O.C. Execs' Pay Jumps, but Stock Brings More

By PATRICE APODACA

May 24, 1999 12 AM PT

SPECIAL TO THE TIMES

Being the boss certainly has its advantages.

The top executives at Orange County’s public companies received a median 20% increase in their cash compensation last year, compared with a 4% pay raise for workers generally.

But it got even better than that. Many executives’ total pay soared far higher as they cashed in lucrative stock options, according to a study conducted for The Times by the consulting firm Watson Wyatt Worldwide.

The study of 145 publicly traded companies found that 187 executives earned $500,000 or more in total compensation last year, while 84 of those made it into the million-dollar paycheck club. Only eight women made the list.

The median total compensation for executives in the survey was $904,000.

Nearly half of the total pay came from the exercise of options--a common method of compensating top managers, as well as many rank-and-file employees, that allows them to buy shares at a fixed price after a certain date. More than 100 executives still are sitting on unexercised options worth more than $1 million, and 81% were granted new options last year.

The highest-paid executive in the county last year was Jerre Stead, chief executive of Santa Ana-based computer distributor Ingram Micro, the largest company in the survey, with $22 billion in annual revenue. Stead had $15.9 million in total compensation--every cent of which came from the exercise of stock options. He draws no salary and receives no bonuses.

Stead also sits on the biggest treasure chest of unexercised options--worth $46.5 million.

While Stead’s pay package is unusual for its absence of any cash compensation, it does underscore the sometimes controversial but growing use of options to reward executives and motivate them to boost shareholder value.

“The biggest single trend is how much long-term incentives--or stock options--are driving compensation now,” said Watson Wyatt consultant Daniel Wetzel.

Though currently the favored method of compensating top executives, options weren’t the only road to riches last year. Many also received cash bonuses, which typically are triggered by the achievement of certain financial goals.

For instance, Greg Weaver, chief executive of the successful apparel concern Pacific Sunwear of California in Anaheim, got a $600,000 bonus in addition to his $509,600 salary and $4 million in realized option gains.

Is the high pay for top executives deserved? Sometimes yes, sometimes no.

On average, Orange County’s publicly traded companies produced annual shareholder returns of 12.5% the past three years. That compares with average annual returns of 27.6% for the Standard & Poor’s 500 index of large-company stocks, and 28.7% for all the Nasdaq Composite index of smaller-company stocks during the same period.

But the picture varies with each company. In Pacific Sunwear’s case, investors have a lot to smile about because they’ve also been rewarded by a rising market value.

“When we went public, the market value of the company was about $60 million. Today, it’s about $750 million,” said Pacific Sunwear Chief Financial Officer Carl Womack, who took home $3.4 million last year, including $3 million in option gains. “We’ve created a tremendous amount of shareholder value.”

In an interesting twist, two of the county’s wealthiest executives, Broadcom Corp. co-founders Henry Samueli and Henry Nicholas III, did not appear on the Times list. Though they are worth more than $1.8 billion each, that wealth comes from their stakes in the Irvine-based maker of high-speed communications chips, which went public in a hugely successful stock offering last year. The pair did, however, receive the second-biggest option grants last year, worth $44.8 million each.

A few of the executives in the survey have since left the companies, including retired Fluor Corp. Chairman Leslie G. McCraw, who was the eighth-highest-paid executive last year with $5.09 million in total compensation--most of it from his severance package.

The Irvine-based engineering and construction services concern also handed out some big options grants last year, including a $14.4-million grant to Don L. Blankenship, chief executive of Fluor’s A.T. Massey Coal subsidiary, and a $9.15-million grant to Philip J. Carroll Jr., the company’s new chairman and chief executive. Carroll also received the largest grant of restricted stock in the county last year, worth $6.8 million.

Fluor has been going through a rough patch, warning that economic and political troubles in Asia and Latin America and falling demand at the coal mining unit will hurt profits. About 5,000 Fluor workers will lose their jobs over the next several months, receiving no severance pay or benefits, as the company restructures.

“There’s no question when there are layoffs, employees look at things like [executive pay],” said Lew Smith, Fluor’s vice president of executive development and compensation.

But Smith maintains that a big incentive-based pay package for a veteran executive like Carroll, the former head of Shell Oil Co., is necessary to return the company to health. Carroll “completely reorganized Shell and turned it around,” he said. “Any time you get a proven CEO, you’re going to pay a little more. Frankly, I was surprised it didn’t take more” to get Carroll to take the job.

Fluor also lent Carroll $5 million to buy a house, agreed to reimburse him for country club expenses and provided him a $5-million death benefit.

