005. It also states that the company will seek shareholder approval of a new incentive plan under which options and restricted stock would be used for executives.

Intel did not respond to requests for an interview. Several other companies also did not respond or declined to discuss executive compensation practices.

"Electronics companies are moving out of options into full-value shares," says Paulin. "There has probably been less of it, though, among chip companies. The culture of the chip industry has always been options."

In response to questions, a Network Appliance spokesperson wrote in an e-mail that the company had the flexibility to use restricted stock and had issued some in the past, and indicated that options would continue to be the main long-term incentive. "We believe that options more closely align employee/executive motivation with shareholder interest." The spokesperson cited an argument, often heard in Silicon Valley, that growth companies need the potential for jackpot payoffs from options to lure the best talent, among engineers or executives.

In an e-mail, a spokesperson for Cisco Systems wrote, "Cisco does not issue any restricted stock or stock appreciation rights. Cisco continues to utilize stock options as part of the overall compensation package for all employees." At its annual meeting last year, shareholders voted down, by a 3-to-2 margin, an AFL-CIO resolution opposed by Cisco management that would have required a significant portion of long-term incentive compensation for executives to be in the form of performance-vesting stock, not time-based options, as is currently the case.

Pay for performance

Cisco management's position underscores the industry's conventional wisdom that options—ipso facto—tie executive compensation directly to the long-term fortunes of the company: If the stock price goes up, executives and shareholders all benefit. If the stock price drops, executives get nothing.

Times are changing. More shareholders, like those at Cisco, are demanding that boards tie long-term pay to performance in more precise terms, and the new SEC disclosure rules will require that pay-for-performance details be spelled out in more than the boilerplate language typical of most proxy statements. This will likely cause some new soul-searching among electronics company boards.

"The best-practice companies will have to prove that they are paying for performance, and the data in the proxy will have to support that," says Richard. "If the CEO is paid at the 75th percentile for his industry and the shareholder value is in the 30th percentile, how can you explain that to shareholders?"

Stock appreciation and profitability are common metrics used to determine annual cash bonuses, and they are sometimes used to award restricted stock in companies outside electronics, says Lane Ringlee, manager of executive compensation for Towers Perrin's San Francisco office, which has electronics clients. "There is a clear alignment between pay and performance," he says. "You'll start to see mainstream electronics companies adopting these."

Mader also sees new performance metrics being adopted. Earnings before interest, taxes, depreciation and amortization are gaining popularity as a better gauge of real earnings, and relative economic value-add—how well a company did relative to peer companies, not to the market as a whole—is also beginning to be used.

Long-term incentive performance measures can also be tied to long-term strategy, such as opening new markets or geographic expansion, thus better aligning the executive's pay with the goals of the company.

As a result of the FASB rule change, Sanmina-SCI, an electronics manufacturing services (EMS) provider, became one of the first electronics companies to adopt an executive long-term incentive program that includes performance-based restricted stock. The company declined to discuss the program, but the details are spelled out in its recent proxy.

For long-term incentive compensation, Sanmina-SCI now awards top executives a combination of options and performance shares. The blocks of restricted shares vest on a three-year schedule, with 25 percent in the first year, 35 percent in the second and 40 percent in the third—if two performance requirements are met: Earnings per share for the stock must meet the goal spelled out in the company's five-year plan, and the stock price must be within a range also spelled out in the five-year plan. The proxy stipulates that both must be met; if only one is achieved, then the stock does not vest.

Pay for failure

A third area of executive compensation under greater scrutiny is severance pay.

Bruce Ellig, author of The Complete Guide to Executive Compensation, explains the rationale behind severance: to give the executive sufficient money to transition to the next job; the more the executive makes, the more difficult it will be to find the new job, and therefore higher severance is awarded. Severance packages larded with forgiven vesting dates and the like go beyond that rationale. "Severance pay is pay for failure— failure should not be rewarded," Ellig argues.

Ellig urges compensation committees to resolve the issue of excessive severance. "They can expect a shareholder proxy resolution limiting the amount of termination payments, especially for failed performance," he says. "If the company pays more for performance failure than it does for performance success, something is terribly wrong."

