Pay setters

Tom Smith ran a big grocery chain for 13 years and was paid handsomely for it. In 1998, his last full year as CEO of Salisbury-based Food Lion Inc., he earned $3 million, according to the formula Business North Carolina uses to calculate executive pay. Adjusted for inflation, that would have been equal to about $3.6 million in 2005. That would put Smith at 20th on this year’s ranking of CEO pay at the 75 largest public companies in the state. He also starred in some of Food Lion’s television commercials, so couch potatoes around the state quickly grew familiar with — some, perhaps tired of — his boyish mug interrupting their favorite shows. Since retiring in 1999, he has dropped out of the public eye but not completely out of corporate boardrooms. These days, Smith helps set pay for executives at Concord-based CT Communications Inc. as chairman of its compensation committee.

He’s not unusual. Eight of the 10 highest-paid CEOs on the list — compiled by the Charlotte office of human-resources consultant Findley Davies Inc. — run companies where the compensation-committee chairmen are current or former CEOs. Four are, or were, CEOs of public companies. The theory is that few know as much about CEO compensation as CEOs. Few have reason to care as much. But is it wise to let CEOs, past and present, set their peers’ pay?

“There are two points of view there,” says Paul Hodgson, a compensation specialist at The Corporate Library, a Portland, Maine-based company that researches corporate governance. “One is that it is the fox guarding the henhouse and that they’re unlikely to be harsh with their fellow CEOs and say, ‘We need to be more modest about our pay levels here.’ Alternatively, they may actually have more authority in that situation and therefore be able to stand up to another CEO.”

Whether it’s the best practice, CEOs often are judged by their peers, and in any given year their pay could go either way. Twenty-three CEOs on our list took pay cuts in 2005, sometimes even when their company produced a positive total return, but 46 got a pay boost — seven even though their companies produced negative returns. The median pay change for CEOs at the state’s 75 largest public companies was 13.1% in 2005. That’s a smaller increase than the previous year but larger than the median total return in 2005 — measured from the first trading day of the fiscal year to the last — of 6.4%. And with a median pay package of $1.4 million, those CEOs won’t get much sympathy from their shareholders.

To get fat pay packages, though, CEOs don’t need shareholder sympathy, just their acquiescence and a strong demand for their talents. “Our system operates on the basis of the free market and of competitiveness,” says Bill Holland, former CEO of United Dominion Industries, a Charlotte-based maker of industrial equipment, and compensation-committee chairman at Lance Inc., a Charlotte-based snack maker. “Top-level executives command a lot of money. That’s just a fact.”

Setting CEO pay is a complicated process that usually takes several months and is part of a larger task of deciding what to pay all of a company’s top executives. “I do not like to see these incentives for the CEO much different than ones for the other top executives,” Smith says. “The amounts might be different, but the same things that guide him or her need to guide the other executives.”

At CT Communications — a local phone company that has branched into Internet access, wireless communications and long-distance service — discussion of CEO Michael Coltrane’s 2005 pay started in mid-2004. The compensation committee instructed Findley Davies to launch a survey of compensation at companies in the same industry — preferably eight or more. “The way I like it is if you can knock out the upper and lower extremes and still have a good listing of companies to balance out, because you never find a company that you can match up with exactly,” Smith says.

In most years, CT’s consultant presents the completed survey to the committee in September and fields questions about it. The committee may request additional information. In November, the full board of directors discusses the company’s goals. Around the first of December, the committee meets again and tries to translate those goals into a pay package that will motivate top executives and place them in the right spot on the industry spectrum. “If you’ve got a CEO and your company is doing average, I think you should pay him near the median,” Smith says. “But if you’ve got one that’s producing results better than those other eight, or better than seven out of the eight, then you should move the CEO higher.”

As at many public companies, CT’s Coltrane receives a fixed salary plus a bonus and other pay based on performance. In 2005, his annual bonus was contingent on the company hitting goals in, among other things, operating revenue; operating earnings before interest, taxes, depreciation and amortization; operating free cash flow; and customer growth. His long-term incentives were based on three-year growth in operating revenue, operating EBITDA, earnings per share and total shareholder return compared with a peer stock index.

