As some of you may have read in our May newsletter, we performed an analysis of S&P 500 CFO pay trends. Beginning in 2007, companies were required to disclose the pay of not only their CEO but also their CFO as part of their Top 5. As a result, we now have two full years of pay data for CFOs at the vast majority of publicly traded companies.

Especially interesting in the analysis this year was the fact that the rate of growth of CFO pay (5.2%) was over three times faster than the rate of growth for CEOs (1.3%). So what’s going on? The glass-half-full view would be that CFOs, with the adoption of Sarbanes-Oxley, have much greater responsibilities than ever before. As a result, it’s much harder to recruit CFOs and, therefore, you need to pay them more.

Cynics, on the other hand, will argue that the required disclosure of CFO pay is itself causing the ratcheting-up of pay. CFOs who now know what their counterparts are making at other public companies may experience increased pay envy, or may believe that the disclosed pay information of their peers is only the pay floor and that actual pay should only go up from there. Is this an unintended consequence of greater disclosure under the new SEC compensation disclosure rules?

It’s most likely a combination of the two factors and others that I’m not even thinking of. At any rate, I thought it would be interesting to point this out and see if this trend continues into the year.

I just returned from WorldatWork’s annual conference in Philadelphia. For those not familiar with WorldatWork (formerly known as The American Compensation Association), they are the world’s largest association for compensation and benefits professionals with over 25,000 members. We first exhibited at WorldatWork in 2002 and have been attending ever since. Ironically, at our first conference in 2002, we were a last minute addition and were given Arthur Andersen’s booth since they no longer had a need for it. (There is MUCH more to that story, but I’ll leave that for a future post.)

Given that this was our seventh year at the conference, it was interesting to see how the exhibit floor has evolved since we first started attending. As WorldatWork’s mission has transformed from “Compensation and Benefits” to one focused on “Total Rewards”, you have an interesting mix of companies seeking to reach out to their members. Everything from gift cards from “Tar-zhay” (a.k.a. Target) to literally dozens of companies offering talent management solutions, a software category that didn’t even exist seven years ago.

As one would imagine, a number of exhibitors offer services related to compensation surveys. As I looked around, I saw aisles and aisles of companies who offer compensation surveys. Think of your local Safeway but Super Sized. So, if the world already has so many surveys, what makes ours different?

Over the past several years, many of our clients have shared their survey frustrations with us and have asked us to develop a solution that helps address their needs. I see our survey as unique in three important areas:

• Transparency;
• Flexibility; and
• Ease of use.

Transparency – Given that a substantial amount of data for our survey is already publicly available, we can readily display this information. How valuable is this feature? Think of surveys that you’ve used and then wondered how they came up with these numbers. Most surveys give you a number without any backup to support the data. This has to be one of the most frustrating experiences for an end-user. Good luck explaining this to the chair of your comp committee. By displaying the source data, when it’s available, this helps remove any discrepancies or ambiguities and gives our users much greater confidence in the decision making process.

Flexibility – A number of current surveys rely on proprietary methodologies. Over the past year, there has been a movement among compensation professionals and associations (in particular, both WorldatWork and GEO) to get survey providers to move to a common standard. Without a common standard, we feel that this is holding back the profession. Over time, what drives innovation in any industry is the adoption of a common standard. Think of VHS vs. Betamax, and for the younger crowd, Blueray v. HD DVD. By moving away from proprietary standards, this removes confusion and uncertainty in the marketplace and leads to much greater customer acceptance and adoption. With our client-driven valuation tools, we believe that we are moving the profession forward with an open platform approach by giving our clients the tools they need.

Ease of Use – Given that we started with a clean slate, we were able to incorporate a number of client suggestions into the design of our survey product, starting from the entry process to accessing the actual survey results. By pre-populating certain information, we drastically reduce the amount of time it takes to complete a survey. In addition, we’re excited about some of the functionality that we designed for the reporting tool to allow our clients to access the information that they’re looking for.

By addressing the critical needs of many of our clients, we’re excited about the impact that we’re having on the industry and the profession. We certainly helped change things back in 2002 with our first product (ExecutiveInsight, our Top 5 proxy database) and see the same opportunity with our survey solution. Given that we already have over 130 companies that have agreed to participate, it certainly feels like we’re onto something.

I’d love to hear your thoughts and questions. Thanks in advance for your input and thanks to our many clients who stopped by our booth at WorldatWork. It is always great to see both new and old faces.