ELECTRONIC BUSINESS HIGHEST-PAID EXECUTIVES 2005

Rank	Name (age)	Title	Company	Total	Total change 2004-2005	Salary 2005	Salary change 2004-2005	Bonus 2005	Bonus change 2004-2005	Other compensation 2005	Other comp change 2004-2005	Value realized (aggregated options exercised)	Value realized change 2004-2005
SOURCE: REED CORPORATE RESEARCH 1 Dr. Irwin Jacobs served as CEO until July 2005. 2 During FY2005 Mr. Bagley's title was Chairman and CEO. 3 Dr. Paul Jacobs served as Exec. VP and President until July 2005, when he was named CEO. 4 During FY2005 Mr. Newberry's title was President and COO. 5 Mr. Altman served as Exec. VP and President until July 2005, when he was named President. 6 Mr. Bingham resigned effective 08/01/05. 7 Mr. Corrigan's status as an employee ceased in May 2005. 8 Mr. Artusi served as CEO and President from 08/01 to 04/05. 9 During FY2005 Mr. Bright's title was Senior VP and General Manager. NA = not available or not applicable
1	Irwin Mark Jacobs1, 72	Chairman	QUALCOMM	$78,465,947	77%	$984,239	-7%	$500,000	-71%	$273,893	2%	$76,707,815	85%
2	James W. Bagley2, 67	Executive Chairman	Lam Research	$32,514,824	0%	$656,240	1%	$1,183,000	403%	$18,570	66%	$30,657,014	-3%
3	Paul E. Jacobs3, 43	CEO	QUALCOMM	$31,430,065	17%	$650,016	22%	$500,000	-49%	$154,645	46%	$30,125,404	20%
4	Bruce M. McWilliams, 49	Chairman, CEO and President	Tessera Technologies	$22,710,996	139%	$314,500	11%	$101,063	-61%	$2,100	*	$22,293,333	148%
5	Willem P. Roelandts, 61	Chairman, CEO and President	Xilinx	$21,901,602	-25%	$715,500	0%	$336,286	-14%	$5,065	-87%	$20,844,751	-26%
6	Eli Harari, 59	President, CEO, Director	SanDisk	$18,124,298	83%	$721,873	17%	$1,740,000	21%	$6,300	2%	$15,656,125	99%
7	Nelson Chan, 43	Executive Vice President	SanDisk	$16,684,686	1918%	$363,634	13%	$600,000	20%	$6,300	2%	$15,714,752	*
8	Samuel J. Palmisano, 54	Chairman, CEO and President	IBM	$16,615,297	67%	$1,680,000	1%	$5,175,000	0%	$308,682	-2%	$9,451,615	236%
9	Sanjay Mehrotra, 46	Executive Vice President and COO	SanDisk	$13,792,580	872%	$421,768	18%	$858,235	-37%	$6,300	3%	$12,506,277	2811%
10	Richard A. Aurelio, 61	Executive Chairman	Varian Semiconductor	$12,743,862	-9%	$380,770	-38%	$440,000	-49%	$325,929	1%	$11,597,163	-6%
11	Martin H. Loeffler, 60	Chairman, CEO and President	Amphenol	$12,334,631	25%	$1,004,000	4%	$808,220	-21%	$15,507	4%	$10,506,904	33%
12	Craig R. Barrett, 66	Chairman	Intel	$12,265,300	-8%	$610,000	0%	$2,727,800	48%	$196,500	15%	$8,731,000	-18%
13	George Hervey, 58	Vice President of Finance and CFO	Marvell Technology Group	$11,569,907	100%	$267,805	7%	$0	*	$500	*	$11,301,602	104%
14	Stephen G. Newberry4, 52	CEO and President	Lam Research	$11,029,000	-9%	$615,385	8%	$1,200,000	126%	$7,202	-7%	$9,206,413	-17%
15	Nicholas M. Donofrio, 60	Executive Vice President	IBM	$10,324,060	3%	$755,834	2%	$1,210,000	2%	$59,814	2%	$8,298,412	3%
16	Andy D. Bryant, 55	EVP, CFO and Enterprise Services Officer	Intel	$10,075,400	51%	$330,000	8%	$1,765,000	93%	$100,300	19%	$7,880,100	46%
17	Alexander Lidow, 51	CEO	International Rectifier	$9,802,094	116%	$700,000	0%	$454,999	-35%	$9,317	-56%	$8,637,778	176%
18	Steven R. Altman5, 44	President	QUALCOMM	$9,138,111	476%	$604,243	18%	$450,000	-54%	$151,183	51%	$7,932,685	*
19	Sanjay K. Jha, 42	President	QUALCOMM	$9,128,457	-7%	$575,011	18%	$425,000	-56%	$149,909	49%	$7,978,537	-3%
20	H. Lawrence Culp, Jr., 42	CEO and President	Danaher	$8,366,598	95%	$1,000,000	0%	$3,250,000	7%	$305,598	16%	$3,811,000	*
21	H. Raymond Bingham6, 60	Former Executive Chairman	Cadence Design Systems	$8,296,815	404%	$525,020	-37%	$410,400	-48%	$15,998	38%	$7,345,397	*
22	Hector de J. Ruiz, 60	Chairman and CEO	Advanced Micro Devices	$8,194,223	257%	$950,019	0%	$4,000,000	225%	$111,563	-1%	$3,132,641	*
