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Special Report: Day 3 of 3

This series has been discussing how changes in the financial and accounting practices of businesses have affected the function of compensation in business and its impact on HR role as a strategic decision maker within an organization. We conclude this discussion today with a look at how technology is changing the fundamental way HR sets and manages compensation today.

A walk through the exhibit hall of the SHRM Conference provides exposure to a truly overwhelming array of technology. It seems there are systems built to input, output, transfer, analyze, and communicate every aspect of HR management. However, are these new technologies really changing the way HR makes decisions, reports results and stands accountable, or are they simply automating systems that have been repeatedly called into question?

Indeed, a deeper look reveals that some technology merely automates existing processes. For example, instead of badgering line managers by phone to complete paper-based employee performance evaluations forms, HR professionals can now badger them electronically to complete electronic employee performance evaluations. Managers can “click the box” and incorporate pre-written sentences about their employees’ performance. HR can electronically push back if the manager rates all of his employees as a “5” on a 5-point scale and can bounce back his salary increase recommendations if they exceed the budget – and HR never even has to talk to them. Now there’s progress.

The most important developments in technology, however, allow us to step back and ask the question “maybe we’ve been doing this wrong all along – can technology now allow us to do it right, or better?” In the compensation area, technology allows us to more easily locate, extract, and analyze market data from surveys, essentially automating human activity. Most web-based tools are just that, web-based versions of previous ways of doing things – faster, less labor-intensive methods. But technology also has opened new sources of data, new types of data, and new ways of analyzing data giving HR the ability to make better business decisions that positively impact the company’s bottom line. How would that affect the organization’s perception of HR?

What if we collected compensation and job data from employees instead of just from employers? Very controversial say some – that would require technology that not only acquires the data, but validates it. But it would provide a new source of data, not just more of the same data from the same sources.

What if we collected data about the employee instead of just about the employer and the job? Very complex, because every job and every person is so different – that would be a mountain of data. That would provide a new type and amount of data that we don’t have now.

What if we could determine pay for an individual based not only on the job the person does, but what the person brings to the job? That’s been discussed in the literature for decades, called “person-based pay” but there has been no way to efficiently or logistically do that. That would be a new method for analyzing the data that generally is not used today.

What if we measured market rates of pay based on the details of each individual’s education, training, certification, skills, and experience, and also included information about the employer, company type, location, job content, reporting relationships, and job accountability. That sounds very complex - and what technology can do is make the complex easy for us to do and easy for us to understand. That would be a revolutionary way of understanding market pay levels and practices.

In most areas of business, complex technology-based decision models now help financial professionals move money among dynamic global markets, gaining higher rates of returns and lower transaction fees; help manufacturing managers move materials and products among sophisticated global networks of suppliers, distributors, and retailers; and help companies decide how to staff and manage projects with complex skill-set needs spread across several continents. These are not web-based versions of paper-and-pencil methods or spreadsheets, but complex real-time data-based solutions to business problems. As HR is held to the same standards for decision-making in what may be the most difficult business issue of all – effective employee compensation practices that produce a demonstrable return on investment – real technology must be the solution with new sources, methods, and ways of understanding the marketplace.

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Special Report: Day 2 of 3

As we discussed yesterday, the current option backdating scandal emphasizes that compensation is more complex and has a bigger impact than many imagined and provides another reminder that the bulk of the traditional compensation practices and concepts are outdated.

Compensation practices have been turned upside down in the past few years. Many experts believe that if you knew everything there was to know about compensation three years ago and have learned little or nothing new since, you now know virtually nothing at all about the topic. Changes in accounting for equity-based compensation, deferred compensation regulations, overtime pay laws, OFCCP rules, institutional shareholder requirements and expectations, continuing scandals such as earnings manipulation affecting bonus payments and – more recently, option backdating. None of these existed in 2003 and they all drive compensation design and planning in 2006.

Unfortunately, the topic of compensation is still being taught to HR professionals as if we’re not in 2006, or even 2003, but in 1983. The focus on wage and salary and pay-for-performance expressed through “merit pay” confirms that many still view compensation the way it was managed over 20 years ago. The limited treatment given to performance management and incentive compensation – which generally have been disasters in many companies due to the disconnections with business requirements – have added frosting to a cake that isn’t there. The most recent trend – re-labeling compensation and benefits as “total rewards” by tossing in “work-life balance” and other content-weak themes – has put what may be the final nail in the coffin of HR-driven compensation processes. At a time when financial professionals are questioning whether the compensation and benefits function really belongs in HR at all, HR professionals seem to be inadvertently signaling that it does not.

If HR isn’t going to be the driver of compensation in the organization what is the alternative? After all, isn’t compensation a “people topic” belonging to the HR department? In many organizations, the answer is increasingly “no.” Given the growing financial complexities of compensation practices today, it is - and perhaps appropriately - being increasingly viewed as a financial topic discussed in purely financial terms - terms that HR has been slow to adopt. Isn’t the employee pay system a central element of business strategy? It certainly is, and it is being removed from those whose believe they are a “strategic business partner” but cannot answer the simple question, “what is their company’s business strategy?”

What does this mean for the typical HR professional? It’s not as if this is the first shot fired across the bow of the HR business function. The field has been under attack for over twenty years. The HR community has urged that its members deserve a “seat at the table” – a table where the language of accounting and finance are spoken and few HR folks speak that language, rendering them functionally illiterate at that table. HR went further and proclaimed “positive ROI” for its programs yet couldn’t begin to discuss how to calculate ROI – and being unable to read a financial statement rendered the notion of ROI in HR to be DOA.

Consequently, as CFOs are taking over the function and asking some basic questions, the HR response is left lacking. Concepts like job analysis, merit pay, broadbanding, and so many others have zero credibility with financial professionals. And rightly so. These are not the compensation basics. It is unfortunate that HR professionals are being led to believe that by understanding job evaluation and merit matrices that they potentially could have a career opportunity in the compensation field. Not any more.

HR’s next opportunity to gain credibility and demonstrate significant business impact comes from the use of technology. As technology has swept over the HR function like all other fields, automating outdated methods and processes many have concluded that things are getting better. In fact “technology” is not just automating what we do now, but enabling us to do it better and overcome the weaknesses of methodologies that were constrained previously by technical limitations, giving HR professionals new tools for driving their agendas. We’ll cover that here tomorrow in The Real Technology of HR.

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Special Report: Day 1 of 3

The growing scandal around price-setting for employee stock option grants has until now focused on two key sets of issues.  First, what are the ethical and legal implications?  Were laws broken or were companies merely doing something the law allows but weren’t operating ethically?  Second, what are the various regulatory implications – accounting, taxation, disclosure to investors, etc?  Will companies have to restate their financial statements for one or more years?  File amended tax returns and pay penalties?  Does the damage extend to employees who may have incorrectly filed their tax returns thinking one type of tax treatment applied to their option when in fact another did?  Can the companies and/or the individuals involved be fined or prosecuted?  It appears that all of these are both possible and likely.

A new set of questions is now being posed.  First, where was HR in all of this? Second, what are the implications for HR going forward?

HR, of course, is where the compensation management function lies in almost every company.  Managing compensation in a corporation requires attention to a complex set of strategic, financial, regulatory, and behavioral factors.  HR long has been criticized for shortcomings on the strategic and financial aspects of managing the human resources of the organization but the impact of this has been difficult to assess.  Certainly HR has been excluded from many important discussions as they did not have a “seat at the table.”  It now appears some of the decisions made at that table could have used an HR voice, but that invitation doesn’t get extended to those deemed unqualified to be there.  So where was HR?  Apparently not at the table where these decisions were made though they certainly appear to have been invited to the table now that the crisis has occurred.  The impact is now much more measurable – billions of dollars in fraud, likely millions more in fees and fines, executive employment terminated, professional reputations ruined, the integrity of professional advisors being questioned, and once again HR being at the receiving end of pointed fingers.

What are the implications for HR going forward?  Is this another brick in the wall keeping HR out, or another door of opportunity opening?  After more than twenty years of yearning to be included, there now is a corporate crisis that underscores the importance of including HR in all compensation discussions.  Can HR do a big “I told you so” and highlight how their involvement might have prevented this, much like how oversight of FLSA status ensures that line managers don’t classify hourly employees as exempt to save money on overtime?  Determining how to pay employees has become a complex puzzle requiring integration of a large number of factors requiring a diverse knowledge base.  Things that may make sense from an employee relations standpoint – “people were complaining and we were just trying to be fair” said one company admitting the backdating practice – have tremendous financial and regulatory implications.  Clearly, concepts like internal equity and employee satisfaction are the tail, not the dog.

Just as driving a car requires a license but driving an 18-wheel semi requires a more advanced license, developing and administering employee compensation programs in the current environment requires more advanced knowledge than the traditional basics of pay.  The bulk of the traditional concepts are not only outdated (as opposed to backdated) but have become damaging to business success.  The new concepts have roots in accounting, finance, tax, law, strategy, and corporate governance, requiring a more advanced license.

HR people want to be in a role that is critical to business success.  To get there, HR people need to know, among other things, the new basics of compensation.  We’ll cover that here tomorrow.

