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Executive Pay Special Report: WORTH IT?: Top brass still collects big packages, but ties to company performance grow

May 29, 2006

Michael Doar once had to give back part of his salary. How times change.

Now CEO of Indianapolis-based Hurco Cos. Inc., Doar offers more bang-for-the-buck than any chief executive in the state, according to an in-depth study of salaries and shareholder returns by IBJ.

One would shudder at the t h o u g h t o f Hurco's board asking Doar to forfeit a penny of his modest salary, as he did one year in the '90s when the Ingersoll Milling Machine Co. asked all employees-including Doar-to fork over some of their compensation as part of a cost-cutting effort.

Doar made $900,000 in 2005, as Hurco's share price jumped 39 percent. Since he took the reins in 2001, the company's stock has ballooned more than 1,200 percent, from $2 to more than $27. In that same time, his salary has increased 160 percent.

"I'm getting paid what I'm worth, and I'm happy with it," said Doar, 51, who's quick with a laugh and dresses modestly in off-the-rack blazers and slacks. Still, he joked, "I wouldn't turn any more money down."

Doar is one example of the biggest trend in executive compensation: tying pay to company performance. IBJ spent a m o n t h c o m b i n g through proxy statements of Indiana's public companies and concluded that executive salaries swell along with profits. When revenue dips, perks like country club memberships vanish.

But there's still a long way to go. Several companies continue to dole out titanic salaries for sinking bottom lines. And the gap between executive compensation and rank-and-file pay is still bigger than a Halliburton defense contract. That's one reason the feds are getting involved, drafting new rules for how companies report executive pay.

To everyday Hoosiers, Doar's compensation might look supersized-it's more than 20 times the average household income in the state. But it doesn't stand out by publiccompany standards. About 100 Indiana executives took home at least $1 million in compensation in 2005, a year when the Bloomberg Indiana Index-a composite of Indiana companies-remained flat.

The 98 men and four women who earned enough to be included on this year's list of the highest-paid public-company executives saw their annual salary and bonus increase by a median of 6 percent.

That's probably a better bump than the average Indiana worker got. While 2005 data won't be available for a month, statewide wages have increased no more than 4 percent annually in any of the four previous years, according to the Indiana Department of Workforce Development.

Yet the salary increases given to Indiana executives look stingy when one looks at the national landscape. According to a study of proxy statements by New York-based Mercer Human Resource Consulting, the salary and bonuses of CEOs at 350 large public companies increased 7.1 percent in 2005.

No more 'pay-for-pulse'

Even as pay for executives grows, a shrinking slice of it comes from just punching the clock.

"We're seeing a continued shift to more performance-based pay," said Ryan Compaan, a senior consultant in Mercer's Chicago office who has worked with Indianapolis clients. "There's a desire to get away from pay-for-pulse to pay-for-performance."

When Warsaw-based Zimmer Holdings Inc. had a 16-percent dip in share price last year, for example, the annual compensation of CEO J. Raymond Elliott-the third-highest-paid chief executive in the state-dropped 14 percent.

Similarly, William Miller, CEO of Columbus-based Irwin Financial Corp., saw a 28-percent drop in his annual compensation in a year the company's stock fell 25 percent.

Most companies-including Hurco, a north-side machine manufacturer-took pains to connect salaries to company performance. Doar got a $300,000 bonus in 2005, up from $125,000 in 2004, and $50,000 in 2003.

"The bonus took a big jump this year because we had such a good year," Doar said. "In the future if we don't do so well, the board will not give me that big bonus."

In fact, Hurco does a better job of connecting the boss's payday to the company's bottom line than any company in the state, according to IBJ's bang-for-thebuck tally (below).

The report card gives a letter grade to all Indiana CEOs who have been in their positions the past three years. IBJ came up with the grades by dividing companies' three-year stock returns by the CEO's 2005 compensation.

It's admittedly simplistic, and observers say CEOs shouldn't be judged just by Wall Street performance. But it's also enlightening.

Brightpoint CEO Robert Laikin earned a higher grade than everyone except Doar, even though he made more than $6.4 million in 2005.

Still, it's hard to imagine many shareholders fussing about the number of digits on Laikin's paycheck. In the last three years, the Plainfieldbased company's shares rose more than 1,000 percent. Laikin's annual take has gone up 431 percent in the same period.

Conversely, when the company struggled in 2001-shares languished below $5-Laikin took home $680,000 with no bonus.

"Having been chairman and CEO of six Fortune 500 companies ... I've always felt strongly about tying compensation to performance," said Jerre Stead, Brightpoint's lead independent director, who pointed out that responsible pay packages can have the added effect of increasing investor confidence and thereby share price.

