Chief Executive Pay Increases 12.6% in ’04

CEO pay is climbing again, rewarding top executives with the biggest gains many have seen since the stock market bubble of the 1990s.

The executives piloting U.S. companies pocketed substantially more in 2004 than in the previous two years. Those gains come even as more corporate boards -- responding to sustained criticism about excessive pay -- rethink the way they award compensation, trying to more closely tie chief executives’ pay to performance.

CEO pay increased by an average of 12.6% last year, according to an analysis of nearly 180 corporate proxy statements by compensation consulting firm Pearl Meyer & Partners. That figure does not include the profits many CEOs reaped by exercising stock options.

The jump in pay takes the average CEO’s compensation to $9.97 million, resuming a long-running rise in pay after two years of little movement.

But that overall figure pales in comparison with the pay netted by some individual CEOs. Directors at Merrill Lynch & Co. awarded chief E. Stanley O’Neal with $31.3 million worth of restricted stock. At Wells Fargo & Co., CEO Richard M. Kovacevich pocketed stock options valued by the company at $20.4 million on top of a $7.5-million bonus.

The surge in what for many CEOs were already huge pay packages contrasts sharply with an overall slowing in pay for rank-and-file workers. In the last year, the pay of the average U.S. worker rose by just 2.6%, an increase more than offset by inflation.

The increase in CEO pay is rekindling debate in corporate governance circles. The argument focuses not just on how much CEOs deserve, but also the extent to which boards of directors control compensation and whether they’re doing enough to ensure that shareholders get their money’s worth.

Some observers see great strides being made to that end.

“I really think compensation committees on boards are getting the message with respect to the relationship between pay and performance,” said Pearl Meyer, president of the firm. “We’re seeing the beginning of, hopefully, a transitional transformation, with the restructuring of executive pay so that it’s more closely attuned to long-term results.”

But the bigger pay packages this year are already drawing fresh criticism from shareholder advocates and others. They are glad to see many companies moving away from the stock options that were a primary source of excessive pay in the late 1990s. But companies’ shift to giving executives restricted stock -- shares that can be sold after a set amount of time has passed -- has replaced options with shares whose worth is largely guaranteed, critics say.

“We’re probably seeing pay packages as rich as they’ve ever been before because a lot of the risk has been removed from the equity portion of the package,” said Patrick McGurn, executive vice president of Institutional Shareholder Services.

CEO pay packages soared in the late 1990s as companies granted huge numbers of stock options whose value mounted with the run-up in the financial markets. And although many firms have edged away from options -- which give executives the right to buy stock at a set price, then turn around and sell if they choose -- they are once again netting huge returns for some CEOs.

The leader of that pack is Yahoo Inc. CEO Terry Semel, who last year pocketed $230 million by exercising options. Semel -- paid almost entirely in options -- was awarded 7.2 million new options last year.

Companies soon will be required to count options as an expense. So a growing number of firms are rewarding CEOs with restricted stock. A much smaller number are partly paying CEOs with “performance shares” -- restricted stock that vests only after an executive steers a firm to meet stated targets.

“There is less of a reliance upon stock options in recent years than there has been in the past,” said Tracy Davis, a compensation consultant for Hewitt Associates.

That change is evident in the pay of executives like Edward E. Whitacre Jr., the CEO of SBC Communications Inc., whose pay totaled nearly $16 million last year. That payout is partly the product of a change in thinking by the company’s directors, who passed on awarding Whitacre and the company’s other executives the large grants of time-vested restricted stock they received the previous year, in favor of smaller grants of shares they receive only when performance targets are met.

“While stock options and time-based restricted stock are linked to the interests of stockholders, they do not have a performance component or measure,” SBC said in its proxy statement. The new arrangement “ties managers’ interests directly to those of the stockholders.”

But critics say the link between pay and performance will be meaningful only when directors at more companies set targets high enough, and stick to them. Shareholder advocates single out companies such as Merck & Co., whose earnings fell sharply last year after it was forced to withdraw its Vioxx pain relief medication.

Despite that, Merck’s board awarded CEO Raymond Gilmartin the same $1.38-million bonus as in 2003 and lowered the performance targets used to gauge his pay for the current year. Gilmartin also made $34.8 million from exercising options and received a new grant of 250,000 options.