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Are CEOs overpaid? Many people think so. If so, many potential causes have been identified: CEOs with too much power, inattentive boards of directors, conflicts of interest by compensation consultants, the use of stock options – the list goes on. Depending on the source, the average CEO in 2005 was paid $10 million to $15 million dollars. This calculation usually includes base salary, annual bonus, payouts from multi-year bonus plans, cash-outs of stock options that were granted as much as ten years ago, and new grants of unvested stock and stock options that have only theoretical value today.

Are rank-and-file workers underpaid? Everyone, I suppose, feels a little underpaid. Depending on the source, the average American worker was paid about $40,000 in 2005. This figure includes base salary or wage and typically excludes overtime, tips, bonuses, and gains from stock-based compensation. The potential causes of this are deemed related to CEO pay – greedy executives, putting profit over people, etc.

Are CEOs overpaid compared to rank-and-file workers? If you read the media stories this year, and in previous years, you might conclude that they are. Many interest groups have determined that the ratio of CEO pay to the “average worker” is an appropriate measure of this problem. Some websites allow you to calculate exactly how underpaid you are compared to your CEO. According to these sources, CEOs are paid between 250 and 500 times that of the average worker, whoever that is.

Before we assess how much pay an executive receives relative to other workers, however, we need to ensure we have measured the pay level of each properly. Then we need to decide whether that is a relevant comparison.

Measuring executive pay
Who are these average CEOs that are purportedly paid hundreds of times more than the average worker? In most analyses, they are CEOs managing the largest public companies in America – usually the top 250, 350, or 500. These are the largest of the 10,000 or so public companies - the largest 3% to 5% of corporations in the country. Given that most managerial jobs pay more for managing larger operations and all other things being equal, we might expect these individuals to be among the top 3% to 5% in pay and we should not expect that they are paid at the average rate for CEOs managing any of the other 10,000 companies, some of which are only a few million dollars in revenue per year.

These large companies, being publicly-traded, all exist for the purpose of generating profit and value for shareholders. There are no private companies, government agencies, or non-profit organizations in the sample. Public companies generally pay their managers more than organizations in these other sectors and have types of pay available, such as stock options, that the others do not.

While this data indicates we might expect these CEOs to be among the highest paid people in the country it’s more difficult to arrive at a factor regarding the relative value of the individuals in the job. Most CEOs I’ve dealt with are highly intelligent, have advanced degrees - often from one of the top universities in the country, or the world - and have worked 70 or more hours per week for most of their career. Even if they weren’t CEO of a public company, people with a resume like that get paid much more than the average person.

The biggest issue in this, however, is the double-counting that goes on. I’ve never understood how one can justify adding together the gain on a stock option granted in 1996 and the theoretical value of an option just granted in 2005, plus the value of theoretical value unvested restricted stock granted in 2005, and include those in “pay” for 2005. There are related issues such as the notion that the “value” of a stock option (and thus the amount included in the pay calculation) is the amount the individual will have to pay the company to exercise that option someday, once it is vested. This is absolutely misleading and absurd. Yet leading business periodicals use the data from well-known data sources to report executive pay this way year after year.

Measuring worker pay
If we want to understand the pay level of the average worker in America, we would have to ensure this included a representative sample of workers of all kinds from companies in all industries, all education and experience levels, and so forth. We would have to ensure we included all forms of their pay – wage or salary, shift differential, overtime pay, bonuses, tips, commission, and stock-based compensation. Without digressing into which sources do and do not do this (hint: none do) it would in theory provide a good portrayal of how much the average worker is paid for his work. We would assume that these are average performers with average levels of education, and so forth.

And, we would want to be confident, too, that, those numbers represent pay for just one year, as no sensible analyst would add together pay numbers from the past 10 years with those from last year and call that “pay” for last year, would they?

Comparing workers
I can’t recall seeing a comparison of how much software engineers are paid versus postal workers, or how much superior court judges are paid versus bank tellers. I think this might mean that no one believes these would be relevant comparisons because different jobs with different educational requirements and different levels of responsibility should be paid differently. We don’t always know or agree how differently, but differently.

Because we’re comparing the average American worker’s pay to CEO pay, we would have to ensure that we’re including all non-CEO positions in that data – software engineers, postal workers, superior court judges, and bank tellers because they are part of the American workforce. We also would include CFOs and Executive VPs and Managing Directors as well as entry-level counter staff at fast-food restaurants. I think we all agree it wouldn’t be fair to exclude other non-CEO executives from that calculation, correct?

Now that we have constructed a fully representative sample of American workers, we’ll have to limit it to those that work for the 250 or 350 or 500 largest American public corporations just for it to be a fair comparison. We should probably only compare to the top 5% performers among all the non-CEO workers, particularly since this is America and we believe in pay for performance so if we’re looking at a group of top CEOs we should compare that to a group of top non-CEO employees. We then we could calculate a more accurate ratio between CEOs and all other workers.

And it would still be completely meaningless. If that’s how you like to spend your time to push your particular political agenda, however, I now feel that I’ve done everything I can to ensure an apples-to-apples comparison.

Having Said That…
I am in no way trying to serve as an apologist for high executive pay levels. After more than 20 years in the field of executive compensation I have seen numerous examples of inappropriate pay for executives – not only in amount, but in reason and in form. Billions of dollars have been paid to thousands of executives who have ruined companies and workers’ lives. I have seen executives join a company shortly before a takeover and get millions in “change in control” payments. (Those payments, too, often appear in the executive pay calculations but not in average worker calculations and tend to inflate the ratio a bit.)

I also have seen numerous examples of inappropriate pay for nonexecutives – sales representatives that made far too much pay due to a flawed incentive plan; a receptionist earning more than double the market rate because she had been with the company for decades and there was no pay cap for any position; software engineers that joined a company at just the right time and cashed out their stock options just before the stock price crashed and the company went out of business due to a poorly developed software product. I have a friend who has a knack for joining companies shortly before they do major restructurings and layoffs; she’s made hundreds of thousands of dollars in retention bonuses and severance pay yet always found her next job right away…or contracted back to the company that just laid her off at double her previous pay rate, on top of the severance pay. (If that kind of data was captured in the “average worker pay” calculation, which it is not and never will be, the ratio might look a little different.)

If there is an excessive CEO pay problem, we won’t fix the problem by measuring the wrong things and then misinterpreting already flawed calculations. That only will encourage misguided legislation and we’ve had plenty of that. It also might encourage big shareholders and their advisors to begin bullying companies into change using arbitrary standards, and we’ve had plenty of that. Disclosure and publicity of pay allows us to identify the egregious situations and apply pressure to fix them but only when the data seem accurate to reasonable people.

I just read that U2 made $236 million on their 2005 tour - $3 million per show (about $1 million per hour) - which was far above Motley Crue’s $33 million for a similar number of shows (a paltry $400,000 per show, well under $200,000 per hour). I don’t think most Americans want to impose an arbitrary cap on CEO pay any more than we want to impose a cap on U2’s concert tour receipts because we know U2 would stop touring, and good CEOs would stop CEO-ing, and neither of those are to our benefit.

So let’s start focusing on the real problem and not on concocted metrics rooted in socio-political sentiments. There is a lot of fixing needed in executive pay practices and these average worker pay ratios have the potential to send us in the wrong direction.

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For those of you that find some of my blogs somewhat technical at times, you should attend the Global Equity Organization Annual Conference and experience the world I live in. Just this morning’s sessions were enough to demonstrate how complex it can be to pay employees around the world with equity. If you’re really paying attention, your head will hurt at the end of each day, but it’s a good kind of hurt.

I wish I could summarize every session but until I pick others’ brains at tonight’s GEO Awards ceremony I’ll have to limit my comments to the sessions I attended.

Beyond the Great Wall – Case Studies
John Bagdonas and Warren Miles (Computershare) plus Cheryl Spielman (Ernst & Young) discussed the complexities of equity compensation in China. If you thought learning the language was the most challenging aspect of venturing to this nation, you haven’t designed and implemented an equity compensation plan there. For many years employers have faced uncertainties due to the lack of regulation there, and recent introduction of some rules hasn’t made things much better.

Ironically, PRC - with its communist worker-oriented philosophy - somehow overlooked in its recent legislation the need for accommodating all-employee share plans. Recognizing the critical role that equity-based compensation can play in encouraging growth and profitability of enterprises, the government is (finally) addressing the topic in its securities and tax laws to help companies understand the rules but their clarification is thus far limited to executives and “key” employees. Of course, many global equity professionals would argue that all employees are key employees, thus the basis for all-employee equity plans. There is still the challenge that PRC prohibits Chinese nationals from owning shares of foreign companies but one cannot find a law stating such restriction, which is somewhat funny until you have to deal with it.

Key points learned: What I also found humorous is that the PRC treats the Hong Kong Stock Exchange as a foreign exchange. Go figure.

Key terms you’ll need to know to converse on this topic: CSRC, Circular 35, SOE, Red Chips, SASAC.

The Impact of Section 409A on Global Equity Plans
This panel - Bill Dunn (PriceWaterhouseCoopers) and Frederic Singerman and David Weiner of Seyfarth Shaw - discussed how the American Jobs Creation Act of 2004 and resulting US tax code Section 409A (the experts pronounce this "Four Oh Nine Cap A") continue to create jobs for lawyers, tax specialists, and consultants. Companies and their advisors are grappling with the complexity of a law intended to stem the abuse in nonqualified deferred compensation arrangements but resulted in unintended effects on equity compensation programs here and around the world. As difficult as this new set of rules has been for companies based and operating in the US, the implications for global firms are truly overwhelming. Mr. Dunn gave the example that a US citizen working in France and subject to taxation in the US who receives a non-discounted stock option there may receive what, under 409A, is a discounted option and have that option taxed at vesting (rather than at the time of exercise) as a result of the employer’s compliance with French law stating how options must be priced. Whew.