23	Christopher M. Pickett, 39	Executive Vice President	Tessera Technologies	$8,088,584	-1%	$257,961	9%	$76,440	-50%	$2,100	*	$7,752,083	0%
24	Paul S. Otellini, 55	CEO and President	Intel	$7,876,600	8%	$608,300	35%	$2,683,400	97%	$158,500	49%	$4,426,400	-17%
25	Yoram Cedar, 50	Executive Vice President	SanDisk	$7,830,817	1068%	$320,299	21%	$500,000	25%	$6,300	2%	$7,004,218	*
26	R. Douglas Norby, 70	CFO and Senior Vice President	Tessera Technologies	$7,551,938	754%	$235,577	4%	$59,560	-28%	$2,100	*	$7,254,701	1161%
27	Cynthia B. Merrell, 44	CFO and Treasurer	Cree	$7,537,102	2007%	$270,005	1%	$74,601	-18%	$336	0%	$7,192,160	*
28	Michael J. Hames, 46	Senior Vice President	Texas Instruments	$7,199,483	737%	$417,920	6%	$575,000	44%	$44,963	-33%	$6,161,600	*
29	Pirooz Parvarandeh, 45	President	Maxim Integrated Products	$6,721,307	-24%	$300,000	85%	TBD	*	$0	*	$6,421,307	-13%
30	Louis DiNardo, 46	Executive VP and General Manager	Intersil	$6,414,545	816%	$350,000	0%	$477,400	36%	$1,700	*	$5,585,445	*
31	Eric Lidow, 93	Chairman	International Rectifier	$6,230,017	23%	$696,237	5%	$0	*	$55,260	3%	$5,478,520	25%
32	Kenneth L. Schroeder, 61	CEO	KLA-Tencor Corp.	$6,129,076	-56%	$746,460	28%	$2,018,130	71%	$1,000	*	$3,363,486	-72%
33	Vahid Manian, 44	Senior Vice President	Broadcom	$5,925,810	-27%	$245,250	33%	$155,000	182%	$0	*	$5,525,560	-30%
34	Wilfred J. Corrigan7, 66	Chairman and Former CEO	LSI Logic	$5,716,276	558%	$491,136	-43%	$0	*	$5,225,140	60827%	$0	*
35	David Orton, N/A	CEO and President	ATI Technologies	$5,623,869	449%	$500,000	30%	$250,000	-61%	$0	*	$4,873,869	*
36	Daniel A. Artusi8, 51	Former CEO and President	Silicon Laboratories	$5,352,700	177%	$128,712	-66%	$0	*	$3,026,017	201634%	$2,197,971	102%
37	Jerald G. Fishman, 60	CEO and President	Analog Devices	$5,268,702	-85%	$930,935	0%	$414,445	-40%	$1,068,797	-20%	$2,854,525	-91%
38	Frank C. Lin, 60	CEO and President	Trident Microsystems	$5,167,762	411%	$575,000	14%	$431,250	131%	$323,646	1%	$3,837,866	*
39	Kirk E. Flatow, 47	Senior Vice President	Tessera Technologies	$5,129,963	-34%	$246,231	6%	$72,625	-36%	$2,100	*	$4,809,007	-35%
40	Judy Bruner, 47	Executive Vice President and CFO	SanDisk	$4,933,586	884%	$363,937	107%	$653,249	101%	$0	*	$3,916,400	*
41	Walter D. Amaral, N/A	Senior Vice President and CFO	SiRF Technology Holdings	$4,744,362	459%	$255,047	4%	$25,799	10%	$0	*	$4,463,516	669%
42	Patrick W. Allender, 58	Executive Vice President	Danaher	$4,674,500	-35%	$550,000	10%	$1,000,000	5%	$239,700	97%	$2,884,800	-49%
43	Ronald P. Edgerton, 53	CEO and President	SigmaTel	$4,533,357	-52%	$379,135	25%	$135,729	-16%	$6,150	*	$4,012,343	-56%
44	Charles M. Swoboda, 39	Chairman, CEO and President	Cree	$4,518,800	506%	$490,378	11%	$322,350	43%	$336	0%	$3,705,736	4516%
45	Kamal K. Aggarwal, 67	Executive Vice President	National Semiconductor	$4,417,920	-18%	$452,426	-4%	$500,233	-67%	$15,241	0%	$3,450,020	1%
46	Nicolas J. Bright9, 49	Executive VP and General Manager	Lam Research	$4,372,494	8%	$387,315	10%	$520,113	100%	$12,492	21%	$3,452,574	1%
47	Michael J. Fister, 51	CEO and President	Cadence Design Systems	$4,269,554	61%	$1,000,038	96%	$2,985,000	43%	$284,516	362%	$0	*
48	Robert H. Swanson, Jr., 68	Executive Chairman	Linear Technology	$4,246,240	-13%	$343,787	2%	$2,256,700	10%	$361,706	-8%	$1,284,047	-39%
49	William J. Ruehle, 62	Senior Vice President and CFO	Broadcom	$4,221,052	1694%	$254,154	45%	$150,800	151%	$0	*	$3,816,098	*
50	Felix Zandman, 76	Chairman, Chief Technical & Business Development Officer	Vishay Intertechnology	$3,989,204	-4%	$975,000	0%	$2,787,454	-5%	$226,750	-8%	$0	*

Bill Roberts is a contributing writer at ELECTRONIC BUSINESS.