Irvine-based pharmaceutical concern Allergan Inc. also slashed its work force last year in a bid by new Chief Executive David Pyott to redeploy resources to more productive areas and boost profits. The company lost $90 million in 1998, on $1.26 billion in sales, after charges related to its restructuring.

Pyott’s pay last year was $3.11 million--including $604,600 in base salary, a $700,000 bonus and $1.8 million as part of a stock price incentive plan.

Market Success Means Take-Home Success

The stock plan, approved by Allergan shareholders in April 1998, rewards top officers if certain share-price targets are hit and held for 20 consecutive trading days. The goals were reached, and thus Pyott received the equivalent of twice his annual salary in additional compensation, said Tom Burnham, Allergan’s vice president of human resources.

“What you’re seeing is the payout for an incredible stock performance,” said Burnham.

Though that’s likely to be cold comfort to the 550 employees who lost their jobs, Burnham said the remaining workers have benefited from Allergan’s rebounding stock price--to the tune of $50 million in additional value for the employee stock ownership plan.

The good news, said Wetzel of Watson Wyatt, is that in general, the more money that executives make, the more shareholders profit.

But compensation will likely undergo increasing pressure from shareholders who want companies to do a better job of matching pay to performance.

“I think we’ve got a ways to go” to make executive pay seem more reasonable, Wetzel said.

Critics of escalating executive pay argue that options, bonuses and other incentives tend to disproportionately reward top executives during good times and do little to punish them in bad times. With the stock market continuing its upward climb, even executives at companies that have underperformed the market can still profit handsomely when they exercise options, sometimes for pennies on the dollar.

“I don’t think we want to be overly romantic about options being all that risky” for executives, said Graef “Bud” Crystal, a compensation critic and editor of the Crystal Report newsletter. “As long as you have a rising tide lifting all boats, how risky is it?”

Crystal believes there simply aren’t enough negative consequences for doing badly.

“The easy part is high pay for high performance,” he said. “The hard part is low pay for low performance.”

Others question whether options and other incentives are truly effective in boosting shareholder value. James Wallace, a UC Irvine professor of accounting, conducted a study last year that concluded that stock option awards have no effect on corporate performance. Top executives “are going to work just as hard whether they make $1 million or $100 million,” he said.

Even so, Stead’s decision to take all his compensation in options is widely regarded as a laudable attempt to tie his pay to the fortunes of Ingram Micro.

“Over the years, as I’ve been chairman of several public companies, I’ve tried to link myself closer and closer to shareholders,” Stead said. “The higher the person gets in an organization, the higher the amount of their compensation that should be at risk.”

Despite the differing opinions, experts say options are here to stay because they are not counted against a company’s profits and are therefore considered the cheapest form of compensation.

What’s more, in a tight market for experienced executives, big options awards are considered a good way to secure talent.

“At a certain level, I’m not sure options drive executive behavior,” said Watson Wyatt consultant Rick Beal. “These executives are incredibly motivated. But it starts to be a retention thing. The number of really good executives is relatively small.”

Attaching Strings to Ensure Fairness

One thing is clear: Executive pay is growing ever more complex.

Consider ICN Pharmaceuticals’ Chief Executive Milan Panic, who took home $2.23 million in 1998, consisting mostly of $701,300 in salary and a $1.13-million bonus.

It came in a year when ICN had a net loss of $347 million on revenue of $838 million, after the company took a big fourth-quarter charge related to the Serbian seizure of its Yugoslavian operations. ICN also last year settled two sexual harassment lawsuits filed against Panic. After hitting a high of about $50 a share in May, ICN’s stock ended the year at $22.63.

David Watt, ICN executive vice president and general counsel, explained that Panic’s bonus was for the company’s strong financial performance in 1997. This year, he said, Panic would receive no bonus.

But last year Panic was also given $4 million worth of stock that vests in stages over several years, and a stock option award valued at more than $7 million. The awards were part of an incentive program, approved by shareholders, Watt said. Granted at $45 a share, the options are deeply “underwater,” he said, and will be valuable to Panic only if he succeeds in getting the stock price back up.

Panic’s pay package contains another feature that is rarely used but is considered by some critics to be the only truly effective way to make executive compensation fair. The pharmaceutical executive’s options will vest only if ICN’s stock outperforms the S&P; 500 and other financial goals are met. If he fails, the options will expire.

A few other Orange County companies have responded to calls for greater fairness from shareholder groups and others by attaching strings to options awards to top executives.

At Cypress-based PacifiCare Health Systems, for instance, top executives’ options vest only if the company’s shares reach certain targets by certain dates; otherwise they expire.