Earlier this week, we announced our first foray into the survey industry, a very big step in our corporate evolution. During our eight year history, access to data has never been an issue, whether for us, or for any of our competitors. Our solutions have been based on publicly available data, primarily compensation data from proxies and other SEC filings in addition to stock price information from market data providers. While quite a bit of analysis and quality assurance goes into the finished solution, fundamentally, source data is in the public domain.

So why take on the unenviable challenge of sourcing proprietary data? Very simply, because our clients asked us to. Since we launched our first executive compensation product in late 2001, right around the time of the surfacing of Enron and Andersen (as they say, better lucky than good!), our clients have continually asked us to provide a deeper look within an organization and go beyond the Top 5.

The good news is that a substantial amount of the data that we’ll need to fill this gap is already publicly available in Form 4 filings, a little known fact that goes surprisingly unnoticed by many boards, executives and compensation professionals. In 2003, the SEC changed Form 4 disclosure rules to require that all equity grants be disclosed for all Section 16 officers, typically the top 10 to 15 executives at most companies. Yes, it’s all out there, but for anyone who has ever had to search through Form 4s, recreationally, it’s on par with sticking hot needles in one’s own eyes.

Given that equity awards typically generate the greatest amount of attention, accurate and, more importantly, transparent long-term incentive (LTI) data for the top 10 to 15 executives is a great starting point. In addition, with the strong support from a number of companies offering to provide the missing pieces, we felt that the time was right for us to take this next step.

With the combination of our technology, expertise in working with SEC data and a committed client base, our mission is to fundamentally change how executive compensation analysis is performed and improve the analysis experience for everyone. Creating a survey to fill this void is the missing piece. For the first year, our plan is to focus on companies in the Fortune 250. What we’re finding is that the demand for our services is especially strong in certain industries and that we’ll be including a number of companies beyond the Fortune 250 based on client feedback.

If you’ve had experience with executive compensation surveys and have suggestions, we’d love to hear your thoughts on what you’d like to see from us. We’re off to a great start and I’ll have some exciting updates for you shortly. Stay tuned. To learn more, read our press release from May 6.

As one would expect, the past couple of weeks have been extremely busy for yours truly. In addition to my regular CEO duties, one area that goes into overdrive this time of the year is the presentation circuit. April included trips to the Conference Board (twice), MCA, ICG and Stanford Law School, not to mention our annual proxy season webinar in mid April (once again, our apologies!). And April was just spring training. With several May presentations around the corner, it would not come as a surprise if my kids happen to forget who’s their daddy.

That being said, the area that continues to get the greatest amount of interest in all of my presentations is performance target disclosure. As I had written earlier, this was clearly a point of contention during last year’s proxy season. And with the SEC’s rabid interest in this area as indicated by the 350+ comment letters sent to issuers in the fall, many expected the fireworks to continue this spring. In our April newsletter, we published an analysis of Fortune 100 companies and found that the disclosure of performance targets for annual incentive bonuses was (are you seated?) up over 25 basis points, from 44% in 2006 to 68% in 2007.

In the rough and tumble world of proxy disclosure, this is big news. (It doesn’t take much to get us excited at Equilar.) Frankly, this came as a shock to me and others at Equilar. Early studies indicated that most companies were going to stick to their guns and NOT disclose performance targets. From talking with several issuers, it was interesting to hear how this was a major point of contention as companies were preparing their proxies. It was interesting to see that the majority of companies ended up disclosing it. It’s good to see the good guys coming out ahead this year.

As the son of an accountant, I was conditioned from a very early age to expect March and April to be busy times of the year. My dad, who is a partner in a boutique accounting firm in New York City, worked late nights and weekends each tax season. While I didn’t follow in my dad’s footsteps and become a CPA, my kids know that this is my busy time of year, too.

Retailers have Black Friday, accountants have April 15th, and at Equilar, we have proxy season. Since we started tracking executive compensation data in 2001, the months of March and April have always been an adventure. While we find ways to improve and streamline our operations each year, the sheer volume of work increases annually. The good news is that all of our hard work continues to find a receptive audience, as witnessed by recent stories in The New York Times, The Wall Street Journal, CNBC and other media outlets.

As part of our proxy season activities, we recently released our annual S&P 500 CEO pay analysis last week. While quite a bit of work went into preparing the analysis, the results didn’t quite rock anyone’s world. At the end of the day, an increase in CEO pay of 1.3 percent in 2007 was pretty tame, especially in light of the financial performance of S&P 500 companies over the same time period. Last year was the second consecutive year in which the pay of S&P 500 chiefs grew at a slower rate than the financial performance of the companies they lead.

