The George Trumbell saga has put a continuing spotlight on CEO contracts.
It has also put pressure on boards to be more transparent in releasing details of CEO contracts, primarily to reassure shareholders that there are links between pay and performance and shareholder value. In the US, there is a move to make all CEO contracts public as Nell Minow* explains.
It was the first class airfare for his mother that convinced me I was on to something. The guy who called me up to yell at me for asking was pretty good too. But let me begin at the beginning, and tell you how I reached that point. We are used to the annual scrutiny of CEO pay in the Fortune, Wall Street Journal and Business Week editions that we like to call the swimsuit issues because they are so popular and so revealing. But proxy statements give you only part of the picture. I became interested in CEO employment contracts as a way to see more of the picture for three reasons. First is the disconnect between the theory and reality of their availability. They are ostensibly public documents but they are filed with the SEC, not sent to shareholders, like the annual report and proxy statement. It is not always possible to know when the contract was signed or amended, so it can be like trying to find a needle in a haystack to track it down. I wanted to make these documents truly public, and the Internet made that possible.
Second, it seemed to me that a CEO employment contract can provide some useful insight into board performance and some insight into the board's relationship with the CEO. We can never be there to hear the board set performance goals or do a CEO evaluation. We don't know whether the board asks tough questions, and we don't know if they ever give tough answers. But the employment contract can give us some sense of the board's ability to impose meaningful standards. Let me put it this way, if the CEO's mother's first class airfare is included in the employment contract, that gives you some sense that "no" is not one of the board's most frequently-used words. I really want to emphasise this point - the primary purpose of this compilation is to help us evaluate directors, not CEOs. We want CEOs to be aggressive and even a little greedy. But we depend on directors to make sure that those qualities are directed at shareholder value. It's fine for the CEO to ask for the moon. But it is the job of the directors to say, "Sure, you can have half of the moon now, and the other half when the share price doubles."
Finally, I thought that asking the corporate secretaries of the S&P 500 to provide me with a copy of a document that is publicly available as a matter of federal law would be a good indicator of the company's responsiveness on matters of shareholder concern. And indeed, the disparity was much broader than I expected. I believe employment contracts are an important indicator of the company's commitment to disclosure and communication with shareholders. We are still at the very earliest stages of this project. Contracts are still coming in. We will be evaluating them more thoroughly, but for now we would like to share some of our preliminary observations.
Best and worst - contract provisions I'd like to begin with some comments on the companies who were either so good or so bad in making shareholder value the goal of the contract that they established the farthest reaches of the range. One caveat, though - our analysis at this early stage is still more anecdotal than comprehensive. Contracts are still being submitted, and the ones we have include a broad array of provisions. The best and worst selection and other examples below are based on our qualitative judgment, and we will continue to make revisions as our sample grows and boards, corporate secretaries, and CEOs change. But we believe our general rule is the right one: Contracts should provide incentives and protections solely designed for tying compensation to the creation of shareholder value. Anything that distracts or contradicts that goal is an indication that the board is not sending a clear message to the CEO, the officers and employees, or to the investment community about its priorities. Of the contracts we've received so far, none is better than the contract of the man many people believe to be the best CEO in America, GE's Jack Welch. It is short and to the point, and its primary purpose is securing the time, attention, and talent of the CEO to the company. It guarantees no special bonuses, payments, or perks and provides no special protection. Those people who say that those provisions are necessary to attract a top-performing CEO should take a look at what this top-performing CEO's contract looks like. The contract is a tribute to Welch and to his board. And none is worse than the contract of Robert Annunziata of Global Crossing, whose tenure as CEO ended on March 3, 2000, after just a year on the job. Annunziata created tremendous shareholder value. But the contract's pay/performance link was weak. As the company's performance leveled off, Annunziata's compensation did not diminish commensurately. According to Forbes, Global Crossing is "an Internet play with all the potential and risks that that entails." The company needs a CEO whose contract is tied to those potentials and risks. Instead, the contract included pay guarantees and perks that indicate a lack of oversight by the board.
Just for showing up, he got a $10 million signing bonus and two million stock options at $10 a share below market. He got our favorite oxymoron - the "guaranteed bonus" of not less than half a million dollars a year. The make and model of the Mercedes the company would buy for him and his wife is spelled out in the contract. He got the use of the corporate jet for commuting until such time as he might find it appropriate to move. And to keep him from getting homesick, his family got first class airfares to come see him once a month. Including his mother. We look forward to reviewing the employment contract of his replacement. We recognise that a board must address opportunity costs in enticing an outstanding prospect. An outstanding executive who has a highly performance-based contract will not be willing to move without a clear chance to do better. This is exactly where a board is put to the test. Compensation consultant Pearl Meyer blames the CEO selection process. "The board too often narrows its selection down to one candidate - then feels so relieved to have finally found someone that they fall in love," she says.
