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CalPERS Creating Focus List to Target Weak Comp Policies
09/01/05
Board Alert
For the first time, CalPERS plans to develop a focus list targeting companies next year that have poor compensation policies, noting that excessive severance packages are a significant area of concern. That’s just one indication of how severance and change-in-control agreements are at the top of the list of issues that major institutional investors will be pressing in the new proxy season.
“Executive compensation has become such an important issue, [so] we are singling that out,” says Brad Pacheco, a spokesman for CalPERS. “One of the top issues is severance, in addition to making sure performance and pay are aligned.”
In the past, CalPERS has created focus lists for general governance issues, but never just for compensation. These public lists create a lot of pressure on boards to make changes. Boards finding themselves targeted often agree to work with shareholders behind the scenes and then yield to reform pressures.
Take last year. About half of the 30 companies that CalPERS put on its focus or monitor lists made requested changes. Five companies moved to annual elections , two companies removed supermajority requirements, and eight companies altered their compensation plans after working with CalPERS behind the scenes, according to Pacheco.
The crackdown on compensation began last year for CalPERS. Some of the staff met with comp consultants and discussed the challenges they have in designing plans. That laid the groundwork for the charge on compensation next proxy season.
TIAA-Cref and CalSTERS will join CalPERS next year in pushing for compensation reform, building on their work in this area this year. “We think some of the central issues are compensation, employee agreements, and retirement benefits and perks, which in our view are very helpful in understanding how boards behave in the boardroom,” says John Wilcox, senior vice president of TIAA-Cref and head of corporate governance.
The new shareholder charge on severance comes as the risks of paying out what shareholders believe is too much become painfully clear. Take former Disney president Michael Ovitz’s $140 million severance package. The amount seemed so excessive for his short tenure at Disney that Disney’s board did not breach its duties in awarding the Ovitz package. But that was only after a lengthy, high-profile case that culminated in the judge’s noting in his decision that the actions of CEO Michael Eisner and the board “fell significantly short of the best practices of ideal corporate governance.”
More recently, the board of directors for Morgan Stanley was hit with a lawsuit by a group of shareholders that took issue with the severance pay it doled out former CEO Philip Pucell and former president Stephen Crawford.
Brandon Rees, a senior research analyst with AFL-CEO’s office of investment, says that while he was disappointed by the Disney ruling, it underlines why investors will pay a lot of attention to this issue going forward.
“Though originally put in place to protect executives, severance and change-in-control agreements are often excessive and widely subject to manipulation by management,” says Paul Dorf, a managing director of Compensation Resources.
He points to the common practice of giving bonus payments to executives fired from a job based on average performance-based bonuses in the past. Beyond basic severance, executives also commonly get benefits and perks of significant value, which are unrelated to performance in many cases.
“People use it in a manipulative way now,” says Dorf. “They can leave and take early retirement, because they now have the opportunity to do so.”
Despite the outcry over large packages and investor groups’ continued vigilance, there are pressures on directors to resist the push for lower payouts. They don’t want the company to be sued by executives, and they want to protect confidential company information after a CEO leaves, according to Dorf. Often an executive has to sign a release to get the payout, though these don’t always hold up in court, he says.
Still, in light of the increased scrutiny and potential derivative lawsuits over compensation, CEO Tim Ranzetta of compensation research firm Equilar says he is getting a lot more requests from companies for data to indicate whether change-in-control and severance agreements are within industry norms. The increase in merger and acquisition activity is another factor leading to closer examination.
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