With another hostile offer launched earlier this week by Electronic Arts (our next door neighbor) who is attempting to acquire Take Two Interactive, I wanted to highlight how companies in play have made changes to their executive compensation plans. Most recently, the New York Times wrote about how Yahoo! approved severance programs for not only the executive team, but for all employees. As the Times pointed out, while you often see severance arrangements for executives, it’s rare to see such protections for the masses.

Another example where a severance plan was put in place for all employees was at Siebel in May 2005. Technically, the plan was put in place before an offer was made, but Siebel was rumored to be on Oracle’s shopping list for quite some time. The official merger announcement came a few months later in September. By the way, for those keeping score at home, Oracle is also right around the corner from us… I hope it’s not something in our water.

With the combination of depressed equity valuations and a slowing global economy, it should not come as a surprise that companies like Microsoft, Oracle and EA, with their bullet-proof balance sheets and cash flow engines, are not taking ‘no’ for an answer in their quest for growth. It will be interesting to see if more companies adopt similar changes to their compensation plans to retain key talent in this period of consolidation.

Setting director pay is probably one of the more awkward decisions for board members. No matter how you slice it, there will always be a conflict of interest. As one would expect, with increased responsibilities, scrutiny and exposure, director pay
continues to increase. However, as part of a recent client project, we identified several companies that are bucking this trend.ⁱ We found it very interesting to read the explanations on why several boards chose to reduce their own pay. Given the current economic environment, it will be interesting to see what changes boards make to align their pay more closely with corporate performance. Thanks to Aaron and David for their help in identifying and pulling the examples together.

Aligning Director Pay with Performance

Ford (F) and General Motors (GM) represent some of the more high profile examples. Both of the carmakers cut director pay by 50% in 2006. According to Ford’s proxy, “the Board of Directors voluntarily reduced Board fees payable to non-employee directors by half.” GM went into more detail in their proxy, connecting the pay reduction to a company-wide turnaround plan:

Under the Compensation Plan, directors are entitled to receive an annual retainer of $200,000. In support of the GM North America Turnaround Plan, the Board has chosen to reduce this retainer. In March 2007, the Board agreed to forgo 25 percent of the retainer, resulting in a retainer of $150,000 for 2007. (The retainer was voluntarily reduced by 50 percent in March 2006.)

Intelligent Systems Corp (INS) provides another interesting example of decreased pay. In their proxy, INS disclosed that “each director declined the annual grant of 4,000 shares in consideration of the company’s failure to meet the continued listings standards of the American Stock Exchange.”

Reductions after Benchmarking

Pulte Homes (PHM) reduced the annual option grant for directors from 16,000 to 7,000. This change is disclosed in an 8-K filing:

On May 11, 2006, the Board of Directors of Pulte Homes, Inc. approved a revision of the compensation to be paid to Pulte’s non-employee directors, effective as of June 1, 2006. The revised compensation was recommended to the Board by its Compensation Committee after the Committee undertook a careful review of market practices and received advice from the Committee’s outside compensation consultant.

NVidia (NVDA) also changed their equity grant practices as disclosed in their proxy:

Although the 1998 Non-Employee Directors’ Stock Option Plan provided for the automatic grant of options to purchase 150,000 shares for the Initial Board Grant and 50,000 shares for the Annual Board Grant, in fiscal 2007 the Compensation Committee reduced the size of the Board grants to 90,000 shares for the Initial Board Grant and 30,000 shares for the Annual Board Grant based on data provided by our Human Resources Department and the compensation consultant. After completing its review of Board compensation in March 2007, the Compensation Committee reduced the Annual Board Grant to 24,000 shares and the Annual Committee Grant to 8,000 shares.

ⁱ A more comprehensive analysis is available in CustomInsight, our online project library, under the title Director Pay Cuts for S&P 500 Companies.

As we enter February, we’re only weeks away from the upcoming proxy season. With a year of the new SEC rules under our belt (can you believe it’s only been a year?), 2008 will be the time where we’ll be able to perform year-over-year comparisons on executive pay under the new system. I just got back from talking on a panel at the ISS/RiskMetrics annual conference and a question that often comes up is measuring the impact increased SEC disclosure will have on executive pay. Will increased sunlight on pay practices sanitize executive pay practices or lead to the “galloping greedy gimmies” in boardrooms across America?ⁱ

At this point, it’s a bit premature to point to any definitive trends. But based on our analysis of proxies from the 2007 proxy season and reactions we’re hearing from issuers on the SEC’s round of comment letters sent in the fall, I’m optimistic and expecting that the positive trend of “investor friendly” modifications in pay practices that we’ve seen in the last several years will carry on into 2008. While there will continue to be outliers who make for entertaining stories, they’re becoming increasingly hard to find.

In addition, we’re curious to see the direction of pay for 2007. Last year, the markets and economy went through a Jekyll and Hyde like experience and were in dire need of Prozac by Christmas. In a matter of months, we went from talk of $100 billion private equity buyouts to red carpet treatment for sovereign wealth funds in the Middle East and Asia. It’s comforting to know that each time I fill my tank with $3.50 per gallon gasoline, I’m doing my part to save our financial institutions. Given the deterioration in the credit markets and the overall slowdown in the economy, it will be very interesting to see the impact this has on pay decisions and the design of pay packages as we move forward.

BTW, in case you missed it in Sunday’s NY Times, Claudia Deutsch wrote about an interesting severance example that one of our analysts discovered as part of our research. Thank you to Texas Roadhouse for embracing the SEC’s plain English approach and sharing with us the most creative and shareholder friendly severance package that we’ve seen so far.

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i For those without kids under the age of 5 (or even comp committee chairs), I highly recommend The Berenstain Bears when you're feeling down. A synopsis - Brother and Sister Bear want everything in sight, and they throw tantrums when they don't get what they want. Wisely Mama and Papa deal with this childhood malady by teaching the cubs about the family budget and the importance of appreciating all that they have already.