Key point learned: Continued uncertainty over the details of 409A creates an amazing minefield for companies pursuing even the simplest global equity plan designs. It’s ironic that many US firms failed in their attempt to export US-based equity plan designs to other countries, and now we are inadvertently exporting our tax rules, creating failures of otherwise successful plans.

Key terms you’ll need to know to converse on this topic: Four Oh Nine Cap A, transition rules, service recipient stock, permitted distribution, offshore funding.

Pleasing Institutional Investors – A Worldwide View
Damian Carnell and James Matthews of Towers Perrin (UK and US, respectively) presented a global perspective on a topic we read about every day in the US media: corporate governance - which is often manifested in stories about excessive executive pay. They point out, however, that the corporate governance movement had its roots decades ago in corporate scandals and actions unrelated to pay. In the US we are now accustomed to dealing with the influence of ISS and various institutional shareholders when seeking shareholder approval of equity plans. As one crosses international borders, the governance framework changes with varying reliance on legislation, regulation, stock exchange rules, and investor pressure, and disclosure. Also, I really liked their term “executive comp rehab” - not that any of my clients would ever need such intervention…

Key point learned: Interestingly, while many countries have incorporated their governance requirements into a single set of rules, the US has not, relying on a combination of stock exchange listing requirements, investors and proxy advisory firms’ guidelines, and various “blue ribbon” panels making it more difficult to understand just what the “rules” are particularly since many of them are in conflict with one another. You have to love the US’s free market approach to this!

Key terms you’ll need to know to converse on this topic: In the UK, ISS/RREV, Cadbury Code, Greenbury Code, Hampel Code, Combined Code, ABI, NAPF. There’s another set for each country and the list goes on.

Keynote: The Medici Effect: Groundbreaking Innovation
Frans Johansson (US)
I often miss the keynote general sessions but how could one not attend a session for which the introduction includes the teaser: “What do termites and architecture have in common? Music records and airlines? And what does any of this have to do with health-care, card-games or cooking? Most of us would assume nothing. But out of each of these seemingly random combinations have come groundbreaking ideas that have created whole new fields.” I thought I knew the unfortunate answer to the termites-architecture piece but found there was another angle I missed.

Mr. Johansson’s topic is particularly well-suited for a group of global equity professionals who come from a variety of technical backgrounds – accounting, tax, law, administration, human resources - and often stay siloed in their area as they think through equity compensation issues. We saw this over the past couple of years with the introduction of new accounting requirements for share-based payments (often labeled “option expensing”) that unfortunately have had a disproportionate impact on some companies’ equity plan designs to the exclusion of other financial considerations, strategic factors, and behavioral drivers. (Why, that’s exactly what I’m covering here in my presentation tomorrow at 2pm!) Diverse teams are the solution (Diversity Drives Innovation was a slide shown several times) says Mr. Johansson so I think that means that the accountants, lawyers, administrators, and even we consultants. need to step out of our siloes if we are going to provide innovative solutions for our clients and employers.

Key point learned: (1) All new ideas are combinations of existing ideas (2) People and teams that break new ground innovate and execute more ideas – the relationship between quantity and quantity of innovation.

Key terms you’ll need to know to converse on this topic: I think Mr. Johansson would prefer that you purchase his book to find this out (which you get for free if you attended this Conference). I already gave away his two key points and shouldn’t tell you his five key ideas for innovation.

Cops, Robbers, and Priests: Stock Plan Fraud and Ethics
Well didn’t these two - Carine Schneider (Smith Barney) and Emily Cervino (Certified Equity Professional Institute) - get lucky; one must choose one’s speaking topic many months in advance of the Conference and while stock plan fraud and ethics were already hot topics a few months ago, the recent scandals on stock option timing and backdating must have boosted interest in this session. Hopefully people didn’t misinterpret the fraud part of the title and think this was a “how-to” session as so many of the other Conference sessions are.

It actually was an excellent how-to session on the steps for avoiding becoming another poster child for stock plan fraud, a group which included in their session Cisco Systems, US Wireless, Mercury Interactive and HMT Technologies. I came away thinking that there is going to be a lot of blogging to do on this topic in the not-so-distant future.

Key Points Learned: I may be a bit sensitive on this point but the highest-fraud age group is 41-50 yet we, I mean they, are only third in the median value of frauds committed. The older the perpetrator the higher the median fraud amount – the over-60 group are the high performers here.

Key terms you’ll need to know to converse on this topic: Ends-based, acts-based, and duty-based principles; Section 302, Section 404, and – of course – SOX.

Someone will undoubtedly complain that while I listed the “key terms” I didn’t spell out the acronyms or define the terms. This is a blog, and if you were at the Conference today you’d already know!

Blog you tomorrow.

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Although many will express a negative opinion about anyone earning a base salary of $1 million, Ameritrade’s CEO has just been given a new pay deal that comes as close as any I’ve seen to the pure model that should emerge for executive pay. The referenced news story gets some of the facts wrong (surprise!) but I always check the source document to find out the correct information as opposed to relying on the journalist’s version. Remember what I said in this blog back on March 24 – your assumption would have again been correct.

The $1 million amount was institutionalized by Congress back in 1993 when they introduced the “million dollar cap” through Section 162(m) of the tax code, making any pay above that amount a non-deductible business expense for the company unless it is “performance-based.” That now seems to be, for larger companies, the CEO minimum wage. (By the way – thanks to Congress for their continued assistance with compensation design matters. Some research shows that the real effect of the million dollar cap was for companies to quickly escalate salaries to that level that may not have otherwise been, plus deterring companies from implementing performance-based plans due to the complexity of the rules.)

Mr. Moglia will get a base salary of $1 million plus an annual incentive opportunity of $9 million, one-third of which is payable in cash and the other two-thirds in stock. The press release does not indicate whether there are any holding requirements on those shares. The balance of Mr. Moglia’s pay will come entirely from payment in Ameritrade shares (not stock options) that will only occur if the company meets certain performance hurdles over a 3-year period. Ameritrade should be filing details of this within the next few days in an 8-K and these details should be revealed. If the annual and 3-year goals are structured properly Mr. Moglia’s pay will be directly and linearly related to share value and is then in essence a commission plan, just like when a sales rep is paid a percentage of sales. Let’s hope Ameritrade was not led astray by some of the recent missteps in pay design such as Coke’s new plan for directors (note I’ve linked to a blog by a prominent colleague who came up with a very similar title for his piece on this, albeit 6 days after mine).

Companies should take this concept one step further and provide a $1 million or $2 million signing bonus to cover the first couple of years’ living expenses, no base salary, no annual bonus unless it is paid 100% in shares that must be held for at least 3 years, and the balance in performance shares. But I said that in a Los Angeles Times editorial back in 1990 and that hasn’t seemed to sway too many people thus far. None in fact, but we’re getting closer.

Tomorrow I’m off to the Annual Conference of the Global Equity Organization in NYC and will be posting from there. Companies in Europe are far ahead of the US in their use of these performance-based plans so I’ll share (excuse the pun) what I learn.

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I could sum up this week’s compensation news in a few brief points. But recognizing that there are at least two sides to every story I’ve included mine which makes for another lengthy posting.

1. It’s shareholder meeting season, and hundreds of companies released their information in proxy statements on executive pay. Many executives made tens, even hundreds, of millions of dollars last year, as the media like to count it, leading to continued concerns about excessive executive pay.

    The other side: Remember the caveat in my recent blog about how the media counts these numbers. A lot of the pay attributed to last year is the result of executives exercising options that are up to 10 years old and in many cases had to be exercised last year before they expired. These gains represent years of hard work, managing through the bubble and the bust, and are often reflective of significant long-term shareholder value creation. Case in point is the article in which I was quoted (misquoted actually, but that frequently happens) regarding Boeing. Even where that was not a factor, the continued adding of apples, oranges, and bananas gives us mixed fruit, not an accurate apple count. Many of the media stories that compare these pay numbers to last year’s share price performance are not only absurd but intentionally misleading because the writers and their consultants know better.

Admittedly, there are overpaid executives in some companies, especially when company performance is considered (which requires matching the time period of pay with the time period of performance, not a simple calculation). In the past week, however, I have encountered some pay and performance issues myself, such as the cook at the restaurant that burned my little boy’s grilled cheese sandwich not once but twice (how hard can that be?). I’m a big fan of pay for performance and conclude that overpaid and underperforming employees are distributed throughout our economy, at all levels of companies, and often seem to be clustered in the businesses I deal with. They don’t have their pay and performance published in the paper but I’m happy to help spread the word.

2. These executives made a whole lot more than just about anyone reading (and certainly anyone writing) this blog. Some organizations are obsessed with calculating exactly how much more these executives earn than the so-called “average worker”. I am encouraged if some of those executives are reading my blog because I think they could learn a lot about some of the fascinating technical aspects of compensation, not to mention the added bonus of hearing my opinion, which is that comparing executive pay to that of the average worker is meaningless, distorted, and incites unwarranted anger.

