THE NEW YORK TIMES REVIEW OF CONFLICTS OF INTERESTS WITHIN THE COMPENSATION

COMMITTEES OF THE BOARDS OF 2,000 LARGE AMERICAN PUBLIC COMPANIES.

Deciding on Executive Pay: Lack of Independence Is Seen

By DIANA B. HENRIQUES and GERALDINE FABRIKANT

December 18, 2002

When America's biggest companies decide how much to pay their top executives, most of them leave the decision to a group of their board members known as the compensation committee. In theory, members of this committee are independent enough of the company's executives to deny them raises or force them to take pay cuts when the company is faring poorly.

In practice, it can be a very different story. An examination of almost 2,000 corporations finds that at hundreds of them, members of the compensation committee work for or do business with the company or its chief executive. In some cases, they even belong to the executive's family.

Legislation enacted this summer after a wave of costly corporate scandals is silent about the makeup of the compensation committee, although the new law set high standards of independence for another important boardroom committee, the audit committee, which oversees a company's financial controls and the auditing of its books.

Yet compensation committees are "definitely more clubby" than they should be, said Roger W. Raber, chief executive of the National Association of Corporate Directors, which thinks that only board

Deciding on Executive Pay: Lack of Independence Is Seen

These cases and others cited here are based on an analysis by The New York Times of a database compiled by the Corporate Library, an investor information service; on the most recently available corporate proxy statements, in most cases those filed this year for the 2001 fiscal year; and on interviews with compensation experts and securities lawyers. The database defines directors as independent unless they have family, business or professional ties to the company or are owners or beneficiaries of some other entity that profits directly from the company's activities, like a law firm or major supplier.

A Decade of Warnings

Even Definitions Are Up for Grabs

Compensation committees are made up of company directors, but they may work with an outside consultant or the company's own personnel executives. Typically, their job is to evaluate the performance of senior management and decide on the top executives' pay. "Historically, it has been extremely rare that a board would ever countermand, or even question, what the compensation committee decided to do," said Paul R. Dorf, managing director of Compensation Resources, a consulting firm.

Experts concede that even committees with minor or nonexistent conflicts of interest can approve outsize pay for lackluster or even poor performance. John W. Snow, chosen by President Bush last week as Treasury secretary, was paid more than $50 million in his nearly 12 years as chairman of the railroad company CSX even as profits fell and its stock lagged the market."But it's one thing to say the C.E.O. is overpaid; it's a step further to say, `and his business partner is on the compensation committee,' " said Nell Minow, editor of the Corporate Library site.

Since at least the early 1990's, oversight groups like the National Association of Corporate Directors have called for fully independent compensation committees. "Achieving both the appearance and the reality of independence demands no less," the directors' group said in a 1992 report.

In the wake of recent scandals, both the New York Stock Exchange and the Nasdaq market have proposals before the Securities and Exchange Commission that would require independent compensation committees as part of their listing standards. "But those are far from a done deal," said Holly J. Gregory, a corporate lawyer at the law firm of Weil, Gotshal & Manges. Both proposals are subject to S.E.C. review and public comment, she said.

Moreover, the two proposals define independence differently, allowing some business ties so long as boards determine that they are not material. The proposals also exempt companies with a controlling shareholder, and would not go into effect for several years.

Paul Hodgson, a senior research associate at the Corporate Library, pointed to the Carnival Corporation, the cruise ship operator. At Carnival, a compensation committee with three members - only one of whom has no ties to the company - approved a $40.5 million total pay package, including stock options, for the chief executive, Micky Arison, in 2001. The committee's proxy report notes that Mr. Arison himself actually recommends the size of his bonus and that there is "no specific relationship" between that bonus and company performance.Tim Gallagher, a Carnival spokesman, said Mr. Arison's compensation was determined by a variety of factors, including the company's performance, its strategic position and its success in weathering the slump in leisure travel after Sept. 11.

