Gulf Between Top, Bottom Gets Wider

Times Staff Writer

Everyone knows that the top dog makes a lot more than the rest of the pack. But the big pay hikes awarded to chief executives are leaving the pack even further behind each year, The Times' annual executive compensation survey shows.

CEOs at California's largest 100 public companies took home a collective $1.1 billion in 2004, up almost 20% from 2003. That compares with the 2.9% raise that the average California worker saw last year, according to the Economic Policy Institute in Washington.

The difference is even sharper at the top rungs of the ladder. The 10 highest-paid executives on this year's list earned 36.7% more than last year's top 10 -- garnering a collective $467.5 million. That's enough to buy about 275 homes in Malibu or 1.5 million sets of golf clubs or two 747 jumbo jets.

Although limited to California companies, the survey reflects a national trend: a widening chasm between the pay of chief executives and rank-and-file employees.

"The average CEO made 42 times the average worker's pay in 1980. That increased to 85 times in 1990 and is now over 300 times," said Brandon Rees, a research analyst with the AFL-CIO's office of investment, a group that tracks, and is critical of, executive pay policies. "That is clearly not a sustainable rate of growth."

Compensation consultants counter that high salaries are driven by competition for the best bosses.

"There's a different market for executive-level jobs," said Nadine Winter, a compensation consultant with Watson Wyatt Worldwide in Los Angeles. "If one company pays more than the market rate and others feel that they have to compete to get top talent, that's what they do. The market has its own momentum."

Yahoo Inc. Chief Executive Terry Semel tops The Times' pay list with a $145-million compensation package -- nearly double the $74 million that put Apple Computer Inc.'s Steve Jobs in the lead last year.

Semel illustrates one reason that executive pay is skyrocketing: Companies make lucrative deals to recruit executives, then have a tough time scaling those deals back, said Patrick S. McGurn, executive vice president of Institutional Shareholder Services Inc. in Rockville, Md.

Semel, who previously co-led the Warner Bros. movie studio, was drafted by Yahoo in 2001 to reinvigorate a company that some analysts said was in a "death spiral." Impressed by Semel's solid credentials in the entertainment industry, Yahoo's board agreed to give him 11 million stock options.

Options are rights to buy company shares at a set price in the future. Five million of those optioned shares were tied to the current market price, meaning any rise in share value would go into his pocket. But the rest were linked to higher prices staggered at different price points, making them effectively worthless unless Semel really moved the company's needle.

That he did. Yahoo's revenue doubled and profit rose 237% last year, according to The Times survey.

Yahoo shares, which traded at about $9 before he took over, have quadrupled in value, closing Friday at $37.27. That boosted the fortunes of Yahoo's shareholders and its chief executive.

In 2004, Semel earned $600,000 in salary. But the company's board gave him 7.2 million additional stock options, worth an estimated $144.3 million. Total 2004 pay: $145 million, up nearly 24,000%.

Last year, Semel reaped $230 million when he exercised 10.1 million in stock rights that were granted to him in previous years. Gains from the sale of stock options are excluded from The Times' calculation of "total direct compensation" because the money, although realized in 2004, was earned in previous years.

Total direct compensation in The Times' survey is made up of 2004 salary, bonus and the present value of stock given to the executive either outright or through stock options. It also includes the reported value of perks, such as personal use of company planes, cars and apartments, as well as financial and tax-planning services, that the executive received during the year.

The data were mined from the companies' most recent proxy statements and compiled by Aon Consulting's EComp Data Services.

Compensation critics say they don't begrudge Semel the $230 million he realized by exercising his past options, but they're critical of the board's decision to continue giving him additional stock options year after year.

"Initially, what the board did at Yahoo was really smart. They awarded him a huge grant of options, but some of them were at a premium price," said Paul Hodgson, research analyst with the Corporate Library, a company watchdog group. "Subsequent decisions by the compensation committee have not been as inspired. They keep feeding him stock options, in enormous quantity, and they're all at market prices. They need to find a new tool."

Semel holds rights to buy an additional 22.5 million shares, which were worth about $395 million when Yahoo put out its last statement to shareholders.

McGurn, who advises big pension funds and other institutional investors on how to vote corporate proxies, told his clients to vote against reelecting the members of Yahoo's compensation committee this year.

Semel's "performance was great, but the calibration is so out of whack that whether they intended it or not, even paltry performance would produce a substantial payout," McGurn said. "When the magnitude of the grant is out of line, you have guaranteed a windfall to the executive. The only thing you don't know is whether the windfall will be enormous or astronomical."

Yahoo counters that Semel has been such a superstar that the company must pay richly to keep him.

"When somebody performs as well as Terry has, certainly other companies will be interested," spokeswoman Joanna Stevens said. "We need to make sure he's well motivated to stay."

This year, Gateway Inc.'s new top dog, Wayne Inouye, struck a deal similar to Semel's initial pact. Inouye, who had been running privately held EMachines before Gateway purchased the company last year, earned $587,077 in salary in 2004. But he got $7.8 million of Gateway stock and rights to purchase 10 million additional shares. Although the estimated present value of those rights -- $39.9 million -- landed Inouye the second spot on The Times ranking, they will be worthless unless Inouye can lead Gateway through a turnaround that boosts share value by more than a third, company spokesman John Spelich said.

