Performance-Pay Formulas Don’t Always Compute

Frank Baxter took a pay cut--a big one. That’s because his company took a profit cut--a big one.

After Los Angeles-based brokerage Jefferies Group saw its earnings tumble last year as conditions in the securities markets soured, Chief Executive Baxter’s own earnings fell. Baxter’s pay last year was hardly small change, but at $631,145, it was down 30% from $906,426 in the previous year.

“We feel we have to perform if we are going to get paid,” Baxter said. “We don’t want to get paid for showing up.”

Baxter is a textbook example of something called “pay for performance”--the biggest development in corporate compensation since cost-of-living wage increases. He’s an example of how performance-based compensation plans are supposed to work: When the company does well, pay goes up; when the company does poorly, pay goes down.

Such compensation plans, which have been implemented at most of the nation’s biggest companies during the past several years, are intended to give management a clear incentive to achieve goals most valued by shareholders--higher revenue, more profit, higher stock prices.

“When you see an executive’s pay go down when the company’s earnings drop, you tend to think the compensation plan is working fairly,” said Carl D. Jacobs, senior consultant at William M. Mercer Inc. in Los Angeles.

But things don’t always work out that way.

Consider Joseph J. Pinola, chief executive of First Interstate Bancorp. Pinola got a 12.4% raise in 1989 even though the Los Angeles-based banking firm’s net income recorded a $124-million loss in 1989 after a $129-million profit in 1988.

The ordinary explanations for such a disparity between pay and performance don’t seem to apply in Pinola’s case.

Companies are sometimes forced to pay more to retain top officers to keep competitors from stealing them away. But Pinola, 65, is retiring in July, so retention isn’t an issue.

Keeping chief executives from being snapped up by the competition isn’t much of an issue under any circumstances, said Michael Halloran, vice president of Towers, Perrin, Forster & Crosby, a Chicago executive compensation firm. “It is rare that the CEO of one company leaves to become CEO of another. Retention is really only an issue for employees below that level,” Halloran said.

Other experts said pay-for-performance plans could be based on criteria other than profits, including stock price, revenue and market share growth. But First Interstate’s revenue is down 14%. Its share of the California market is flat, and it is losing ground on a national basis.

Its stock is worth less today than it was in 1985, when it hit a low of $41.50. It now trades in the $38 range and has fallen as low as $31 in the past year.

A First Interstate spokesman defends Pinola’s pay by noting that the job is difficult and carries a great deal of responsibility. Moreover, a recent ranking in American Banker, a trade publication, notes that Pinola’s 1989 pay ranks him only 37th highest-paid in the banking industry, even though he’s running the nation’s ninth-largest bank.

American Banker also ranks the top bank holding companies by performance. Out of 26 so-called super-regional banking companies, First Interstate’s 1989 results rank it 24th in terms of performance. First Interstate’s profits have improved in the first quarter of 1990.

Pinola’s pay situation is not unique. Lots of executives get a raise even as their companies falter.

A recent study by Towers Perrin said the median raise for chief executives of the nation’s top 100 companies was 9.2%, even though corporate profits were up just 4.8%.

“There is no question that executive compensation in the U.S. has developed a momentum of its own, divorced from corporate financial results for a number of companies,” Halloran said.

There is plenty of anecdotal evidence in California supporting Halloran’s point:

* ICN Pharmaceuticals, an Irvine-based drug company, gave its top officers raises as high as 91% in 1989, even though ICN posted a $82-million loss during the year. The previous year’s profit totaled $17.7 million.

Chief Executive Milan Panic got a 39.6% pay hike, boosting his cash compensation to $574,050--not counting $71,390 in legal accounting and insurance fees provided to Panic by the company as part of his employment agreement. ICN’s net sales increased 11% during the period, but the company’s stock price fell.

ICN said most of the huge pay hikes were caused by bonuses executives earned in 1988 that weren’t paid until 1989, as well as a special bonus rewarding top officers for completing a corporate acquisition.

But Panic’s hike was the result of a new employment contract. The board granted Panic the big raise to bring his salary to competitive levels and “ensure his retention” at the company. Panic founded ICN in 1960; a spokesman said he didn’t know if Panic had considered leaving.

* Thomas V. Jones, chairman and chief executive of Northrop Corp., earned $795,721 in 1989 compared to $681,250 the previous year, even though the company posted an $81-million loss last year, in contrast with a $104-million profit the year before. Net sales fell to $5.2 billion from $5.7 billion. And the company’s shares, which sold in the $32 range in 1988, now trade for less than $18.

But a company spokesman said what looked like a 16.8% pay hike is misleading--actually reflecting payment for accrued vacation time that Jones collected when he retired Dec. 31. In reality, Jones hasn’t received a raise since 1987, and no Northrop executive has earned a bonus in two years, said Northrop spokesman Tony Cantafio.

Ironically, Jones will earn his biggest raise by retiring. His annual stipend under Northrop’s retirement plan will pay $920,685 annually--35% more than his 1989 base salary.

* Profit at Caesars World Inc. fell 13% in 1989, but Chief Executive Henry Gluck won a raise of more than 30%. His total salary in 1989 rose to $1.33 million from slightly more than $1 million the year before. Raises for three other top Caesars officers ranged from 27.5% to 37.5%.

Caesars does have an incentive compensation plan based on the casino-hotel firm’s profitability. So why did Gluck’s base salary and his incentive pay jump during a year of declining profits? “Based on the formula, that’s just how it worked out,” said Roger Lee, senior vice president of finance.