How KB Home CEO's pay went through the roof

By Kathy M. Kristof and Annette Haddad

Dec. 17, 2006 12 AM PT

Times Staff Writers

KB Home may be the fifth-largest U.S. home builder, but it was No. 1 when it came to pay for its chief executive.

Over the last three years, former CEO Bruce Karatz made $232.6 million in compensation. That’s nearly three times what the chief executives earned at Pulte Homes Inc. and Centex Corp., which are bigger and more profitable.

Among the nation’s 12 largest builders, Karatz’s closest competition came from Robert Toll, the CEO of Toll Bros. Inc. He pulled in $138.7 million over three years -- a sum that Karatz outdid by nearly 70%.

Karatz, 61, retired under pressure last month after an internal investigation found that he picked stock option grant dates that inflated the value to himself and other executives.

Under his employment agreement, he could walk away with as much as $175 million in severance pay, pension benefits and stock options, a package that has prompted fresh criticism from large shareholder groups, who say Karatz has been overpaid for years.

To put Karatz’s compensation in context, the Los Angeles Times reviewed pay packages for chief executives at the 12 largest home building companies for 2003 through 2005.

Karatz emerged as the clear leader, despite the fact that his Westwood-based company’s 2005 results -- $9.4 billion in revenue and $842.4 million in profit -- put it in the middle of the pack.

So how did Karatz come out on top?

Compensation experts point to two features in his contract that helped guarantee outsized earnings.

The first, and most significant, was a clause that promised Karatz a bonus between 1% and 2% of KB’s earnings before taxes, said David Leach, managing director of Strategic Apex Group, a compensation consulting firm in Los Angeles. Other large publicly traded builders also reward their CEOs with bonuses based on a percentage of pretax earnings, but usually only after the company meets profit thresholds. Only Lennar Corp. CEO Stuart A. Miller has a pay plan similar to Karatz’s, but it’s not nearly as lucrative. He can earn 0.5% to 1% of pretax profit.

Tying compensation to pretax profit without other restrictions all but guarantees massive payouts at a company of KB’s size, Leach said.

“You might see something like this in a start-up company, but not at a major corporation,” he said. “The numbers just get way too large.”

Secondly, Karatz’s pay formula also stipulated that his percentage would be based on how much the company earned before paying executive salaries and bonuses, which were substantial at KB Home, said Paul Hodgson, senior research associate at the Corporate Library, a research firm based in Maine.

“Any bonus formula that has to calculate income before you’ve paid all your bonuses is obviously paying too much out in bonuses,” Hodgson said.

Karatz may also have benefited from a friendly board of directors, in particular the five-man compensation committee, which is led by Occidental Petroleum Chairman and Chief Executive Ray Irani.

Irani is no stranger to high pay. Oxy paid him $49 million in cash and stock and gave him options with a potential value of $97 million in 2005. Also on the committee are two other chief executives: Leslie Moonves of CBS Corp., who earned $22.8 million in 2005, and J. Terrence Lanni, chairman and CEO of casino company MGM Mirage, who earned $9.6 million and was granted options with a potential value of $35.5 million.

“We are always leery when you have another company’s CEO on a compensation committee,” said Ed Durkin, director of corporate affairs at the United Brotherhood of Carpenters, which has a $40-billion pension fund. “They don’t want people to say no to them, so they are particularly generous.”

A fourth member of the committee is James A. Johnson, who has been dubbed a “problem director” by the AFL-CIO for serving on the board of UnitedHealth Group Inc. That company’s CEO, William W. McGuire, retired this year in the wake of a stock-option scandal. The fifth member of KB’s compensation panel is Luis Nogales, managing partner of Los Angeles private equity firm Nogales Investors.

The members declined to be interviewed about how they determined Karatz’s pay formula. Karatz and KB Home executives also declined to comment.

Named CEO in 1986, Karatz has been lauded by Wall Street and industry peers for rebuilding the company’s image after it was hit with a series of lawsuits alleging shoddy construction in the early 1990s, when it was known as Kaufman & Broad.

“Bruce was among the best CEOs,” said Greg Gieber, an analyst at A.G. Edwards & Sons. “He was candid and had a good understanding of what builders are facing.”

Karatz has defended his pay, saying it was tied to performance. From 2003 to 2005, KB Home’s profit more than doubled and its revenue rose 60%. And from the end of 2000 and to the end of 2005, the company’s stock price rose fourfold.

But those results were hardly unique during the recent home construction boom. The two biggest builders, Pulte and Centex, posted similar profit growth and stock gains. Several other builders fared even better. In the same period, Hovnanian Enterprises’ stock rose tenfold and Ryland Group’s grew sevenfold.

“A trained monkey could have run a publicly traded home builder over the past three years and done pretty well,” said Durkin of the carpenters union.

Amy Borrus, deputy director at the Council of Institutional Investors, faulted KB Home’s board for not ensuring that Karatz’s pay was more in line with what other home builder CEOs received.

“This suggests a board that was asleep at the switch,” she said. “If your CEO is earning that much more than all of his peers, you might want to take a look at why that is, and whether it’s justified.”

To many directors’ way of thinking, however, paying an executive too much is better than risking the loss of a prominent leader.

“In business, good people are hard to find, and if you’ve got one that’s really doing a good job, you want to make sure that there isn’t another board picking your guy off -- because that will really cost you and your shareholders money,” said Roger Mertz, a partner at San Francisco-based law firm Allen Matkins who advises directors and companies.

KB Home executives declined to say how much Karatz’s successor, Jeffrey T. Mezger, would be paid as CEO. Those figures will be disclosed when the company files its annual report and proxy statement in the spring, spokeswoman Caroline Shaw said.

As KB’s executive vice president and chief operating officer, Mezger earned $28.3 million in cash and stock-based pay over the last three years. He also received stock options with a potential value of $55.4 million, assuming that the company’s stock price rises an average of 10% a year, according to KB’s public filings.

In the aftermath of Karatz’s resignation, some of KB’s biggest stakeholders say they intend to look closely at the company’s compensation plan as soon as it’s available.

“Karatz’s executive compensation package has created more than a blip on our radar screen,” said Pat Macht, spokeswoman for the California Public Employees Retirement System. “It would appear that this is another example of compensation that desperately needs addressing.”

kathy.kristof@latimes.com

annette.haddad@latimes.com

Compensation comparison

*--* 2003-05 2003-05 2003-05 ’05 revenue salary* value of stock total pay CEO Company (In bill.) (In mill.) options (In mill.) granted** Richard J. Pulte Homes $14.7 $30.7 $57.6 $88.3 Dugas Jr.

Timothy R. Centex 14.4 51.6 34.7 86.3 Eller

Donald J. D.R. Horton 14.2 27.6 4.6 32.2 Tomnitz

Stuart A. Lennar 13.9 58.1 24.8 82.9 Miller

Bruce Karatz KB Home 9.4 80.6 152.0 232.6

Ara K. Hovnanian 5.9 44.1 93.5 137.6 Hovnanian Enterprises

Robert I. Toll Bros. 5.8 88.4 50.3 138.7 Toll

Dwight Schar NVR 5.3 40.0 29.4 69.4

Ian J. Beazer Homes 5.2 22.6 5.9 28.5 McCarthy

Larry A. MDC Holdings 4.9 54.7 59.3 114.0 Mizel

R. Chad Ryland Group 4.8 72.4 na 72.4 Dreier

Stephen J. Standard 4.2 47.8 4.7 52.5 Scarborough Pacific

*--*