In 2005, Brightpoint shares increased in value 113 percent and Laikin's annual compensation grew 130 percent, to more than $2 million. Compensation intended to reward long-term performance, including grants of stock and stock options, pushed his pay past $6 million.

He doesn't blush at the big paycheck.

"The clear message is, if executives execute the strategic plan and financial targets are hit that the shareholders would be happy with, then the executives are going to be compensated," he said.

Laikin's compensation also mirrored another national trend: He received most of his long-term pay in the form of a stock grant, and collected only a small stash of stock options. Options give executives the right to buy shares in the future at the price on the date they're awarded.

"Following a lot of the scandals like Enron, it seems like there has been a little bit of a trend away from the use of stock options and towards things like restricted stock [awards]," said David Denis, the Burton D. Morgan chairman of private enterprise at Purdue University's Krannert School of Management.

Why? Stock options are worth money only if the stock price goes up.

"[With options], managers could engage in some sort of fraudulent activity to boost the share price temporarily," Denis said.

Failing grades

Not every company ties pay to the bottom lines as closely as Hurco and Brightpoint.

"The trend might be encouraging, but there is a fair amount of pay being awarded for lack of performance," pointed out Daniel Pedrotty, counsel for the AFLCIO's Office of Investment in Washington, D.C.

Left-leaning union bosses aren't the only ones screaming foul. The Oracle of Omaha, Warren Buffett, sent a flaming arrow through corner suites in the latest annual report for his investment firm, Nebraska-based Berkshire Hathaway Inc.

"Too often, executive compensation in the U.S. is ridiculously out of line with performance," Buffett wrote. "That won't change, moreover, because the deck is stacked against investors when it comes to the CEO's pay. The upshot is that a mediocre-or-worse CEO-aided by his handpicked VP of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet and Bingo-all too often receives gobs of money from an ill-designed compensation arrangement."

Buffett, the world's second-wealthiest man, drew a salary of $100,000 in addition to $209,000 in fees for serving as chairman and CEO of Berkshire in 2005.

What Indiana CEO would get Pedrotty and Buffett the most fired up? Probably Standard Management Corp.'s Ronald Hunter, the only executive to earn a failing grade for his 2005 performance.

Even as the Indianapolis-based company's stock dipped 53 percent last year, Hunter still pocketed nearly $900,000-more than most of his peers at other small Indiana public companies.

Standard Management awarded Hunter $1.3 million in compensation in 2003, meaning that, while the stock has dipped more than 60 percent in three years, his paycheck has been docked only 30 percent.

Hunter did not return a call for comment, and the company's public filings do not detail how Standard Management's compensation committee determines his salary.

Fishers-based Marsh Supermarkets Inc. also declined to comment on CEO Don Marsh's $1.4 million salary for fiscal 2005, a span when the company's stock slid 16 percent. The salary was unchanged from the prior year but was $400,000 higher than that received by any of his small-company counterparts.

The grocery chain determined Marsh's salary based on his experience and the company's performance, according to its 2005 proxy statement. It called the salary "appropriate in light of the corporation's financial objectives and performance" in 2005.

Yet while the supermarket chain declined to offer a defense of the CEO's salary, observers were quick to pick up a sword for him. It's dangerous to judge an executive based solely on a company's Wall Street success, they said.

Gas prices affect stock prices. So do international politics. And sometimes, a small loss is a huge victory.

"If we're talking about the CEO of General Motors, we might define [good performance] as cutting the loss in half," said Bob MacDonald, a principal in CTW Consulting, a Wayzata, Minn.-based corporate governance consultant. "If we're talking about the head of Microsoft, we might define good performance as something different."

In other words, Marsh Supermarkets might not have made much money in 2005-$4 million on $1.7 billion in sales-but many thought the company was headed for bankruptcy as a result of extreme competition from mega-retailers. And Don Marsh at least kept the company on the rails until it found a buyer. Boca Raton, Fla.-based Sun Capital Partners this month agreed to buy the company for $88 million.

How much is too much?

For the second year in a row, the CEOs of Indianapolis-based WellPoint Inc. and Indianapolis-based Eli Lilly and Co.-the state's two largest public companies-were the highest paid.

WellPoint's Larry Glasscock made $24.5 million. Lilly's Sidney Taurel made $16.6 million.

Is that too much?

For some, such stratospheric salaries can't be justified.

"There's a line of reasonableness," said the AFL-CIO's Pedrotty.

Hurco's Doar agreed some of his peers are overpaid, but he wouldn't comment on specific individuals.

"There are some CEOs whose compensation is way out of line," he said.

Much of the criticism stems from the gulf between executive pay and worker salaries.