    The other side: Many executives are good negotiators, some have professional negotiators working for them, and others might be good buddies with those on their Board of Directors who have a voice in determining their pay. (We can gripe about that last point all day and won’t change the fact that business is often done among friends and always will be.) Many others were in the right place at the right time. But others are brilliant strategists and managers who have managed a complex multi-billion dollar multinational corporation in a manner that has created enormous value for shareholders, employees, customers, and our economy. Yes, CEOs make hundreds of times more than we average folks do. There’s a complex set of reasons for that and continually complaining about it will not get anyone a 20,000% pay increase – they could, however, start a company that ends up being worth $10 billion and then they might earn $10 million a year, too. That would require enormous effort which is what many of these executives have expended and they’re being paid for the results.

3. These stories described in #1 and #2 above dominate the business section this time of year which limits the number of interesting topics to write about, but this next item is keeping things interesting. At least a few of the individuals in #1 and #2 above may have received additional compensation, beyond what was intended by the formal compensation program, due to a questionable practice in how their options were granted. It appears some companies may have granted options on days when the share price hit a low, ensuring the options produced gains much higher than they might otherwise have. When they missed that opportunity, they may have simply backdated the options when they were granted later. The most recently accused include UnitedHealth Group (whose CEO has about $1.6 billion in option value – no I did not misspell “million”) and Vitesse Semiconductor. “Yeah, these options were really granted a few months ago before that big price run-up that I just made a lot of money on. Yeah, that’s right, that’s the ticket.” (If you weren’t watching SNL in 1985 you might not get the reference to the Pathological Liar character but it seems fitting.)

    The other side: I blogged about this earlier this week. We thought that after Enron, Sarbanes-Oxley, and a number of CEO perp walks that these kinds of things wouldn’t happen any more. Oh well, let’s roll out some additional legislation shall we? No, let’s just jail the crooks, if in fact a crime was committed, and not blame the problem on stock options. It’s costing Americans too much money to continue having these scandals eroding the confidence of US companies in the world’s capital markets.

4. Some companies reacted to #3 above by either putting the individuals suspected of the behavior on “administrative leave” or by promising not to do it any more.

    The other side: I’m not sure but I think that if I had done something similarly unethical and illegal my leave might be much more than merely “administrative” – probably more along the lines of “incarcerative” and “refund-ative” (c’mon, that’s no worse than calling it ‘option-gate’ which some journalist inevitably will do.)

Pardon my tongue-in-cheek tone today, but reading a week of these kinds of headlines, for one who is dedicated to the field of compensation – and dedicated to professional integrity – requires maintaining a sense of humor about it at times. Too much time is spent on superficial numbers and analyses and not enough time on the real issues. Sometime soon I’ll write about the various “golden parachute” and severance deals that have produced some very excessive compensation for some very inadequate performers so that we can understand the real problems that need solving. Here’s a preview.

I'll be posting next week from NYC at the Global Equity Organization (GEO) Annual Conference where I will have to be very brief because I must spend less time blogging and more time attending critical events like the evening receptions. As everyone knows, that is where the real work gets done and I have a job to do. Maybe I’ll add a gossip section to the blog - though I wonder how compelling gossip among global equity professionals could really be: “I can’t believe what they did with their option term! This won’t help them a bit with their FAS123R expense and there were better ways to deal with ISS’s concerns on their plan.” This might set me up to say something like “you had to be there.”

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The big news last December was that Pepsi surpassed Coke for the first time in history on a key measure: not taste, or brand recognitions, but market capitalization, the value of all shares of common stock outstanding in the market place. More simply said, how much the world of investors thinks the company is worth. Pepsico stock has steadily risen over the past 20 years; there have been flat periods and some volatility, but the long term trend is up. Coca Cola, after having a bubble in 1999, is now trading about where it was 10 years ago. The companies’ market cap have run neck-and-neck over these past four months; at today’s close, Coke was 2.7% more valuable than Pepsi.

The big news today is Coke’s change in approach to compensating members of its board of directors. If you have followed over the past few years the trends in pay for members of public company boards you might wonder about the meaning of today’s announcement that directors of Coke will be paid entirely based on the company’s performance. On the surface, that sounds like a good thing to most people. Who hasn’t heard their boss, at some point in the past year or two, emphasize that your employer “pays for performance?” It seems if anyone should be held accountable for company performance it’s the board of directors. Under Coke’s new plan, if the company misses its goals the directors get zero pay.

But let’s back up. Not long ago, directors at US public companies typically were paid through a combination of cash retainers (essentially a base salary), meeting fees (incentive compensation for actually showing up for the job), additional retainers and fees for serving on various committees of the board (kind of like overtime pay), and stock options. It was thought that the stock options ensured that directors were compensated, at least partly, only if the company created value for shareholders through increases in stock price. Many will recognize this as highly similar to their own pay arrangement with their employer – salary, bonus, and stock options.

Then came Enron, et al, and the notion that stock options encouraged short-term thinking and manipulative behaviors. Never mind that the real problem underlying Enron, and more recent deceptions involving stock option grants, are not inherent in the options but in the criminal behavior of a few executives. Conveniently timed at the end of the bull market, some companies concluded that options are “bad” and shifted to grants of free stock to directors. Now they would get paid regardless of stock price change, though arguably they would earn less if the price goes down and more if the price goes up. Unlike options, however, if the price goes down or goes nowhere they still get paid which as we all know is not true with stock options.

Now, Coke has gone a step further. Directors are paid in contingent grants of stock (called “units” for technical reasons that I won’t go into here) and they only get the cash value of those units if…no, not if the stock price goes up, but if the company reports growth in EPS. Earnings per share. Many readers will think that this must be good. That’s what all companies strive for, right? Profit? The directors will only be paid if the company profit increases, and then they’re paid based on the value of the stock so they have an interest in the company just like shareholders do.

Well, sort of. Unfortunately, despite its widespread acceptance as the shorthand measure for profit, EPS is the most easily manipulated financial measure in existence today. In addition, the widespread misunderstanding of various measures of profit such as EPS is highlighted by today’s Wall Street Journal story that uses the terms “earnings per share” and “operating earnings” interchangeably and incorrectly so. (I tried, but I couldn’t make it through an entire blog entry without pointing out the continued media misrepresentation of pay practices.)

Perhaps because I teach accounting and finance for WorldatWork, the professional association for compensation practitioners, I am a stickler about these things. It is critical to understand, however, that the Board of Directors of Coca Cola has just decided to pay itself based on a measure which an accounting expert can tell you is a measure quite easy to manipulate. Did you know, for example, if a management team (or board of directors) is going to miss its EPS goal that it can use the shareholders’ money to repurchase shares from shareholders on the open market and immediately increase EPS? Yes, you read that correctly: if the company is not profitable enough to meet its EPS goal, it can use its money to buy its own shares so that it meets the goal. (This is because the calculation for EPS is earnings divided by number of shares outstanding; by reducing the latter, EPS increases creating the illusion of increased profit.) The academics that study this topic, like my colleague Dr. Daniel Beneish, politely refer to it as “earnings management” which is somewhat like referring to tardiness as “punctuality management” by saying that you weren’t really late, their clock was wrong.

There was a much better solution to this. Coke - and every other public company - should pay directors only in stock options, require long-term holding of the options or those shares received from exercise of the option, and be done with it. No goal-setting, no controversy over which measure is chosen or how high the bar was set, no possibility of directors getting paid but shareholders getting no gain. Instead, it’s as if we shook the bottle, popped the cap, a lot of fizzy brown water shot out the top, and we concluded we had to dump what’s left in the bottle because it must be bad. And we didn’t even recycle the bottle.

Only time will tell. In three years, we’ll see if the Coke directors have met their goals and get cashed out of their share units, and we’ll see if my shares of Coke (I own a total of 100 shares, woo hoo!) have increased in value. If those shares are still worth in 2009 what they are worth in 2006 and were worth in 1996, I think I’m going to have a problem with this new compensation plan at Coke. Truth be told, I already have a problem with it, but you knew that from reading my blog today.

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If you saw the article in the Mercury News Thursday morning, "Stock Option Flow Slows" you might think that (a) this is news , (b) companies are giving out fewer stock options to employees, and (c) this has something to do with new accounting rules. I think (a) no, (b) somewhat and (c) no.

I suppose it is news that Bear Stearns issued a report with data indicating that this is the case. Their report says that companies in 2005, compared to 2000, are issuing (a) fewer options and (b) less total "value". I think (a) yes and (b) no.
But (a) has been occurring for the past four or five years and it is old news.

If I was really drunk right now, but much less drunk than the time I was the drunkest I've ever been, the news might be that I'm not really all that drunk. In 2000, US companies were drunk on stock options. There was no accounting expense required for employee stock options and shareholders were giddy about the bull market (widely misinterpreted as their investing savvy) so they didn't mind that they were being diluted. Employees in the US got lots of options. Employees outside the US in those same companies, where pay is a fraction of US pay, often got the same number of options. New hires got big option grants (even though we hardly knew those people) and continuing employees got grants every year - even the poor performers (we can't give them zero, they might complain or leave). Today, companies are granting fewer options than they were in a time when many granted an absurdly high number of options. But that is not news.