One reason that cases like these persist is that mutual funds and other institutional investors have not used their power to demand strong, conflict-free compensation committees, said Bruce R. Ellig, the author of "The Complete Guide to Executive Compensation" ( McGraw-Hill, 2001). Institutional investors have to step up, Mr. Ellig added. "It's not the small shareholder who can stand up and say, `Excuse me, Mr. Chairman, but I think you're overpaid.' "

Some Case Studies

Questionable Ties at 200 Companies

More than 200 large corporations - including some of the nation's best-known and most widely admired companies - have had compensation committees with members who have disclosed ties to the company or its chief executive. members with no personal or business ties to the company should serve on its compensation committee. "They just don't have the rigor of oversight that we see with other committees, especially audit committees."

Mr. Raber added: "That, to me, is going to be the continuing crisis: looking at some of the pay practices, especially the severance packages. We have another storm to go through, and frankly, it's going to be ugly."The study by The New York Times of almost 2,000 of the largest American corporations, measured by their stock market value, shows that 420 of them, more than 20 percent, had compensation committees in 2001 with members who had business ties or other relationships with the chief executive or the company that could compromise their independence. Dozens of those members were company executives.

At more than 70 companies, even the chairman of the compensation committee had such ties, and in nine cases the chairman was actually an executive of the company.

These are just the connections that have been fully disclosed to investors. That such ties are not always disclosed was illustrated yesterday, when Frank E. Walsh Jr., a former member of the compensation committee at Tyco International, pleaded guilty to charges of failing to report that Tyco had paid him a $20 million fee for his role in a company deal.

Potential conflicts of interest cropped up at some of the nation's best-known companies.

For example, at Clear Channel Communications, the nation's largest radio chain, only one of the five people on its compensation committee is free of potential conflicts. The committee has retained - indeed, sweetened - pay packages that guaranteed raises for the chairman, L. Lowry Mays, and his two sons, regardless of company performance. The sons have severance agreements that entitle them to 14 years of salary, bonuses, benefits and stock options if they quit because the board fails to choose one of them to succeed their father as chief executive. Clear Channel said the committee met existing federal guidelines for independence.

At the Great Atlantic and Pacific Tea Company, which owns the Waldbaum's, Food Emporium and A.& P. supermarket chains, only one of the three people on the compensation committee is independent. A second is the family lawyer for the 38-year-old chief executive, Christian W. E. Haub, and a third works for Mr. Haub's parents, the company's controlling shareholders. The committee has regularly approved raises and larger bonuses for Mr. Haub, despite the company's worsening business problems. The company said it was considering revising the committee's composition, but said the pay was appropriate. And three of the eight people who set the final pay package for John F. Welch Jr. when he was chief executive of General Electric have done business, through their own companies, with G.E. Their decision, which at first looked like a pay cut for Mr. Welch, actually gave him a 50 percent raise for the year. That raise substantially improved Mr. Welch's pension after he retired in early September 2001. The company declined to comment on the arrangement, although it has subsequently taken steps to increase the independence of its board.

A Decade of Warnings

Even Definitions Are Up for Grabs

Experts concede that even committees with minor or nonexistent conflicts of interest can approve outsize pay for lackluster or even poor performance. John W. Snow, chosen by President Bush last week as Treasury secretary, was paid more than $50 million in his nearly 12 years as chairman of the railroad company CSX even as profits fell and its stock lagged the market. "But it's one thing to say the C.E.O. is overpaid; it's a step further to say, `and his business partner is on the compensation committee,' " said Nell Minow, editor of the Corporate Library site.

Right now, about all that market regulators require of compensation committees is that they explain their decisions in the annual proxy statement. But many of those reports, several securities lawyers said, are little more than boilerplate detailing a rationale that can be mystifying or contradictory. Paul Hodgson, a senior research associate at the Corporate Library, pointed to the Carnival Corporation, the cruise ship operator. At Carnival, a compensation committee with three members - only one of whom has no ties to the company - approved a $40.5 million total pay package, including stock options, for the chief executive, Micky Arison, in 2001. The committee's proxy report notes that Mr. Arison himself actually recommends the size of his bonus and that there is "no specific relationship" between that bonus and company performance. Tim Gallagher, a Carnival spokesman, said Mr. Arison's compensation was determined by a variety of factors, including the company's performance, its strategic position and its success in weathering the slump in leisure travel after Sept. 11.

