Exec Pay Becoming an Issue for Investors

A growing number of mutual fund managers are taking executive pay policies into account when deciding where to invest, according to a new survey. It may be high time that individual investors do the same, industry experts say.

“Outlandish compensation should be a compelling warning sign for any investor,” said Nell Minow, editor of the Corporate Library, a Web site that focuses on corporate governance issues. “It is a symptom of a bad board” of directors.

“People used to call these issues a ‘distraction,’ ” she said. “Now they’re realizing that they’re core to the investment.”

With questionable executive pay practices featured prominently in recent scandals at Enron Corp., WorldCom Inc. and Global Crossing Ltd.--to name just a few--a sampling of opinion among mutual fund managers indicates that they are beginning to see Minow’s point.

Ninety percent of the 33 fund managers surveyed recently said they are using corporate pay practices “at least some of the time” as one of the factors they consider when making investment decisions, according to Pearl Meyer & Partners, the New York-based compensation consulting firm the survey.

That’s a dramatic increase from the firm’s last such survey, conducted four years ago, when 58% of the fund managers questioned took pay into account when making investment decisions.

Moreover, in 1998 only 30% of fund managers thought chief executive pay was excessive, compared with 70% today.

“Investors are scrutinizing executive pay and corporate oversight as never before,” said Steven E. Hall, managing director of Pearl Meyer. “While our survey isn’t conclusive, it indicates that funds want directors to focus more closely on their companies’ executive compensation programs and their effect on shareholder interests.”

President Bush, lawmakers and securities regulators already are debating reforms aimed at improving oversight of compensation policies by boards of directors. And a group of institutional investors that includes such fund industry icons as Jack Bogle of Vanguard Group and Bill Miller of Legg Mason Inc. launched a movement in April aimed at boosting corporate managers’ accountability to shareholders.

In the meantime, individual investors may want to watch pay practices themselves, recognizing that it provides a fairly obvious clue that management has gone awry.

For instance, Minow said, an investor who watches pay closely might have sold Global Crossing shares when the stock was selling in the $50 range. That was when the company revealed that it had granted 2 million stock options at a $10-per-share discount to market value to short-time CEO Robert Annunziata. That guaranteed Annunziata a $20-million payment for doing no more than standing still.

“The fact that they were going to give him such an absurd payment showed that the board had absolutely no power to say no to him,” Minow said. “He could have said, ‘I want you to turn me green,’ and they would have said, ‘Sure. We’ll get some paint.’ ”

Ranking by CEO Pay

Although hindsight helps make agreements such as Global Crossing’s appear both obvious and egregious, it’s tougher to spot the transgressions early, said Amy Domini, who manages socially screened mutual funds at Domini Investments in Boston.

Domini screens companies for pay practices by figuring out where a chief executive ranks among his or her peers. In the past, she considered it a warning sign if a company’s CEO was among the 10% most highly paid. Now, her threshold is lower--she kicks out the 15% most highly paid.

But even that may be insufficient in this era of rapid pay increases and extreme excesses, she said.

“It’s been difficult to screen because the numbers kept rising so dramatically each year,” Domini said.

Domini also looks at how directors are paid, because an overpaid director probably is reluctant to shake things up, she said.

‘No Raw Number’

Still, few experts have simple strategies for deciding when pay is out of line.

“There is no raw number that you can say is simply too much,” Minow said. “But there needs to be true pay for performance.”

A few yardsticks: If executive pay doesn’t fall when company earnings are down, if managers are paid hundreds of millions to perform no better than their peers, if the top five executives are taking home a substantial chunk of the earnings of the entire company--all of these are indications that something may be wrong, Minow said.

When those warnings are present, shareholders must take an active role by voting against directors who have approved the deals--the members of the board’s compensation committee, she said.

“People feel helpless,” Domini said. “They think they’re just too small to make a difference. But there’s an old Ethiopian proverb that says, ‘When spider webs unite, they tie down the lion.’ There has never been an important social change without grass-roots support.”

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns, visit The Times’ Web site at www.latimes .com/perfin.