"It's a terrible problem," said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

The ratio of CEO pay to worker was 431-to-1 in 2004, up from 301-to-1 in 2003, according to the most recent data available from the Washington, D.C.-based Institute for Policy Studies. That's down from a high of 525-to-1 in 2000.

The University of Delaware's Elson, however, said CEOs deserve a nice paycheck.

"It's the CEO that sets the agenda for the company. It's the CEO that provides the vision and ultimately makes the big decisions. He or she is by far the most important person in the company," he said.

WellPoint shareholders are unlikely to pick a fight over Glasscock's salary. The health insurer, now the nation's largest, had a terrific year, propelling the company's shares 39 percent higher. Glasscock's total compensation-which includes stock options and awards-increased 48 percent.

"WellPoint's executive compensation principles rigorously tie pay to the performance of the company," said spokesman Jim Kappel. "Executive management is rewarded only after delivering significant benefits to members, associates, providers and shareholders."

Since Glasscock joined WellPoint in 1998, membership has increased nearly 600 percent and employment has increased 265 percent, Kappel said. The company's stock is up 343 percent since it become publicly traded in October 2001.

"It's extraordinary what he and his team have done," said Mitchell Shapiro, dean of the School of Business at the University of Indianapolis.

More so, Glasscock's pay is in line with his peers.

Dr. John Rowe, CEO of Hartford, Conn.-based insurer Aetna, made $27 million in 2005. That's $3 million more than Glasscock, even though Aetna had half the revenue of WellPoint-$22.5 billion compared with $44.5 billion.

Philadelphia-based insurer Cigna Corp. had $16.7 billion in revenue in 2005 and paid CEO H. Edward Hanway $18.9 million.

In other words, WellPoint pays Glasscock about what the market says he's worth.

What about Taurel? The company says he's also compensated for performance.

The pharmaceutical manufacturer treaded water on Wall Street in 2005. And Taurel's paycheck reflected the stagnant stock price. While his salary and bonus jumped 26 percent, his total compensation-including long-term awards-dropped 28 percent.

"We want more than 50 percent of his compensation to be ... performancebased," said spokesman Phil Belt, but the company uses much more than stock price to determine compensation.

And Taurel's $16.6 million likewise ranks right in the middle of his peers.

P.R. Dolan, CEO of N.Y.-based Bristol-Myers Squibb Co., made $15.4 million in 2005. The company had $19.4 billion in revenue, slightly more than Lilly's $14.9 billion.

New York-based Pfizer Inc. paid CEO Dr. Henry McKinnell $20.9 million in 2005. The company had revenue of more than $50 billion.

Naked CEOs

The rancor about executive salaries is about to hit a fever pitch, which should translate into more companies jumping on the pay-for-performance bandwagon.

The Securities and Exchange Commission is in the process of drafting new guidelines for next proxy season that will require additional disclosures about executive pay.

"I have a feeling that when people are forced to undress in public, they'll pay more attention to their figures," SEC Chairman Christopher Cox told a March meeting of the Washington, D.C.-based Council of Institutional Investors.

More than likely, companies will have to list more details about perks, retire- ment packages and post-employment compensation.

Some companies already disclose some interesting tidbits. For example, Carmelbased Adesa Inc. gave CEO David Gartzke $5,000 for club dues and $63,000 for personal aircraft usage. Donald Schwanz, CEO of Elkhart-based CTS Corp., got $5,000 for an executive physical, $3,000 for tax preparation and $12,000 for financial planning services.

More than likely, the SEC also will require companies to list a total compensation number for all senior executives. Currently, proxy statements list various forms of compensation, but do not require a single tally.

"There are going to be a lot of jawdropping moments," said the AFL-CIO's Pedrotty.

The union is pushing for two additional changes. Currently, related-party transactions, when companies do business with board members or companies controlled by employees, must be disclosed when they're in excess of $60,000 annually. The SEC is considering raising that threshold to $120,000.

"If the goal is to increase disclosure," Pedrotty said, "then the threshold should be kept at $60,000, if not lowered."

Pedrotty would also like to see more disclosure about peer groups and benchmarks.

"If an executive is awarded pay because he beat his peer group, shareholders should know about it," he said. "It's all with the intention of not allowing companies and boards to move the goal posts."

Analysts say the greater transparency will accelerate the trend toward pay-forperformance, since it will be harder to hide perks.

Unfortunately, say critics, the changes also could have an unintended effect of fueling increases in pay and perks, as CEOs push to keep up with their peers.

"There are going to be some CEOs who are going to be paid more," said U of I's Shapiro. "[CEOs] are going to get the word to their boards that, 'Listen, here's somebody else in my industry. He's got the use of the private jet. I gotta be able to go out and meet with customers [like he does].'"
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