When General Electric's compensation committee negotiated Mr. Welch's final preretirement pay package, its members included three men whose companies have done business with General Electric: Sam Nunn, the former senator and a partner in the law firm of King & Spalding, which has worked for the company; Roger Penske, who has an indirect stake in a trucking partnership engaged in a joint venture with the company; and Kenneth Langone, chief executive and controlling shareholder of Invemed Associates, which also has done business with the company.

General Electric's proxy statement for 2001 suggests that Mr. Welch had been given a pay cut: $16.1 million in salary and bonus, down from $16.7 million a year earlier.

But in fact the figure in the proxy represents just eight months of service by Mr. Welch, who retired in early September 2001. His annual rate of pay, therefore, was about $24 million - a 50 percent increase for the year. Over the previous five years, when the company's performance was much stronger, his annual raises never exceeded 33 percent.

Few would have considered 2001 a banner year for Mr. Welch. The company's stock fell sharply after the embarrassing collapse of its bid for Honeywell during the summer.

But a raise in 2001 was particularly beneficial to Mr. Welch because it increased his monthly pay, a crucial factor in determining the size of his pension, according to Graef Crystal, a compensation consultant. Specifically, his annual pension was based on how much he made in his top-earning 36 months of service over the previous 10 years. Without the 2001 raise, his annual pension would have been about $7.5 million, rather than the $9 million he received, Mr. Crystal said.

Earlier this year, General Electric made changes to its board to increase its independence and changed the makeup of its compensation committee.

Clear Channel, based in San Antonio, is the nation's largest radio station chain and a major provider of live entertainment. The company was a co-producer of the Broadway hit "The Producers" and handled national tours for stars like Madonna and the Backstreet Boys. It owns television stations and billboard companies, and manages major sports figures, including Michael Jordan and Andre Agassi. But since 1990, the company has been dogged by antitrust investigations and complaints from the music industry that its radio stations will not play music by artists who are not represented by the company's promotion unit.

But those uncertainties are not reflected in the company's pay policies, compensation experts say. Mr. Mays, the 66-year-old co-founder and chief executive, has two sons working at the company - and all three men are guaranteed raises and stock option grants each year, in addition to the unusual 14-year severance plan set up for the sons.

This arrangement was approved by a previous committee. But having inherited the agreement, "the new committee has not backed off; on the contrary, they have compounded the problem rather than addressing it," said Brian Foley, an independent compensation consultant. For example, he said, the committee has given the sons additional payments that added millions to the value of their severance packages.

Clear Channel said the compensation deals were set up to ensure continuity of management and stability of leadership. Clear Channel's five-member compensation committee includes only one outsider with no company ties: John H. Williams, a retired senior vice president of First Union Securities.

The other members include Vernon E. Jordan Jr. and Alan D. Feld, whose Washington law firm, Akin, Gump, Strauss, Hauer & Feld, has collected legal fees from the company. Another member is B. J. McCombs, who was a co-founder of the company with Mr. Mays and whose children's trust funds, along with trusts for Mr. Mays's children, lease office space to Clear Channel.

A fourth member, Thomas O. Hicks, a partner in the investment firm Hicks, Muse, Tate & Furst, also has ties to the company. Pan American Sports Network, an affiliate of Hicks, Muse, purchased the television rights for the United States Open tennis tournament from a company later acquired by Clear Channel. When Pan American filed for bankruptcy protection in March, Clear Channel was left on the hook for payments that Pan American owed under the agreement.

And until August 2001, when he gave up his committee seat, the sixth member of Clear Channel's compensation committee was Lowry Mays himself.

A company spokeswoman said the board's lawyers had determined that Mr. Jordan and Mr. Feld qualified as independent under the new federal guidelines. Other committee assignments will be reviewed as new rules are adopted, she said. The Great Atlantic and Pacific Tea Company's business has been in turmoil for years. In recent years, the company has closed stores, laid off workers and eliminated its stock dividend. Last spring, it found it had been using unacceptable accounting for years and revised three previous years' results.