While it’s debatable how much value investors are getting out of the new SEC disclosure rules, the analysis indicates that board members are taking pay decisions very seriously and that most companies are doing the right thing. Yes, there will always be companies that are in a state of denial and issues surrounding executive compensation will not be solved overnight. But overall, the trend is certainly to move in a more shareholder-friendly direction.

Now that we have the benefit of two years of data under the new SEC rules, it will be interesting to see year-over-year changes in key practice areas (such as perks, severance and change in control arrangements, and clawbacks, etc.) in future newsletters as we dig deeper. Stay tuned.

One area of executive compensation that has received a tremendous amount of attention over the past year is the disclosure of performance targets. While many companies disclose metrics, it’s less common to see companies include their actual targets/goals in their CD&As. Last year, we found that 44.4% of Fortune 100 companies disclosed annual incentive plan performance targets for their executives with varying levels of specificity.

As we enter proxy season, I’ve had the pleasure of reading the CD&As (lucky me!) of early filers and came across one that I found especially interesting. In American Electric Power’s CD&A, they included their Wall Street earnings estimates and how the calculation of an executive’s bonus is tied to EPS performance:

Annual Performance Objectives: In February 2007 the HR Committee established AEP’s 2007 ongoing earnings guidance of $2.85- $3.05 per share as the funding measure for AEP’s annual incentive compensation program. This performance measure required earnings per share equal to:

As someone who spent six years on Wall Street before starting Equilar, I’ve been asking myself these questions ever since the new SEC disclosure rules were announced nearly two years ago. What is the linkage between an executive’s performance targets and the guidance that companies are providing to the investment community? Wouldn’t one expect them to be somewhat aligned? And, if not, why aren’t they?

Another interesting thing to point out about the AEP CD&A is that not only did they compare 2007 performance against 2007 EPS guidance, but they also disclosed what the targets are for 2008, something that I don’t think that I’ve seen before.

In January 2008 the HR Committee also established AEP’s 2008 ongoing earnings guidance of $3.10- $3.30 per share as the funding measure for AEP’s annual incentive compensation program. This performance measure requires earnings per share equal to:

If AEP’s ongoing earnings for 2008 is less than $3.10 per share then no annual incentive compensation will be paid out to executive officers or to other employees. The 2008 earnings per share target is $0.25 (or approximately 8.5%) higher than the 2007 earnings per share target.

It will be interesting to see if more companies take this lead as the pace of proxy filings increases in the upcoming weeks.

For further reading on the topic of performance metric disclosure, The Wall Street Journal published a very interesting article on this subject last Friday.

Take Two Interactive (TTWO) recently adopted a broad-based severance plan for all of its employees. While on the surface the arrangement sounds similar to Yahoo!’s, there are several key differences which I asked Derek and Alex to summarize below for everyone. If you choose to read the 8-Ks, you’ll find TTWO’s disclosure provides greater detail on the severance arrangements.

With another hostile offer launched earlier this week by Electronic Arts (our next door neighbor) who is attempting to acquire Take Two Interactive, I wanted to highlight how companies in play have made changes to their executive compensation plans. Most recently, the New York Times wrote about how Yahoo! approved severance programs for not only the executive team, but for all employees. As the Times pointed out, while you often see severance arrangements for executives, it’s rare to see such protections for the masses.

Another example where a severance plan was put in place for all employees was at Siebel in May 2005. Technically, the plan was put in place before an offer was made, but Siebel was rumored to be on Oracle’s shopping list for quite some time. The official merger announcement came a few months later in September. By the way, for those keeping score at home, Oracle is also right around the corner from us… I hope it’s not something in our water.

With the combination of depressed equity valuations and a slowing global economy, it should not come as a surprise that companies like Microsoft, Oracle and EA, with their bullet-proof balance sheets and cash flow engines, are not taking ‘no’ for an answer in their quest for growth. It will be interesting to see if more companies adopt similar changes to their compensation plans to retain key talent in this period of consolidation.

Setting director pay is probably one of the more awkward decisions for board members. No matter how you slice it, there will always be a conflict of interest. As one would expect, with increased responsibilities, scrutiny and exposure, director pay
continues to increase. However, as part of a recent client project, we identified several companies that are bucking this trend.ⁱ We found it very interesting to read the explanations on why several boards chose to reduce their own pay. Given the current economic environment, it will be interesting to see what changes boards make to align their pay more closely with corporate performance. Thanks to Aaron and David for their help in identifying and pulling the examples together.