Remember that then the market crashed and shareholders got mad. But a lot of those employee options got repriced\ or exchanged so that the employees weren't penalized for the stock price decline, even though others may have gotten rich during the bubble. That irritated some investors. Since then, many of the companies that were granting an absurdly high number of options cut back to above average levels - less drunk now. Shareholders of some companies refused to approve more shares for employee stock plans. No more for you, sir, I'll call you a taxi. Some companies didn't even bother asking shareholders to approve more shares even though they had run out. Closing time, indeed. It's important to note that several companies gave smaller grants, or no grants, because they ran out of shares and it wasn't good timing to ask for more. But they'll get more this year, and may have to do extra-large grants to make up for last year. I personally know a couple of companies that are doing this. So when is a zero not really a zero?

Reports like those issued by Bear Stearns are based on data from hundreds of companies and it takes a lot of work to pull all that data together. But those of us who study each company in detail know there is much more to the story. Microsoft, instead of granting stock options, now grants restricted stock units in a number about one-third of the number of options it used to grant. So, did they "reduce" their grants by two-thirds? Or did they reduce their "option grants" to zero? A few other companies like Amazon made a similar change. I have seen, and continue to see, these types of errors in reports issued by reputable firms. (This article, by the way, notes that restricted stock is now "popular" but I have no idea what the criterion for being popular is. I do know, however, that granting restricted stock is still a minority practice, like popular orange shoes, and is very unpopular with a lot of investors.)

What about the company that didn't issue options last year because they allowed employees to exchange worthless underwater options for newly-priced options? Is that a zero too? And what about the company that moved its annual option grant date from December to January, and went 13 months between grants with none in calendar year 2005. Zero? As the mathematicians in the audience know, zeroes can bring down an average quite a bit.

Here's a really deceiving part of the story. You might remember that stock prices were quite a bit higher in 2000 than in 2005. The NASDAQ was roughly double where it is now. Due to a bizarre but widely accepted belief that an option granted when a share of stock is at $100 is twice as valuable as an option granted when that same stock is at $50, we conclude that we are giving less value because stock prices are lower. In other words, those $100 options we gave you are worth much more compensation even though our stock price is now at $50. For those of you who understand stock options you probably noted the absurdity of that last sentence. That's the "duh" part. Options granted when stock prices are a fraction of what they were in 2000 are of lower "value" because the Black-Scholes option pricing model says so. Not.

But wait, there's more! Companies definitely took action in response to the new accounting rules for stock options. Few people know that US companies spent millions of dollars of shareholders' money over the past two years on consultants who helped them to develop "better" estimates of the value of stock options granted to employees. (Did you miss the news story on that?) This became a compelling activity because of the need to start reporting that value as an expense reducing reported profit. In virtually every case, that "better" estimate was a lower one (surprise!). Don't take my word for it, just read their 10-Ks. Thus the reported "value" of employee stock options went down because companies got "better" at low-balling the number. Did that reduce employee pay? Of course not. And of course there are those companies that accelerated vesting to avoid recognizing any expense at all, so those options will now require an accounting expense of zero and must therefore be worthless. Hmmm. How did you calculate those, Bear Stearns? Seems to me that those options just got a lot more valuable.

Amidst all of the smoke and mirrors, many companies have indeed started issuing stock-based compensation to employees on a more reasonable and thoughtful basis (I do not include the vesting accelerators in that group). But let's not think that a massive reduction in option grants has occurred because some will take that as further evidence that the US worker has experienced a massive pay cut while executives have not and then introduce federal legislation to fix the problem. The real news is that companies are radically changing how they pay employees which is the big positive outcome of the new accounting rules and shareholder pressures. Many companies are taking the first fresh look at pay practices since a time before many business journalists had started learning their cursive. That is the really big news but the data won't show up in reports issued by accounting analysts at investment banks who I happen to think should leave the compensation business to people who actually know something about compensation and go focus on investing.

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It was humorous timing that the morning news contained pay updates for both the CEO of Apple Computer, Steve Jobs, and the CEO of Expedia, Dara Khosrowshahi. Mr. Jobs’ salary continues to be $1 per year as it has been for the past 3 years. Mr. Khosrowshahi received a salary increase of 82% to $1,000,000 from $555,000. That percentage increase is a bit above the survey data averages, by seventy-some percentage points.

Before you feel sorry for Mr. J (I mean no disrespect but am going to abbreviate their names for the remainder of this), remember that he is the CEO of two companies – Pixar (being acquired by Disney) and Apple. Also note that he has just finished his 3-year vesting period on a grant of restricted stock from 2003 which at Apple’s fiscal year-end stock price was worth about $532 million. If you agree with my 3-year average method to analyzing executive compensation, Mr. J earned about $177 million per year for his CEO work at Apple which one might argue is a part-time job.

Mr. K, who oversees a company with less than 15% of the revenue and market cap of Apple, received a restricted stock unit grant of 800,000 units, worth about $45 million at today’s price and he’s eligible for annual cash bonuses. But unlike Mr. J’s restricted stock grant, vesting of 80% of Mr. K’s units is contingent on performance goals, while the other 20% vests after one year. In the worst case scenario and excluding any bonus payments, Mr. K will earn $10 million next year even if the goals are not achieved and Expedia’s stock price stays flat. Of course, if Expedia stock quintuples over the next two years as Apple’s stock just has over the past two – and we assume that this would only happen if he meets his financial performance goals – he’ll earn about $113 million per year. If he hits his goals but the stock stays flat he’ll get about $23 million per year.

Who’s the higher-paid CEO? The headlines this morning say Mr. K by a million to one. History says Mr. J. by 10 to 1 or 20 to 1, but that gap could be closed if Expedia stock soars like Apple did. I still don’t know what to do with the part-time issue for Mr. J. It would take a good compensation analyst the better part of a day to really figure this out and that analyst probably has better things to do.

And whose pay is more aligned with shareholder value creation – Mr. K’s high salary and performance-based stock or Mr. J’s $1 salary and free stock? These are the questions of our time and the reason that pay for members of Compensation Committees of Boards of Directors has increased substantially over the past few years.

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Unions and Lawyers (and Bloggers) Criticize Pay, or (Disclosure x Complexity = Conflict)

Amidst the flurry of compensation stories this week, labor unions made compensation headlines on three big pay issues - none directly related to collective bargaining per se. Two of these result from the increased disclosure of executive pay interacting with the complexity of executive pay, one of which results from the uncertain source of disclosure and the incomplete treatment of complex pay arrangements.

Pilots won't move up talks with American: Union is upset over airline's $100 million in executive bonuses (Dallas Morning News) - In the context of pending discussions over improving pilot productivity, American's unions reacted to a long-term incentive payout plan for 973 managers. The bonus awards result from increases in AMR's share price under the airline's long-term incentive plan. This program determines awards based on AMR's share price performance relative to those of a group of competing airlines. The union feels this payout is inappropriate at a time when the airline is struggling to reach profitability.

Pilot costs are becoming a bigger concern for all airlines and several of American's competitors made recent reductions in pilot wages, benefits and retirement plan. Yet it sounds like the executives might be getting pay increases.

My opinion? If the executive long-term incentive program is in line with competitive norms - new competitive norms in the airline industry, not the outdated and excessive ones - then the amount of pay is not an issue. But cash-based multi-year programs based on share price appreciation versus peers are inappropriate. These should be structured to be equity-based programs with longer-term holding periods, not arbitrary 3-year cycles. But it's much easier to attack a big number like $100 million than to deal with the more complex issues. Like what if executive pay was tied to increases in pilot productivity. Hmmm.

Lawsuit Contests Pay Package Hewlett Gave to Former Chief (New York Times) - Two labor unions filed a lawsuit over ex-CEO Carly Fiorina's severance pay, claiming it exceeded a limit approved by shareholders restricting such compensation to 2.99 times an executive's base pay plus bonus. Fiorina's severance package of $21.4 million was 3.75 times her $5.6 million salary and bonus, the lawsuit claims, and contends that her severance package could be worth up to $42 million when the value of her stock, options and her pension are included.

At issue is whether the bonus that Ms. Fiorina received under HP's long-term cash incentive plan counts. The three-year plan provided bonuses to executives if certain financial targets were met. The plan stated that executives who were fired, however, would not receive payment. The board gave Ms. Fiorina $14 million, which was 2.5 times her salary and regular bonus, and an additional $7.38 million from the long-term bonus plan. "It is a severance payment no matter what they call it," said Michael Barry, a partner at Grant & Eisenhofer, which filed the lawsuit on behalf of the unions.

My opinion? Fiorina's new hire package when she joined HP was excessive and her exit pay was similarly excessive. In between those two payments HP's stock price tumbled (yes, it was the burst of the bubble but it also underperformed peers since then). Nice work if you can get it. And the only thing worse than these cash long-term incentive plans is the ones that pay when you've been fired.

Union says Microsoft salaries lag (Seattle Post-Intelligencer) - The Washington Alliance of Technology Workers, which would like to unionize the Microsoft work force, released information of questionable origin showing compensation guidelines at Microsoft were unchanged between 2004 and 2006 for eight of 21 pay grades at the lowest end of the pay structure. For others, the increases were below 3 percent. Microsoft says its overall compensation is "highly competitive in the industry."

The article also quotes a survey by the Institute of Electrical and Electronics Engineers showing the median base salary for its members in the computer industry rising by about 6.7 percent between 2004 and 2005 but in the Seattle area, where Microsoft has a large presence, salaries fell by about 2 percent. "Overall, you can clearly tell what their goal is," said Marcus Courtney, president of the WashTech union. "In terms of what they're paying out in annual increases to employees, they're trying to hold the line well below 3 percent a year."