"But starting the negotiating process by telling us 'Don't lose the deal' is hardly a strong position from which to negotiate. Instead, the board should require its recruiter to develop at least two well-qualified and interested candidates it would be glad to hire. Then there's an opportunity to negotiate a compensation package that is to the benefit of both the executive and the shareholder."
Best and worst - responsiveness We do not believe that it is a coincidence that GE was also one of the earliest to respond to our request, landing them an A- for responsiveness. There is not necessarily a correlation between being forthcoming with the contract and having a contract that fits our criteria for shareholder value - our choice for the worst contract was also submitted very promptly. But both are good indicators of a company's commitment to shareholders, and are often found together. Many other company secretaries could benefit from following this example. Our initial letter was sent to 500 corporate secretaries in July of 1999. Only 68 responded. We made follow-up phone calls to the remaining corporate secretaries in November. The overwhelming majority of them told us they had never seen our initial letter. After we faxed copies to them, we heard from another 88. This left us with 331 companies not responding or refusing, plus several who ducked one or more of our questions in their replies. We prepared two letters. The first was to the CEOs of the non-responsive companies, with a copy to the head of the investor relations office. The second was to the boards of directors of companies that had refused to provide us with the contracts and contact information.
Of the 308 non-responsive companies, the CEO letter produced 68. Of the 23 refusing companies, the director letter produced five. A flurry of responses came in following a blast fax about our project from the American Society of Corporate Secretaries. Those who still have not responded, or who continue to refuse, received F grades. We are in the process of obtaining those contracts, and we will be adding them to our site. As Joe Louis would have said, they can run, but they can't hide.
Termination clauses CEOs who are terminated for cause do not receive the full package of termination benefits that they would if they were terminated without cause. This makes sense. Anyone terminated without cause should be entitled to some financial arrangement as compensation. The problem is that in the world of CEO employment contracts, terms like "cause" are redefined in a manner that would give pause to Lewis Carroll. One might think that "cause" would include failure to perform. But employment contracts whittle away at the definition to make it impossible to terminate employment based on poor performance without incurring liability for substantial additional payment. "Cause" is most often defined as felony, fraud, embezzlement, gross negligence, or moral turpitude. Some contracts also include willful refusal to follow the direction of the board. At Toys R Us, the contract for former CEO Michael Goldstein provided that he could not be fired for cause without "a felony involving moral turpitude" - apparently garden-variety felonies do not qualify.
Newmont Mining's Ronald C Cambre has a contract that requires three-quarters of the board to find that he acted in bad faith in order to support termination for cause. Richard J. Kogan's contract at Schering-Plough provides that if he challenges a "for cause" termination, his own determination of good faith prevails unless there is a final and non-appealable judgment to the contrary by a court. Very few contracts even mention poor performance as the basis for termination for cause, and some of those require a showing of bad faith to make it clear that failure to perform alone is not sufficient for "cause." The recent push to make termination "without cause" payments equal those for termination in connection with a change in control is particularly troubling. Change of control payments are intended to align the interests of the CEO with the shareholders in evaluating a business combination. Payments for termination "without cause" are intended to ease a non-performing CEO out the door. They can also provide an incentive for a bored CEO to trigger his own parachute with a buy-out deal that may be contrary to the long-term interests of the shareholders.
The cost of these provisions may be small in comparison to the peace of mind that comes from being able to fire an unsatisfactory CEO without worrying about litigation (this was the reason provided by the AMP board in determining George Trumbell's payout). We think boards can do better than this. One of the justifications often claimed for astronomical amounts of CEO play is the element of risk. But provisions such as this can make the position risk-free, as departures by CEOs at AT&T and Global Crossing demonstrate. Any other employee at any other level has some accountability for poor performance. We would like to see some performance basis in the definitions of cause, to make sure that pay and performance are as closely linked as possible. The negotiation of CEO employment contracts is massaged as thoroughly by headhunters, compensation consultants, and lawyers that most of the contracts are mostly made up of routine provisions and boilerplate. Even a preliminary analysis, however, shows us that the contracts can provide some useful insights into the CEO-board relationship.
As we expand the site to add more companies and provide more depth, we hope that shareholders will be able to make more informed judgments about the credibility and effectiveness of directors and communicate their goals and concerns to corporate management and directors.
* Nell Minow is editor of the The Corporate Library (c) 2000 Nell Minow, all rights reserved
The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.
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