July 30, 2008
Skyrocketing compensation is now under scrutiny. Utility execs have been rewarded handsomely in the past but tough times may change all that.
In 2008, utility CEOs are facing two contradictory trends in compensation. An SNL Energy survey reveals that CEO compensation at most utilities has been rising. At the same time that pay packages are expanding, many boards are linking compensation to performance and not just rubberstamping bonuses and stock options. Nonetheless, many boards seem reluctant to crack down on rising CEO bonuses, continue to offer more stock options and sometimes yield to CEO demands even when the stock price is lagging.
"The definite, overarching theme is pay is up for executives in the energy business," noted Chris Crawford, executive director at Longnecker & Associates, a Houston-based executive compensation company that consults for energy and utility companies. He attributed the rise in CEO compensation to the limited supply of seasoned energy talent and the increasing demand for their services.
"In a super-regulated environment it takes a sophisticated individual to run an energy company," Crawford said. A number of baby boomer executives are reaching retirement age, and there'll be fewer seasoned CEOs in the marketplace. Hence, utilities have to keep CEO compensation packages competitive or face losing their talent. But "just because a board scrutinizes CEO pay doesn't mean it is reducing compensation. It's trying to make sure compensation is aligned with shareholder interest and stock performance."
In fact, SNL Energy's 2008 survey of the top 100 utility CEOs confirms that compensation packages are on the rise. The top five earners for 2008 were: J. Wayne Leonard, CEO of Entergy Co., whose entire compensation package was $26.2 million, including $15.7 million in stock options; followed by $21.3 million for Murry Steven Gerber, CEO of Equitable Resources, a natural gas company; $19.7 million for Michael G. Morris, CEO of AEP; $19.5 million for John W. Rowe, CEO of Exelon Corp.; and $15.6 million for Anthony J. Alexander, CEO of FirstEnergy Corp. CEOs of 16 utility companies earned upward of $10 million in compensation, and 44 CEOs earned more than $5 million.
"Boards feel a lot of competitive pressure from investors to hire the best CEOs. From an investor perspective, a good CEO will help drive a stock's value many times what his package costs," says Ed Metz, director of SNL Energy.
Too many boards are not independent of the CEO, which can create problems, explained Paul Hodgson, the Camden, Maine-based senior research associate at the Corporate Library, a governance research firm. In those situations, when the utility's performance and stock price falter, the CEO comes to the board, explains why targets weren't hit and that the economic situation was challenging, and convinces the board to pay the bonus.
New Benchmarks
Compensation is increasingly tied to performance: earnings per share growth, return on equity and other customer satisfaction metrics, explained Ira Kay, a New York-based executive compensation consultant with Watson Wyatt Worldwide. Despite the evolution, energy CEOs "can go to private equity or another energy firm. They have labor market power, and boards are, in fact, concerned, if not alarmed, that if CEOs leave, they can cause considerable damage if the company's market cap goes down."
Some boards have been stringent about cutting CEO compensation due to poor performance. "If the stock price goes from 30 to 15, compensation is going down. Make no mistake about it," Crawford stated. Boards are increasingly holding CEOs accountable for the company's performance value and adjusting the compensation package to ensure CEOs aren't overpaid.
"The real question to ask about CEO pay is what is the peer group earning they're being assessed against?" adds Suzanne Hopgood, who heads the boardroom education program at the National Association of Corporate Directors and runs the consulting agency, the Hopgood group. Hopgood said that most boards tie performance to meeting long-range goals of five years.
Even if a company's stock price declines 10 percent in one year, the company's stock may have risen 40 percent over the last four years, and the CEO will still be entitled to a bonus. At the same time, changing CEOs every couple years is risky business.
CEO bonuses though have been slashed. Charles Peck, a senior advisor to the Conference Board, a New York-based nonprofit business research firm that compiles an annual CEO compensation report, noted that if performance goals aren't met, some CEOs "are getting zero bonuses." Moreover, boards are reviewing any perquisites that seem excessive or could damage a company's reputation if they were revealed in the daily newspaper or online -- private jets and country club dues, to name two.
This intensified board scrutiny is also changing how boards operate, Peck added. In the past, CEOs often served as chairmen of their own boards. "That is being viewed as contradictory. When the chairman is independent, you get true board oversight."
"Although we've seen improvement in the link between pay and performance, we're a long way from the optimal level," adds Corporate Library's Hodgson. He thinks that if the company hasn't met its targets that the CEO should receive only base salary and basic benefits but relinquish much of their bonus and stock options. "Too often, there's a mindset that if we don't pay them this year, they'll leave and go elsewhere." But isn't that like the owner of a last place baseball team refusing to fire the manager because the skipper will find another job? Failure is often rewarded, Hodgson surmised.
While pay scales for CEOs are enviable, a recession could alter that. Analysts all agree the added scrutiny is good for execs and investors alike.
By Gary M. Stern
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