July 28, 2010

Equilar, a compensation research firm, reported that in 2009 the median compensation of CEOs for the top 200 companies declined 13 percent from the previous year to $7.7 million. The decline was attributed to stock and option awards losing value because of the 2009 stock market plunge. Yet an SNL Financial study of utility CEO compensation in 2009 reveals that the top 25 utility CEOs saw their executive compensation increase by 39 percent to 123 percent and 49 of the top 50 showed rising packages.

The utility industry "may have had a bigger recovery over that time period when data was collected," explained Kevin Hollock, director of Cornell University's Institute for Compensation Studies. Since consumers rely on electricity and don't cut back significantly even in a recession, the energy industry is much "less cyclical than buying fancy shoes," he added. Yet Hollock was surprised by the rise in compensation for energy CEOs compared with other industries.

But Chris Crawford, executive director of Longnecker & Associates, a Houston-based executive compensation consulting company specializing in the energy market, expected compensation for energy CEOs to outpace other industries. He attributes rising utility CEO recompense to supply and demand. "When you look at the supply of available key technical and executive talent, it's short and getting worse," Crawford said. "The world financial crisis didn't change that dynamic."

Proving Crawford's contention was the $9.8 million in stock incentives granted to J. Wayne Leonard, the CEO of Entergy in 2009. Mike Burns, spokesperson for Entergy, explained that the board granted 100,000 restricted stock grants, which can't be vested until 2011 and 2012, in "recognition of his exemplary leadership and to convince him to stay."

Hence, boards are boosting utility leaders' pay packages to avoid a revolving-door CEO situation, which disrupts a firm's stability. Energy CEOs are facing an increasingly complex, competitive and changing environment. "CEOs are challenged based on implementing strategies regarding carbon tax, how to grow the company despite demand destruction, and increasing share price while maintaining the dividend," said Bruce Peterson, a Houston-based senior client partner at Korn/Ferry International, specializing in energy CEO compensation. Boards are reluctant to change the captains of their ships when business is volatile.

Most energy CEO salaries have remained relatively flat but long-term incentive benefits such as options, restricted stock awards and pensions are rising, noted Peterson. Boards are aligning CEO compensation with long-term goals rather than focusing on quick fixes and short-term gains. Furthermore, many long-term incentive awards are only granted if the stock price or revenue rises 10 percent, connecting compensation to performance. Crawford noted that the value of a stock award detailed in a proxy is misleading and can only be determined at the time of vesting.

Energy CEO remuneration also spiked in 2009 because many utilities showed stock price gains of 30 percent or more, Crawford suggested. "The stock market rally of 2009 created a windfall for many CEOs," noted Amy Borrus, deputy director of the Council of Institutional Investors, a nonprofit advocacy group for corporate governance.

Board Discretion

In many cases, the packages were high because CEO compensation is benchmarked against key competitors. Most boards "don't want to pay the most or the least but want to be in the 75th or 80th percentile," Peterson adds. Borrus contends that too many boards "set the targets too high" when benchmarking against competitors, and often don't negotiate a way to cut compensation if the stock price is stagnant or revenue lags.

These rising CEO salaries are facing intense scrutiny. Activist organizations such as Institutional Shareholder Services, CALPERS and other large retirement funds question why compensation spikes if the share price dips. "Shareholders don't mind paying CEOs when the company is performing well. But CEOs who make out like bandits when company performance is spiraling downward are upsetting to shareholders," Burrus said.

Jesse Fried, co-author of Pay without Performance: The Unfulfilled Promise of Executive Compensation and a law professor at Harvard University, attributes the problem of rising compensation to boards not being held accountable for their decisions. Fried said often "directors benefit from giving CEOs excessive pay, which is disconnected with performance." The board members who rubber-stamp executive pay increases often get reelected in uncontested elections. Fried would like to see shareholders given more say in replacing directors.

Indeed industry insider Crawford noted that the financial reform bill that is proceeding in Congress includes a provision that shareholders must approve compensation for the top five executives. That provision alone would create additional scrutiny in how boards determine compensation packages in the future.

Crawford expects energy CEO compensation to remain high for the next few years. "I don't see supply-and-demand issues changing in several years. The environment will be tight, and baby boomers are going to retire," he said.

 

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Gary M. Stern