My opinion? Labor unions need to join us in the 21st century where workers in technology companies, and many other sectors, have multi-faceted pay packages that include bonuses and stock. I didn't notice the union complaining about all those individuals who have become millionaires over the past couple of decades from their Microsoft share plans. It's a little more complex (actually a lot more complex) than unions would like it to sound. I'd also like to suggest that the union stop comparing apples (salary structure movement) and oranges (actual salary increases) but then I might sound like a compensation geek.

Some other tidbits this week:

Speaking of complex pay packages, check out the Compensation for the new CEO of SGI (San Jose Mercury News) - (I don't know why this story was just published as this information was filed by Silicon Graphics back on February 2.) Anyway, he'll be receiving a base of $75,000 per month through the end of the company's fiscal year in June (that's $900,000 per year) then $50,000 per month after that (wow, a 33% "pay cut" the headlines will say next June); annual bonus up to 200% of base; a transaction bonus of 1% of net proceeds of equity financing transactions (i.e., SGI sells stock to the public or a group of investors and he gets a percentage, like the investment bankers do); restricted stock equal to 1% of SGI's outstanding shares (worth a little over $900,000) – we often call these "free shares" as all he has to do is stay employed to get them; 5.4 million stock options, equal to 2% of the company's outstanding shares, so he'll make $5.4 million if the stock price goes from 35 cents to $1.35; and even more stock upon the occurrence of certain financing events (so that he doesn't get diluted along with the rest of the shareholders). And if he's terminated he'll get another $1 million or so to cushion the fall.

My opinion? He must be a great negotiator. If he performs, he gets money. If the market likes his performance, he'll make more money. If he dilutes shareholders with additional equity financing, he gets more money. If he gets fired, he gets more money. And if he just sits around and nothing really happens he'll only make about $1 million per year until he's fired and gets the additional $1 million. I'll bet if one of the labor unions could understand this package, they'd be very upset.

Coca-Cola paid $9.66M in bonuses to execs (Seattle Post-Intelligencer) - I'm not sure what is interesting about five executives being paid $9.66 million in annual bonuses. Oh, wait, I know – Coke's share price has underperformed the market and its peer group for the past five years, losing 27% of its value, and the executives continue to get annual bonuses, stock options, long-term incentive payouts based EPS (earnings per share) which has no relationship to share price, and in addition to all this a pension plan (remember those?) plus a supplemental executive pension plan. I'm not a union member but I am a shareholder of Coke and don't like this one bit. (That was the "my opinion" part if you didn't catch it.)

Gannett chairman's 2005 total pay $4.1M (Seattle Post-Intelligencer) - I though my calculator was shorting out, but that's just because where I went to school we were taught that the definition of "total" is "entire" or "whole." In this news story, however, the "total pay" calculation only includes base, bonus, and "other compensation" of tax gross-ups (the company paying some of his income taxes), legal services, supplemental medical insurance, and supplemental life insurance. The figure does not include other elements of total pay including the grants of stock options and restricted stock he received last year. I could argue the other side and say that stock options and restricted stock, because they are unvested at the date of grant, should not be included in "total pay" for the year but then we'd have to add in the value of prior grants that vested last year. Now that would be really complex.

Yes, it's very difficult to understand compensation these days whether it's for soda pop executives in Atlanta, newspaper publishers in Virginia, airline executives in Dallas, former technology CEOs in Silicon Valley, or software engineers in Seattle. Or that guy at SGI with the really complicated deal – but I'll turn that one over to the mathematicians at PayScale.

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When I sit down to write my weekly catch-all blog on Friday I always wonder if I’ll be able to derive some theme or pattern, or if it will just be a list of links on the topic. This week was a treat, because the theme is clear:

Advice for This Year’s Executive Compensation Season: Assume the Reported Numbers are Wrong

That’s right, assume they are wrong. Some will be correct but most will not so if you want to bet with the odds, you’ll come out ahead my way.

What do I mean? I mean that when you read an article in the media over the next few months (well, any time really), it will report executive pay data that is not correct. I won’t write about this every week because it becomes tedious and results in my irritating more journalists than I would otherwise irritate. But we have some real gems this week:

KB Home Chief Gets $34-Million Pay Package (LA Times)
“The chairman and chief executive…earned $34 million in salary and bonuses in its fiscal year.” This is an example of not only the headline and introduction being incorrect, but the two being contradictory. He received $1 million in salary and $5 million in bonus. That’s $6 million on my calculator. He got 250,000 stock options at a price of $62.34 (which you will soon see reported in other publications as having a “value” of $15.6 million and added into this year’s pay), a $28 million restricted stock award (which vests over several years), and a payout of $3.53 million under the long-term incentive program (which was paid this year but earned over the previous three years). As an executive compensation expert I could argue several different values for this “pay package” but none of them would add up to $34 million, and I suppose I could count both his annual bonus and his long-term bonus as “bonus” in which case his “salary and bonus” were $9.53 million. But the most important point is that the article’s headline and analyses are 100% incorrect.

Wages not keeping pace with inflation, survey finds Income falls 2.3%, net worth up 6.3% from 2001 to 2004 (SF Chronicle)
Pay for CEOs at KB Home and Adobe (see below) make it interesting for reporters to write things like “"The economy is growing but the profits of that are not being shared with workers. They're going to the CEOs and the people owning stock." BEEP (that’s my incorrect-answer-buzzer, like on the game shows). Unfortunately the government wage data excludes pay that employees earn from stock-based compensation. So it’s correct that profits are going to the “people owning stock” but incorrect to write that profits are not being shared with workers. Give any Google employee a call.

Applebee's CEO Gets No Bonus After Results (Associated Press)
We have a winner, sort of. The writer got one fact correct. The CEO got no cash bonus. And he only got a measly 3.75% salary increase (that’s less than you got, right?). He did however get 47,500 shares of restricted stock (double the value of his restricted stock grant the year before) and 279,000 options (49% more than he got the previous year). But because he received no bonus you will probably see this story reported elsewhere discussing his “pay cut.” Please.

Adobe CEO realizes $10.56 million from stock options (Associated Press)
This piece is one of the rare ones that is correct. The CEO realized $10.56 million in gains from grants in previous years. Salary, bonus, and new option grants are reported separately. You will see this CEO’s “pay for the year” reported elsewhere, however, as the total of all of these numbers and will have to wonder which is correct. This one reports the basics correctly.

Alright, enough writing about writers. Here are some other interesting compensation stories from this week. Just remember my caveat.

One-Third of IT Workers Plan to Leave Their Jobs in 2006, CareerBuilder.com Survey Finds (CareerBuilder)
If this prediction is correct – and there are many corroborating projections and data trends – pay for these jobs will surge as salary increases resulting from the move, signing bonuses, new hire equity grants and other forms of transitional pay occur. Employers who have spent the past couple of years nickel-and-diming employees will get a harsh dose of the real cost of turnover.

Talk of limiting UC execs' outside roles Several top officials on many corporate, nonprofit boards (San Francisco Chronicle)
The problem of “over-boarding” – sitting on too many Boards of Directors to possibly be doing a good job on any one of them, or at your primary job – has already hit corporate America. It sure pays well, though. The UC system is continuing to learn about disclosure and accountability. (Disclosure: I have a graduate degree from UCLA and have no issues with the UC system or its schools. It is one of our country’s great educational systems. But I am a big fan of full disclosure.)

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Be sure to read my blog earlier this week Take This Executive Compensation Quiz . Maybe I’ll try to be a little more serious next week. Or maybe not.

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1. Boards Tie CEO Pay More Tightly to Performance
2. Outgoing executives still reap a profit
3. A Major Perk For Executives Takes A Big Hit

1. Executive pay is going up
2. Executive pay is going down
3. Both “A” and “B”
4. Neither “A” nor “B”.

So, what’s your answer? A? B? C? D?

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The big news in executive compensation circles over the past couple of weeks has been the release by the Securities and Exchange Commission of a 370-page proposal requiring greater disclosure of executive pay and insider transactions in publicly-traded companies. This continues the SEC’s strategy of increasing executive pay disclosure as a solution to excessive executive pay. The current disclosure rules, adopted 14 years ago, led to much greater disclosure and executive pay since then has increased at a rate many times that of the rank and file worker. Various statistics complied from these disclosures indicate the going rate for a CEO is in the 8 figure range (i.e., $10 million or more) per year with the top earners in a year typically well into 9 figures, like Terry Semel of Yahoo! who recognized $230 million last year.

Clearly, disclosure alone has not stopped the free market for CEO pay from operating. It has, however, provided ample fuel for efforts by various shareholders and advisors to attack executive pay practices in a more targeted manner. For example, companies are under pressure to scrutinize executive severance, golden parachutes, and various aspects of stock awards. So it appears that greater disclosure does have a positive effect in ensuring that the methods by which executives are paid are understood by affected stakeholders. The SEC's role – to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation – is thus furthered by better executive pay disclosure.

There is no equivalent of the SEC, however for other types of organizations. For example, while residents of the State of California are arguably important stakeholders in the University of California – as taxpayers, parents of students, and beneficiaries of public education – there is no governmental organization that sets disclosure requirements for executive pay at the UC. As reported in today's San Francisco Chronicle, there are apparently a number of errors by the UC in "giving top executives extra compensation without approval from university regents." This has come to light not because of required disclosures to which public companies are subject, but as a result of an investigation triggered by journalists and pursued by various politicians and a resulting external audit.