And in October, its president and chief operating officer, Elizabeth R. Culligan, left after less than a year in the job, dismaying Wall Street about the company's leadership. "We are concerned about management's ability to budget and execute on its business plan," complained Mark Husson, an industry analyst at Merrill Lynch.

Nevertheless, in 2001, Mr. Haub, the chief executive, received a cash salary and bonus totaling just under $1.2 million, a 53 percent raise

over the previous year.

"I really did have to stop and wonder how he got paid a bonus for 2001," said Judith Fischer, managing director of Executive Compensation Advisory Services in Alexandria, Va. "It's very questionable."Richard P. De Santa, vice president for corporate affairs at A.& P., said the pay package reflected A.& P.'s return to profitability in 2001.Mr. Haub is the son of the controlling shareholders, and his mother, Helga, is a board member. The chairman of the compensation committee, John D. Barline, is a legal adviser to the Haub family. A second member, Rosemarie Baumeister, is an employee of the Haub family's interests in Germany, which do business with A.& P.

Mr. De Santa said the board was considering changing the makeup of the committee, as part of a continuing effort to make the board more independent. Many companies - like General Electric and Clear Channel - have provided outstanding returns to shareholders over the years despite potential conflicts on their compensation committees. And, while many directors with company ties would not comment publicly, several noted that those ties were fully disclosed, had been blessed by company lawyers and were too insignificant to affect their judgment.

But although individual directors may feel they can serve faithfully despite such ties, a compensation committee with conflicts is often a signal that the board is not strong or independent enough, said Ms. Minow of the Corporate Library. "Particularly in this era when the investor community is very skeptical of boards of directors, it is really important that the boards be above suspicion."

Possible Remedies

An Uphill Battle for Challengers

Shareholders who try to challenge their chief executive's pay package in court or in the boardroom face an uphill fight, lawyers and shareholder activists say. For one thing, it is hard to see problems coming, said Ed Durkin, director of corporate affairs for the United Brotherhood of Carpenters, whose pension funds have been demanding independent compensation committees at a number of companies for the last five years.

"The committee reports have no predictive value at all; some of it is not in the English language," Mr. Durkin said. As a result, he said, only experts can usually decipher the practical effect of various compensation policies on the chief executive or the shareholders.

And compensation committees are not required to disclose which experts they consulted to develop the chief executive's package. That makes it difficult to determine what other business ties, if any, the consultants have with the corporation or the chief executive, several securities lawyers noted.

Compensation committees rarely hire a consultant not recommended by the chief executive, said Mr. Raber of the directors' group. "A lot of rubber-stamping goes on," he said.

The new listing standards proposed by the New York Stock Exchange and Nasdaq would require independent compensation committees, although each proposal has limiting features. Companies with a large controlling stockholder, like A.& P., would be exempt under both plans, and the Nasdaq proposal permits one nonindependent committee member to serve for up to two years under "exceptional and limited circumstances."

The two plans define director independence a bit differently, lawyers noted, and it is not yet clear that they would ban some business ties that shareholders may find troubling.

Some companies that disclosed potential conflicts on their compensation committees in their most recent proxy statements have taken steps to increase their committees' independence. But business ties among outside directors serving on the committees remain fairly common, said Mr. Dorf, the compensation consultant. The New York Exchange and Nasdaq proposals "have yet to have an impact," he added.

In the past, litigation has not been a useful weapon for battling excessive executive pay, according to Michael Perino, visiting law professor at Columbia. The courts - most significantly those in Delaware, where most large corporations are registered - have generally treated executive pay as a matter best left to the business judgment of the board, Professor Perino explained. But some experts think that may be changing under the weight of the current scandals. "We're in a totally new environment now," said Amy Goodman, a corporate law expert at Gibson, Dunn & Crutcher in Washington. "You can't divorce executive compensation from what has happened as a result of all the scandals of the past year."

Return To Board Options Home Page