The process varies from company to company. But many rely on consultants and try to peg CEO pay to company performance within its industry. The process is more detailed and defensible at many than it once was but still can produce results that are puzzling when pay is compared with company performance in the same year. Coltrane, for example, got a 57% raise in 2005, when CT’s total return was a paltry 1.4% and its net income dropped slightly. Most of the increase came from an option grant and long-term incentive payouts aimed at boosting future performance and weren’t influenced only by 2005 results.

Company performance can be affected by industry trends, long-term goals and extraordinary circumstances. CT’s bottom line was stagnant, but it’s in an increasingly competitive industry — with long-distance carriers, cell-phone companies and cable-television operators wanting bigger shares of local phone markets — and net income took a hit from the cost of laying more fiber-optic cable, which Smith says will help it compete long-term.

Likewise, it’s hard for outsiders to easily understand the deal Lance gave David Singer. He received about $6 million in 2005, ninth on our list. That’s more than six times what his predecessor, Paul Stroup, made in 2004 and more than seven times what Singer made in 2004 as chief financial officer of Charlotte-based Coca-Cola Bottling Company Consolidated. It was 35% more than Holland made in his penultimate year as CEO of United Dominion, though Lance is less than a third the size United Dominion was in Holland’s day, before it was purchased in 2001 by SPX, now based in Charlotte.

Lance didn’t exactly sparkle in 2005. Its total return was a minuscule 1.1%, and net income dropped 26%, though part of that decrease stems from the purchase of Tom’s Foods, a Columbus, Ga.-based competitor, for $38 million in October, Holland says.

Singer’s pay had to be big, in part, to lure him from Coke Consolidated, where he was CFO 19 years, Holland says. Besides, Lance historically hadn’t paid well. Most of Singer’s 2005 pay was in restricted stock that won’t vest for five years. “A great deal of his compensation was equity-based and will either pay out or not pay out. It’s valued at a point in time. But based on how the company performs, he may or may not earn that money.”

Although he once did the same kind of executive work as Singer, Holland is certain he can be impartial. After all, he answers not to Singer but to the company’s shareholders. “If a particular board or a particular committee is not in step with what their shareholders think they should be hey can kick them out. And that happens.” It’s more difficult at Lance than at some companies because its directors aren’t voted on annually, but staggered terms for directors also can help prevent precipitous purges by shareholders, Holland says.

Since it passed in 2002, the Sarbanes-Oxley Act has made boards and CEOs more accountable for corporate finances and more conscientious about explaining CEO pay. In July, the U.S. Securities and Exchange Commission issued rules that will force companies to clarify executive compensation even more. Among other things, they must report a dollar value for all equity-based compensation and a total compensation figure comparable with those at other companies. The new rules will close most loopholes companies have used to avoid disclosing full CEO compensation, Hodgson says, but he doesn’t expect them to give complete details about the performance measures used to set pay.

He would like shareholders to have a stronger voice in setting CEO pay, such as nonbinding votes on compensation-committee reports. A negative vote wouldn’t overturn the decision but would send a message to board members. Holland says such a vote could set bad precedent and blur the lines between shareholders, directors and management. “You could get down to saying, ‘Is the company setting the right capital-expenditure budget? Are they aggressive enough in their growth plans?’”

No matter how fully it’s disclosed, CEO pay isn’t likely to go down soon. People capable of running big public companies are in short supply, and heightened interest in CEO pay could, paradoxically, lead to more pay, says Hank Federal, principal and Southeast compensation-practice leader for Toledo, Ohio-based Findley Davies. “With the ever-increasing scrutiny around the businesses and what they do and how they pay these executives, they have less and less room for any kind of error. Therefore, it is contracting the pool of very qualified CEOs. When you’ve got people demanding and needing high-qualified CEOs and a shrinking pool, what does that typically do? It raises prices.”

Below is a partial breakdown of CEO compensation and company performance.

CEO Compensation v. Performance
(Top 10)