Aligning Director Pay with Performance

Ford (F) and General Motors (GM) represent some of the more high profile examples. Both of the carmakers cut director pay by 50% in 2006. According to Ford’s proxy, “the Board of Directors voluntarily reduced Board fees payable to non-employee directors by half.” GM went into more detail in their proxy, connecting the pay reduction to a company-wide turnaround plan:

Under the Compensation Plan, directors are entitled to receive an annual retainer of $200,000. In support of the GM North America Turnaround Plan, the Board has chosen to reduce this retainer. In March 2007, the Board agreed to forgo 25 percent of the retainer, resulting in a retainer of $150,000 for 2007. (The retainer was voluntarily reduced by 50 percent in March 2006.)

Intelligent Systems Corp (INS) provides another interesting example of decreased pay. In their proxy, INS disclosed that “each director declined the annual grant of 4,000 shares in consideration of the company’s failure to meet the continued listings standards of the American Stock Exchange.”

Reductions after Benchmarking

Pulte Homes (PHM) reduced the annual option grant for directors from 16,000 to 7,000. This change is disclosed in an 8-K filing:

On May 11, 2006, the Board of Directors of Pulte Homes, Inc. approved a revision of the compensation to be paid to Pulte’s non-employee directors, effective as of June 1, 2006. The revised compensation was recommended to the Board by its Compensation Committee after the Committee undertook a careful review of market practices and received advice from the Committee’s outside compensation consultant.

NVidia (NVDA) also changed their equity grant practices as disclosed in their proxy:

Although the 1998 Non-Employee Directors’ Stock Option Plan provided for the automatic grant of options to purchase 150,000 shares for the Initial Board Grant and 50,000 shares for the Annual Board Grant, in fiscal 2007 the Compensation Committee reduced the size of the Board grants to 90,000 shares for the Initial Board Grant and 30,000 shares for the Annual Board Grant based on data provided by our Human Resources Department and the compensation consultant. After completing its review of Board compensation in March 2007, the Compensation Committee reduced the Annual Board Grant to 24,000 shares and the Annual Committee Grant to 8,000 shares.

ⁱ A more comprehensive analysis is available in CustomInsight, our online project library, under the title Director Pay Cuts for S&P 500 Companies.

As we enter February, we’re only weeks away from the upcoming proxy season. With a year of the new SEC rules under our belt (can you believe it’s only been a year?), 2008 will be the time where we’ll be able to perform year-over-year comparisons on executive pay under the new system. I just got back from talking on a panel at the ISS/RiskMetrics annual conference and a question that often comes up is measuring the impact increased SEC disclosure will have on executive pay. Will increased sunlight on pay practices sanitize executive pay practices or lead to the “galloping greedy gimmies” in boardrooms across America?ⁱ

At this point, it’s a bit premature to point to any definitive trends. But based on our analysis of proxies from the 2007 proxy season and reactions we’re hearing from issuers on the SEC’s round of comment letters sent in the fall, I’m optimistic and expecting that the positive trend of “investor friendly” modifications in pay practices that we’ve seen in the last several years will carry on into 2008. While there will continue to be outliers who make for entertaining stories, they’re becoming increasingly hard to find.

In addition, we’re curious to see the direction of pay for 2007. Last year, the markets and economy went through a Jekyll and Hyde like experience and were in dire need of Prozac by Christmas. In a matter of months, we went from talk of $100 billion private equity buyouts to red carpet treatment for sovereign wealth funds in the Middle East and Asia. It’s comforting to know that each time I fill my tank with $3.50 per gallon gasoline, I’m doing my part to save our financial institutions. Given the deterioration in the credit markets and the overall slowdown in the economy, it will be very interesting to see the impact this has on pay decisions and the design of pay packages as we move forward.

BTW, in case you missed it in Sunday’s NY Times, Claudia Deutsch wrote about an interesting severance example that one of our analysts discovered as part of our research. Thank you to Texas Roadhouse for embracing the SEC’s plain English approach and sharing with us the most creative and shareholder friendly severance package that we’ve seen so far.

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i For those without kids under the age of 5 (or even comp committee chairs), I highly recommend The Berenstain Bears when you’re feeling down. A synopsis - Brother and Sister Bear want everything in sight, and they throw tantrums when they don’t get what they want. Wisely Mama and Papa deal with this childhood malady by teaching the cubs about the family budget and the importance of appreciating all that they have already.