"He could have taken the money he got for his equity stake in EMachines and gone to sit on a beach, but the compensation committee wanted to keep him," Spelich said. "We have three or four years of really hard work here. If we are able to pull that off, we all benefit. Equity-based compensation is a large portion of the Gateway pay package for the vast majority of our employees."

Another problem with executive pay, critics say, is that the pay-for-performance ethic typically goes only one way: soaring when performance is good but rarely declining.

To be sure, some executives cut their own salaries in tough times, said Alan Johnson, managing director of the New York-based compensation consulting firm Johnson Associates. They might turn down a bonus or decline stock grants, he said. But it's a rare board that demands cuts in executive salaries, he added.

"It is very hard to just say no," Johnson said.

In fact, 39 of the executives on The Times list earned less in total direct compensation than they had the previous year. But in some instances, the pay cuts are misleading.

That's because many companies give stock options to their chief executives just once every few years. That makes the CEO's pay look unusually rich in some years and unusually poor in others.

Both Apple Computer Inc. and Cisco Systems Inc. fall into this category. Apple's Jobs earned just his $1 annual salary in 2004, compared with $74 million in direct compensation -- from stock -- in 2003. At Cisco, John Chambers' cash pay was up by $1.9 million -- a bonus. But his total pay was down 95% because he didn't receive any stock options during the year.

In other cases, a pay cut may be illusory. EBay Inc.'s Margaret Whitman saw a 16% cut in total direct compensation, largely because she received fewer options to buy EBay stock. But her cash pay -- a $994,052 salary and a $1.55-million bonus -- was up 27%.

Because stock options carry risk -- EBay's shares, for example, are down 34% this year -- the higher salary and bonus could more than make up for the diminished options. (And with total pay of $36.2 million, Whitman remains near the top of The Times ranking.)

Only 17 executives saw both cash pay -- salary, bonus and perks -- and total pay, which includes stock grants, decline in 2004. Many of them worked for companies in trouble, including Calpine Corp., which suffered a $440-million net loss in 2004; First American Corp., whose profit fell 23%; and Titan Corp., whose profit was down 54%.

One CEO who did appear to take an unequivocal pay cut was Google Inc.'s Eric Schmidt, who reduced his own salary 85% and announced plans to work for $1 a year in the future. But his lifestyle probably won't suffer: Schmidt's stake was valued at $1.5 billion when Google went public in August and closed at $100.34 a share on its first day of trading. Google had risen to $266 a share as of Friday.

Less wealthy CEOs can take solace in the fact that pay cuts are often temporary. Corporate boards that skimp on raises in lean years have been known to make up the difference when good times return.

That was the logic behind the 129% raise that Safeway Inc. Chief Executive Steven Burd received last year, company spokesman Brian Dowling said.

By some measures, the raise might look questionable -- company revenue inched up by 1% last year, and the stock tumbled 7%. But Safeway returned to profitability in 2004, earning $560 million after a $169-million loss in 2003, which was attributed to a 4 1/2 -month strike and lockout at the company's Southern and Central California grocery stores.

"When performance gets better -- when the company goes from a loss position to a profit position -- CEOs get rewarded," Dowling said. "He had absolutely no bonus in years when the company wasn't making any money or the company was in a loss position. What the board did was correct his compensation, because if you look at the compensation for other grocery CEOs, Steve was well below market."

Sometimes, executive pay soars even in bad years.

Sanmina-SCI Corp., a San Jose telecommunications company with $12 billion in sales, lost money in 2003 and 2004. Yet Chief Executive Jure Sola scored a 1,500% hike in total pay during 2004, according to The Times survey. Sola was paid $19.8 million last year, while the company lost $14.9 million.

Sola said his raise didn't tell the entire story. The bulk of his pay is in stock, he said, which cannot be turned into cash for several years. If he leaves the company or if the stock price tanks -- it declined 60% in 2004 -- it could be worth nothing.

"It's a carrot that is given to me and to every other employee for the company," he said. "If you do well, you should be rewarded. If you don't, you should be fired."

Sola said he didn't know why the board opted to give him such a large carrot in such a bad year. "I cannot get into the minds of our directors," he said.

Similarly, Charles Schwab Corp., which had a 12% decline in profit and a nearly flat market value, gave its namesake founder a 283% hike in total compensation, according to the survey.

Schwab earned $3.5 million in 2004 from a combination of his $900,000 salary and the $2.5 million present value of stock options granted to him during the year.

Schwab spokesman Glen Mathison said the comparison was misleading. Schwab got the grant in January 2004, reflecting 2003 performance, when net income had tripled. Moreover, in leaner years, the executive has given back stock options that the board awarded him and has declined to take bonuses that the company's performance-based formula would have otherwise provided.

"Chuck Schwab provides the leadership, vision and inspiration that has generated growth and superior performance over the long-term history of this company," Mathison said. "We believe the record of the last four years demonstrates that both he and the board of directors are firmly committed to aligning pay with performance."

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CEO pay at California's biggest companies

(Tabular data not retained in TimesOnline. Table is available in Editorial Art database.)

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