The disclosure movement is picking up speed. We can expect to see a new system of pay disclosure at the UC which will then spread to other universities and public organizations. The disclosure will lead to more scrutiny of pay practices and methods and give stakeholders a better view of how the organization is being governed. There is no question that pay practices are a central element of the governance of organizations. Any time a person or group of people have the power to set their pay or the pay of those who work for them, there is the opportunity to misallocate resources. Most of us, of course, don’t get to set our own pay. As far as I can tell the only ones who still do, ironically, are members of Boards of Directors of public companies and that information is fully disclosed.

Here are some interesting facts:

Robert Dynes, UC President, currently is paid a base salary of $405,000 as set by the UC Regents. Mr. Dynes publicly apologized to the Senate Education Committee last week for the compensation errors.

State Senator Abel Maldonado, (R-Santa Maria) - a member of the Senate Education Committee - receives a base salary of $110,880 as set by the California Citizens Compensation Commission, reflecting a 12% increase in December 2005. The Commission members are appointed by the Governor of California who has declined to accept his annual salary of $175,000.

One of the UC compensation issues is the 15 months of "paid leave" that a Ms. Greenwood received after her resignation as a UC Provost, totaling over $300,000. Ms. Greenwood also apparently received a $125,000 "faculty housing allowance" when she was hired for a non-faculty job requiring relocation from Santa Cruz to Oakland where, according to the National Center for Housing Policy the median home price is $128,000 lower. Odd.

These are the things we can learn only through disclosure and transparency.

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This is the first of our weekly summaries of pay-related stories in the media. This week we begin to see the ramp-up of "executive compensation season" -- when most public companies release their executive compensation information in proxy statements during March, April and May. This is being accelerated this year by a new SEC proposal for more rigorous disclosure requirements; the continuing focus on corporate governance; and the role of executive compensation in some high-profile business stories.

Be sure to read my previous entry this week, What’s Good for the Country is Good for General Motors, and Vice Versa.

Here are the major stories this week, features planes and automobiles (no trains), a struggling government bank, and why they do it better in the UK:

Executive-Pay Debate Highlights Minimal Power of Shareholders (WSJ) - unlike in the UK, shareholders in the US can review, complain, and propose changes but have no real power over how executives are paid.

Be Prepared When Opportunity Calls: Job Interviews by Phone Are No Less Formal Than Face-to-Face Meetings (WSJ)

Fannie CEO Gets Stock Award Amid Probes (Reuters) - the CEO of Fannie Mae receives a large restricted stock award, and...

Fannie Mae Gives 4 Execs Restricted Cash (NY Times) - the other executives get a large restricted cash award, rather than restricted stock.

GM slashes CEO pay, dividend in new cost-saving drive (Yahoo! News) - a major pay and benefits shakeup

Delta Offers Pilots A Payment Plan If Pensions Are Cut (WSJ) - the airline offers pilots a cash payment to get rid of the expensive pension plan, but...

Pilots union for Delta vows strike if contract is rejected (Seattle Times) - The chairman of the union's executive committee said Thursday the pilots will strike if their contract is cancelled as part of the carrier's attempt to impose $325 million in concessions

CEO, Pay Thyself? Airline Executive Rewards Mirror Broader Trend, Readers Suggest (WSJ)

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When Charles Wilson, Chairman of General Motors, said that in 1955 in response to a US Senate inquiry, he meant that GM's monopolistic practices were beneficial to the American economy. Unfortunately the quote is true again but today it refers to something else: pay cuts.

Today GM announced that everyone at the company will get some type of pay reduction. The CEO's salary is being cut by 50% to $1.1 million. Other executives will get salary reductions ranging from 10% to 30%. No executives will receive cash bonuses or cash long-term incentive payouts for 2005. All employees will have their healthcare benefits reduced. Employees who are holders of GM stock will see another reduction as the dividend is cut in half, reducing the current yield from 8.6% to 4.3% - comparable to a risk-free 1-month Treasury bill. Even members of the Board of Directors will take a 50% cash compensation reduction to $100,000. Ouch.

Earlier this month it was reported that employee pay in the US was outpaced by inflation over the past year meaning that in real dollars, employees on average took a pay cut. This, on top of increases in health care costs and reductions in retirement contributions continues the erosion of pay levels in the US.

What's good for America, it seems, is indeed good for GM.

But wait - Wall Street is doling out a record $21.5 billion in bonuses to employees for 2005 while Google is offering some new hires record-setting pay packages of salary, hiring bonus, and stock units and pay for university presidents is hitting new heights.

We knew none of this information 3 months ago and it is not reflected in our salary surveys. What is going on?

The answer is simple: a dynamic global market for employees. How much someone was paid last week, last year, or five years ago, is becoming irrelevant. Push the reset button: the question is how much it is necessary - and affordable - to pay someone with the combination of education, skills, experience, and other qualifications to do that job today. If the employee's "ask" is higher than the market's "bid" then they may have no job and, if that continues long enough, their market value may be zero. (Well, they could probably get a minimum wage job at the local fast food joint.) But, if the employer's "bid" is based on poor information they may have turnover and difficulty hiring qualified employees.

GM has learned it has an unaffordable pay program. Some US workers are learning they have unaffordable pay expectations. Employers are trying to figure out how to have an affordable and competitive pay program in the dynamic global markets. If they had the answer yesterday it may have just changed today. It may change again tomorrow.

The market rate for talent is being set almost as efficiently as the global markets for stocks, bonds, and commodities with real-time 24-hour electronic trading. Many people make money by buying in one market in one time zone and selling a few hours later in an exchange in another time zone; that's called arbitrage, taking advantage of short-term efficiencies in the global market. To do that you need global real-time information. Employers are learning to "sell" (layoff) in one time zone and "buy" (hire) in another, which also requires global real-time information. Other markets remain more stable and see soaring pay levels due to talent shortages. Therein lies our challenge.

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Today's issue of the Seattle Times reports that some police officers employed by the Port of Seattle have more than doubled their base salary by working large amounts of overtime. This and other payments (on-call pay, leave pay, standby pay) resulted in total cash compensation of $175,000 for the highest paid officer in 2004. The data is displayed in a chart showing the officers' names, base salary, number of hours worked, and total additional pay. This information is publicly available, of course, because these individuals are paid with public funds.

Friday's issue of the San Francisco Chronicle reports that a continuing investigation by the Chronicle has identified the University of California has a Senior Management Severance Plan that pays employees who resign voluntarily or retire. That is quite different from the typical severance pay plan which is intended to provide transitional compensation for employees who are involuntarily terminated or laid off. "Why are individuals getting 'severance' payments for voluntarily resigning from a job?" said (Ward) Connerly, who served on the governing board (of UC Regents) from 1993 to 2005. I think that is a good question to be asking but would have been more timely asked when the program was put in place in 1990, and asked every year during a review of the organization’s pay programs.

These two examples of public pay disclosure illustrate two key points. We seem to like to know how much other people are paid but more importantly there are situations which call for the disclosure of pay. Public officials, the CEO and four highest paid executives of public companies, and even police officers have their pay data publicly available by laws and regulations requiring such disclosure. But more importantly, disclosure provides the public the opportunity to scrutinize not only the amounts but the reasons for the pay.

Whether or not Port of Seattle police officers are working too many hours, they are being paid according to federal and state wage law and that is good. Whether or not a President of a University should receive additional severance pay because they quit their job... I think that needs some additional discussion, and that discussion would not be possible without the disclosure facilitated by the Chronicle's investigation.

It won't be long before this concept will be extended to organizations in the private sector. For example, if our federal tax dollars are paying the salaries of employees of a corporation that is rebuilding infrastructure in Iraq under a US government contract, should we see those pay numbers, too?

Disclosure of pay not only helps us to govern the use of the tax dollars but adds vital information to the marketplace. I have never thought about becoming a Port officer or a University of California executive but I see now that they both have more lucrative pay arrangements that I would have thought. That might cause me to rethink my current job which does not pay overtime, on-call pay, or standby pay and certainly will not provide severance pay if I decide to quit. There are some sweet deals out there and now we can all know a little bit more about them for our personal career planning decisions.

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The California legislature is considering requiring the University of California to provide more disclosure of executive pay policies and practices. This is apparently in response to a San Francisco Chronicle story accusing the UC of "quietly" handing out "hidden" cash compensation - $871 million in all – to UC employees.

Like much media coverage of pay issues, the article cites a number that includes a mix of items that aren’t necessarily scandalous. Of the $871 million, $39 million was for bonuses and incentive pay, $4 million for housing and auto allowances, and $54 million for severance pay and accrued vacation – hardly out-of-the-ordinary pay practices. The other 89% was for a variety of purposes ranging from relocation allowances to fellowships. I would need to know more of the details but am not immediately alarmed.

But here’s the rub: Pay has long been considered a private and personal issue. We don’t discuss it at family gatherings or cocktail parties. Pay stubs are in sealed envelopes. Many employers have specific policies against any employee disclosing their pay to another employee. We’re accustomed to reading about the salaries of professional athletes and movie stars, and how many billions are held by the world’s richest. But I still don’t tell you what I’m paid, and you don’t tell me.

