On the front lines of executive pay: revisiting the top comp stories of 2007 suggests some next-stage steps for crafting pay programs that meet board, shareholder, and regulator requirements

Directors & Boards, Summer, 2008 by Jack Dolmat-Connell

LAST YEAR BROUGHT some remarkable stories to the executive compensation forefront--from huge CEO severance payouts to equally huge paybacks and to shareholder activism through "say on pay." Here are our selected highlights of the top comp stories of 2007:

* Home Depot's Bob Nardelli: Early in January 2007, Home Depot's CEO Robert Nardelli resigned under a mutual agreement with the company over a conflict regarding his hefty annual compensation package. Nardelli had purportedly refused to take major cuts in his pay or to link his pay with shareholder gains, yet still successfully negotiated a whopping $210 million retirement package despite his overall less than stellar performance during his six-year tenure at Home Depot. While Nardelli's case is an outlier in the field of severance pay, this story created a huge media blitz and added to widespread perception of out-of-control CEO pay.

* The Subprime Mortgage Scandal and CEO Fallout: The far-reaching consequences of the subprime mortgage losses have extended to executive pay. The CEO departures caused by the subprime failures have been substantial. CEO Charles Prince III left Citigroup in November 2007 after Citigroup realized between $8-11 billion in losses connected with subprime mortgage investments as of his departure. Prince received no severance pay but left the group with benefits valued around $29.5 million. E. Stanley O'Neal of Merrill Lynch left in October 2007 with, again, no severance pay but benefits valued at $161.5 million. Merrill Lynch was hit with an $8.4 billion third quarter loss related to subprime investments. The market went into a tailspin in connection with the subprime fallout, but certain executives still walked away with money lining their pockets.

* UnitedHealth CEO Payback: Minnesota-based UnitedHealth Group Inc. was one of the largest companies embroiled in the stock option backdating scandal. Under former CEO William McGuire's watch, UnitedHealth executives were granted stock options where the grant dates were changed to give an optimally low stock price to allow executives to reap more rewards upon award exercise. In a surprising turn, McGuire agreed to surrender around $198 million upon his resignation in light of the backdating scandal, and then further agreed to surrender $420 million in stock option claims and retirement compensation. McGuire's forfeiture is one of the largest paybacks in corporate history. But no need to feel sorry for him--he will still be able to keep over $800 million in stock options.

* Compensation Consultant Independence: House Rep. Henry Waxman released a report in December 2007 that analyzed serious conflicts of interest by compensation consultants to Fortune 250 companies. After an extensive investigation, Waxman's report showed that among the studied companies, almost half were receiving other services from compensation consulting firms, and that consultants that provided other services to these companies were paid nearly 11 times more for providing other services than they were paid for providing executive compensation advice. Additionally, the report stated that "in 2006, the median CEO salary of the Fortune 250 companies that hired compensation consultants with the largest conflicts of interest was 67% higher than the median CEO salary of the companies that did not use conflicted consultants." The lack of disclosure in proxy reports concerning additional services gives the false impression that the compensation consultants are "independent." The report may give momentum in 2008 and beyond for new SEC regulations or government-backed changes to executive compensation consultant independence.

* "Say on Pay": Blockbuster Inc. became one of the first companies to implement a shareholder resolution to give shareholders an advisory vote on executive pay. The resolutions, known as "say on pay" initiatives, were introduced in proxy votes at over 60 companies in 2007. So far, many companies have not achieved the necessary 50% to ratify the proposals; but other companies, such as Aflac and Verizon Communications, have implemented say on pay initiatives. The House of Representatives passed a bill introduced by House Financial Services Chairman Rep. Barney Frank that allows shareholders to introduce say on pay proxy votes. The increase in say on pay shareholder activism demonstrates a new willingness by companies to engage in dialogue with shareholders on the hot-button issue of executive pay. While still a small step, say on pay will take the executive pay dialogue to a more open and fair level.

* New (Better?) Proxy Disclosure: The SEC's new proxy disclosure rules caused a big wave in 2007 as the proxy season for the first time required more information about executive pay, aimed at increasing investor ability to compare managerial pay at publicly owned companies. The new SEC rules require a Compensation Discussion & Analysis section that was implemented to clarify the "how" and "why" of executive pay, new charts showing potential payments in connection with executive terminations, and increased disclosure in relation to executive perks. But have the new disclosure rules really helped investors to better understand the mechanics of executive pay?