So far, the strategy has paid off for PacifiCare Chief Executive Alan Hoops, who was the ninth-highest-paid executive last year with $4.72 million in total compensation. Hoops, who has been praised for turning around the managed care company after its problem-plagued acquisition of FHP International in 1997, exercised options worth $2.5 million.

PacifiCare’s Chief Financial Officer Robert Stearns received the biggest stock option award last year, worth $27.3 million. But it’ll be worthless if the company doesn’t meet specific financial goals.

Stearns “has got a very large carrot,” said Larry Wangler, a principal at the consulting firm Towers Perrin in Irvine, who helped design the PacifiCare pay package. But he believes shareholders approved the deal because they think it will enrich them as well. Management “will create $1.1 billion of shareholder value before they even get a dime,” he said.

But even this kind of attempt to more closely tie pay to performance has its downside, experts say. Usually, to compensate for executives’ risk of receiving nothing, far bigger options awards are given.

“It has greater performance characteristics than other options packages--that’s the good thing about it,” Wetzel said. “But for the bigger risk you offer more options and risk greater future shareholder dilution.”

The growing use of options also has helped foster a perception that executives are enriching themselves even when a company is in a downturn.

But the issue is seldom clear-cut. Such is the case with PairGain Technologies, the Tustin provider of telecommunications equipment, which saw its earnings slide and its stock slump last year. Despite its troubles, three PairGain executives were among the county’s highest-paid individuals last year, with total compensation of more than $3 million each.

PairGain Chairman Charles Strauch said that such numbers might look bad on the surface but that the vast majority of that compensation came from the exercise of options that were awarded many years ago when PairGain was a much smaller company.

“It looks like guys that exercise options that are sometimes 10 years old are robbing the bank,” he said. “It’s a typical founder issue. I make my money based on equity.”

Ingram Micro’s Stead said he’s rankled by critics who say some executives are being enriched largely because of the rising stock market.

But he admits that in many cases pay is clearly out of whack with performance, and he predicts more executives will follow his lead in giving up a guaranteed salary.

“The trend is clearly moving toward what I’m doing, and that’s the way it should be,” he said.

Times researcher Sheila Kern contributed to this report.

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Big Gainers

Largest Restricted Stock Grants

Value of stock given to an executive, usually vests over several years. Amounts in thousands:

*--*

Name Company Grant 1. P.J. Carroll Jr. Fluor $6,800.0 2. Milan Panic ICN Pharm. 4,014.0 3. D.L. Blankenship Fluor 2,435.6 4. Adam Jerney ICN Pharm. 1,204.2 5. William H. McFarland Irvine Apt. Com. 881.7 6. L.G. McCraw Fluor 828.9 7. John E. Giordani ICN Pharm. 802.8 tie Bill A. MacDonald ICN Pharm. 802.8 tie David Watt ICN Pharm. 802.8 10. Kenneth B. Roath Health Care Prop. 779.2

*--*

Note: William Foley total includes options from both Fidelity National Financial and CKE Restaurants

Source: Watson Wyatt Worldwide

Highest-Paid Women

Women who received the highest total paid compensation at publicly traded companies in Orange County. Amounts in thousands:

*--*

Name Company Compensation 1. Kathy Bronstein Wet Seal $2,336.3 2. Linda M. Lyons M.D. Pacificare 692.6 3. Kelly A. Gray St. John Knits 664.8 4. Kathryn A. Braun Western Digital 653.9 5. Jane Wolfe Downey Savings & Loan 646.0 6. Joy Schaefer WFS Financial 540.3 7. Marie St. John Gray St. John Knits 527.4

*--*

Largest Unrealized Stock Option Gains

Value of stock options not exercised. Amounts in thousands:

*--*

Name Company Grant 1. William P. Foley II CKE Restaurants $49,650.4 2. Jerre L. Stead Ingram Micro $46,500.0 3. Henry T. Nicolas III Broadcom 44,813.8 tie Henry Samueli Broadcom 44,813.8 5. Milan Panic ICN Pharm. 41,623.6 6. Adam Jerney ICN Pharm. 25,049.5 7. George A. Lopez ICU Medical 18,853.6 8. William J. Ruehle Broadcom 16,915.6 9. Mark. A. Vidovich Day Runner 15,620.7 10. C. Thomas Thompson CKE Restaurants 14,046.1

*--*

Pay Peaks

* Highest paid

Jerre Stead

Chairman, Ingram Micro

$15.9 million

* Biggest salary

Robert Gray

Chairman, St. John Knits

$1.6 million

* Biggest bonus

Stephen J. Scarborough