Public company executive pay has been published in proxy statements for decades, however, and over the past 12 years the requirements have increased. The new Chair of the Securities and Exchange Commission, former House of Representatives member Christopher Cox, has indicated that greater disclosure of executive pay in publicly-traded companies is a top priority for him and will announce the proposed requirements at a meeting tomorrow, January 17. Pay of nonprofit organization executives has been reported in government filings for many years, and now is reported annually in the media. This is consistent with the continuing pressure from shareholders, analysts, and shareholder advisory firms calling for more disclosure. Like so many things that are changing in the world, pay is going public.

Internally, HR departments historically have been the keeper of pay information, resulting in a culture where managers and employees know a minimum about pay practices. This has the unfortunate effect of protecting ineffective, inequitable, and unfair pay practices. But imagine if everyone’s pay was posted somewhere, just like the amount we paid for our home is published in county records (and now online). Imagine if everyone knew how much their peers, and friends, and boss, were paid. Would that be a good or a bad thing?

It seems an increasing number of people would like to know more about the pay of others, and that people deserve to know. We at PayScale think everyone should be able to know pay -- of course without disclosure of anyone’s identity or details that would allow you to deduce their identity. But anyone should have access to information on what the marketplace values, and does not value, in a person and their skills and experience.

We think that HR shouldn’t be the only ones to know how much people are paid, just as Realtors should not be the only ones who know the price of houses. This makes for a more effective and more equitable pay system, across our economy and across the globe. The internet has proven that the free flow of information about book prices, housing values, job openings, and dating interests is mutually beneficial to all parties. It’s time for pay information to go there, and it has.

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What are other companies doing? Employers continue to ask this question as they try to understand how much and in what form to pay employees. While never an easy question to answer, it has recently become a lot more complicated.

The dynamic global talent market and increasing complexity of total compensation design have speeded the obsolescence of traditional survey data collection and reporting methods as resources for compensation planning and competitive intelligence. With employment costs comprising the largest single expense category in many organizations, there is a new pressure to understand these costs and what the organization is getting in return.

In addition, as compensation data and decisions have come under increased scrutiny by boards of directors and outside stakeholders, organizations must ensure that competitive intelligence on pay levels and practices is meets validity and reliability criteria This combination of forces is causing a sea change in compensation and benefits survey practices and the ways of measuring and reporting them.

Salary Surveys Are No Longer Enough.

Introduced more than 50 years ago, survey techniques developed for the salary-only model have not changed all that much and are inadequate in a time when the notion of total rewards is widely accepted. Although early models have been extended to capture newer pay practices, most efforts have consisted of pencil-and-paper surveys migrated to spreadsheets and Web interfaces and have included new data categories for benefits, bonuses, stock options and other forms of pay. Yet these changes don’t address the increased complexity, urgency and scrutiny faced by HR professionals.

The new pay environment requires a practical approach to address vastly varying amounts and combinations of salary, incentive and equity-based pay, benefits, paid time off and other employment features now common for many types of jobs, not just executive-level positions. And as the notion of the “job” gets fuzzier and the individual’s unique combination of education, experience, skills, certifications and track record become the basis for pay determination, answering the question “What are other companies doing?” has become a more multidimensional and ever-changing challenge.

The Future of Pay Intelligence Lies in Salary Searches.

Facilitated by the Internet and related technologies, new methodologies are emerging that explain pay, based on real-time data, to an extent never before possible. Contrary to the traditional survey model, these modern-day methods recognize that the “job” is merely one variable that must be considered in explaining pay levels in the marketplace and gaining a complete picture of pay.

Fully appreciating and taking advantage of this changing paradigm for competitive intelligence requires understanding the elements of the change underway:

1. Expectations for Real-Time Data. While the availability of the Internet enables new ways of collecting, reporting and using compensation information, the dynamic nature of the talent market and turbulent business environment requires it. Real-time data is essential for effective decision-making. You wouldn’t buy shares of a company’s stock based on the price six months ago, and decision makers will no longer rely on static pay survey data to make informed decisions about how to attract and retain top candidates and employees.

2. The Needs of Empowered Users. The democratization created by the Internet has broken down the wall between traditional HR roles, hiring managers, and employees or candidates, further enhancing dynamic data collection and analysis and challenging traditional roles of data submitters, data users, and employee-employer decision-making. This has occurred in parallel with the individualization of pay – the increase in the number of “special deals” in employee pay, a difficult trend to manage and one that is not fully reflected in compensation survey data today.

3. The Emergence of Participative Data Collection. With the Internet, multi-point data collection can be conducted at minimal cost with the unprecedented ability to explain significant variations in pay. Older methodologies that measure pay based on the job, rather than the person, evolved when organizational structures were relatively static and hierarchical, job mobility was low and the knowledge worker was not a prominent force in the economy. The result: pay levels within a single job title that are so broad they’re meaningless. The data that explain these variations reside with the individual and are difficult to obtain through the standard survey process.

4. The Power of Searches over Surveys. Instead of being limited to predefined survey criteria like company revenue or number of employees to generate pay intelligence, new methodologies allow dynamic queries driven by criteria that are specific and meaningful to market pay levels. So, while a survey might tell me that my company is paying above the 90th percentile for our database administrators (which might alarm my CFO), a multidimensional search would reveal that our DBAs are really paid at our market average given their education, experience and specific skills, and that company size is irrelevant for this job. The key difference is that the data reported match the characteristics of who is in the job, not just a superficial description of what the job is.

As we begin to see new methodologies bring more sophistication, access and cost reduction to the process of gathering and analyzing competitive pay intelligence, you may soon find that an Internet-based compensation search — not a survey — is the solution to finding out what other companies are really doing about employee pay.

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Until recently, the ubiquitous use of stock options made competitive comparisons a relatively easy process. Now, significant changes in plan design - triggered by new accounting rules, the corporate governance climate, and emerging "standards" from a variety of constituencies –render the old metrics inadequate. Overhang, run rate, Black-Scholes values, and other measures give an inaccurate view of pay levels and value transfer, leading to misguided decisions.

As companies assess alternative forms of share-based awards – performance-based options, stock-settled SARs, restricted stock and RSUs, performance shares – as well as changes in the mix between equity and cash, the decision process requires assumptions about the "value" and "cost" of each type of award. Firms attempting to understand their competitive position using survey data and their compliance with investor requirements face new challenges given the outdated methodologies being used. This session explains the emerging metrics and techniques being used by leading companies in understanding the value and cost of share-based payments in this new environment and presents a model for navigating through the complex decision process. The presentation includes a preview of new standards in 2006 from organizations including the SEC, ISS, S&P, ABI and others.

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Over the next few months, Compensation Committees, CFOs, compensation professionals, consultants, accountants, and others will be preoccupied with the imminent adoption date (for most companies) of 1/1/06. The most common phone inquiry I receive these days is "what are other companies doing?" to which the response is "calling me to ask what other companies are doing."

Seriously, there is an obsession with the notion that someone, somewhere has figured out "the answer" to equity-based compensation under FAS123(R), and that consultants know the answer and just won't tell. The truth is, however, that there will not be a single solution along the lines of the simplistic 1990s "options for everyone, 4 year vesting, and an ESPP" approach. Companies relying on survey data to guide their strategy are going to be disappointed, misguided, and at a competitive disadvantage.

Are companies moving toward restricted stock and restricted stock units (RSUs)? Not to the extent the headlines would lead you to believe. Some companies have added restricted stock grants to annual option grants, but mostly at the executive level. Some have made a single restricted stock grant to a single executive, usually in a new hire situation, landing them in the category of "companies abandoning options for restricted stock."

In my presentation at the NASPP conference in November (www.naspp.com/Conference2005/) I will make the point that the media and those feeding the media frenzy (consultants and others) are erring on three points:

1. Causality - the assumption that adoption of FAS123 and the granting of restricted stock proves that the FAS123 adoption was the reason for the restricted stock grant. There are few companies where these two actions are even remotely connected.

2. Attribution - the inference that a company's adoption of a long-term incentive plan that allows for the granting of restricted stock counts as a company now using restricted stock. Much of the survey data being bandied about today is measuring the wrong thing and reporting data submitted by individuals who don't really know the difference.

3. Single Variable - most of all, the conclusion that changes in long-term incentive plan design and grants are the result of accounting rule changes, rather than a confluence of factors including flat stock prices, companies that are not creating any value for shareholders, corporate governance pressures, and the interesting interactions of these three.

A quick look at the 2-year, 3-year, and 5-year stock price charts for the companies that pioneered the aggressive use of stock options tells the real story. When stock prices were rising during a bull market with technology stock glamour, stock options were guaranteed to deliver pay in most of those companies. But when these glamour companies have matured, lost their growth potential, and spent time and money fighting accounting rules rather than innovating technology solutions, stock options become impotent - a bonus plan with an unrealistic target.

Growth companies will continue to pursue growth company strategies which will include a central role for stock options but not to the exclusion of other pay tools, such as restricted stock, which have always made sense in certain situations. Mature and declining companies will make use of the corresponding strategies which will include more cash, more restricted stock, and other forms of pay that compensate people for working at a company that is not delivering returns that exceed the cost of capital and thus have flat stock prices. Smart companies will end up, after this next FAS123 frenzy, with compensation programs that rely on sound strategy, rigorous analysis, and effective execution rather than mimicry of questionable survey data.

That is what "other" companies are doing.