How to Fix Outstanding CEO Pay Packages and Agreements

Mike Melbinger, Winston & Strawn, LLP

Why Must the Compensation Committee Fix Existing Arrangements?

There are at least three good reasons why members of the Board should consider revising the employment agreement and/or compensation package of the CEO.

1. To protect the Board members from potential liability. If a court were to find that directors permitted a CEO to receive millions of dollars in excessive compensation (i) by failing to meet minimal standards of due care, (ii) by not considering information such as the aggregate costs of a pay package, including severance, a court might find that the Board abrogated its duties to the company and failed to act in good faith. This could mean that each director would have to pay several million dollars out of his or her own pocket - without being reimbursed by the company or the D&O insurance carrier. And even if you win the case - like the Walt Disney directors have, so far - the cost to your time and reputation is incalculable. Even just having this conversation with the CEO should give the Board some protection under the business judgment rule.
    
2. To protect the Company and its shareholders. First, the Board can save money for the Company and its shareholders by reducing payments. That can be significant, but the real protection to the Company and its shareholders, involves avoiding an embarrassing fiasco over excessive pay that plays out in the press and/or the courtroom. Additionally, plaintiffs are bringing lawsuit alleging that the statements in the Compensation Committee report do not match up with the payment history.
    
3. To protect the CEO by providing a greater certainty that the CEO actually will receive the full amount of compensation and benefits for which he or she has bargained. The press and the courts are offer several examples of bitter and costly disputes between Companies and their former CEO over the compensation to be paid after termination. Often these disputes occur because directors first realize, at the time of termination, the enormous amount that is due to the departing CEO -- and the directors feel compelled to act. Ask the CEO: "Wouldn't you rather have a few less dollars that you are certain to receive - than set both of us up for a costly fight and a lot of bad publicity?" It is not too late. Note that former SEC Chief Breeden's report in the Hollinger affair observed that the Board should be judged by its entire record, including prompt efforts to clean up a mess once it is discovered.

Strategies for Fixing Packages and Agreements

The following are some suggestions designed to make this difficult task go as smoothly as possible - and some obvious places to look for improvements. Not all of these will be applicable to every Company or CEO.

1. Do the tally sheet. After the CEO has sat through the tally sheet presentation together with the Board, he or she might have a holy cow moment and volunteer to relinquish some items without the difficulties of negotiation.
    
2. Look for ways to better link pay to performance, as so many have described during the conference. If the Board can get the CEO's buy-in to the principle of true pay-for-performance, that should help set the stage for a more constructive discussion than if the Board comes into a meeting demanding cut-backs.
    
3. Get independent help. Get the support of an independent consultant and your own lawyer. Hopefully, it can be a cooperative process, but if necessary, let your consultants and lawyers wear the black hat (that's what lawyers do).
    
4. Annual Pay Decisions (base, bonus, long-term incentives) are almost always “easier to address” than existing contractual commitments. Look there first.
    
5. Future equity awards are always easier to fix than past ones. These are the easy and painless fixes.
    
6. Look for excessive perks. Perceptions do matter. The press and the public often seem to be more bothered by perks than salary and bonus amounts.
    
7. Look for items that do not have an immediate economic impact. Fixing and adding "for cause" provisions employment and all other compensation agreements is a no-brainer, including "after discovered cause." Fix or add claw backs of compensation for "cause" terminations.
    
8. Look for the compounding affects of the intertwined compensation programs. Dick Grasso's SERP at the NYSE started out looking like most every other SERP. But the compensation components that were added over time had a dramatic multiplying effect on the payments required under the SERP, with results we all know too well. Eliminating some of these "multipliers" also can be a relatively pain free step for the Board and the CEO.
    
9. Look for changed circumstances. For example, when the Board brought the CEO to the Company several years ago, it may have had to lure him or her away from a well-paying, secure job at a good company - where he or she had in-the money equity awards - and get the CEO to move cross-country to take over the Company. Generous compensation and severance protection was necessary at the time. But now that the CEO has been here for several years, those factors no longer apply. The Board may be able to ratchet down some of those protections. Consider a "sunset" feature for certain provisions.
    
10. Look at how external factors, like a run up in the stock price, that have affected the CEO's compensation and employment contract. Have circumstances changed due to stock market values, or the CEO’s tenure or success with the Company?
     
11. Look for holdover provisions in agreements and packages from the go-go, ethics free 90's. (Things got out of control for a while.)
     
12. Look for over-reliance on surveys - and pay based on peer groups that do not match up with the Company.
     
13. Look for and emphasize the actual amount of accumulated wealth, realized and unrealized - or "carried interest" as some refer to it - resulting from previous equity grants. At some point, the Company may have created enough wealth for the CEO. No law requires you to increase compensation and awards each year.
     
14. Look for bargaining chips or trade-offs. The CEO wants something more - or you propose to give something more - fine. but let's bargain.
     
15. Look for provisions that create the wrong incentive - such as a retention plan or agreement that actually pays better for an early departure.
     
16. Make a list of the prominent CEOs who have set an example but voluntarily reducing their salary or bonus or equity award - and the well-known companies that have taken action.
     
17. Make a list of some CEOs who were forced to accept a reduction by a court or the SEC.
     
18. Prepare, prepare, prepare. You should expect resistance when show up at the board or compensation committee meeting and suggest a rollback. For years the compensation consultants and "agents for executive talent" went into compensation committee meetings with statistics and studies suggesting higher pay. The Board needs to prepare its case just as well.
     
19. Consider adding a claw back of compensation to cover expressly a situation where there is a restatement of earnings.
     
20. Double-check indemnification agreements for the officers to ensure you are not indemnifying even in the event of bad acts.
     
21. Consider a cap on the future appreciation of stock awards (Schlumberger).

CEO terminations have increased dramatically. Most CEOs understand that they don't hold all of the cards anymore and that the market often reacts positively to the replacement of a CEO.