GILDED PAYCHECKS: Troubling Conflicts;
Outside Advice on Boss's Pay May Not Be So Independent
By GRETCHEN MORGENSON
New York
Times
April 10,
2006
For Ivan G. Seidenberg, chief executive of
Verizon Communications, 2005 was a very good year. As head of
the telecommunications giant, Mr. Seidenberg received $19.4
million in salary, bonus, restricted stock and other
compensation, 48 percent more than in the previous year.
 |
| Note that the Times mislabeled the
graph. "The graph showed Mr. Seidenberg's direct annual
compensation for the last five years -- consisting of salary,
bonus, restricted stock and the cost of perquisites, known as
'other pay.' It did not show 'total compensation,' which would
also have included stock option
grants." | Others with a stake in
Verizon did not fare so well. Shareholders watched their stock
fall 26 percent, bondholders lost value as credit agencies
downgraded the company's debt and pensions for 50,000 managers
were frozen at year-end. When Verizon closed the books last
year, it reported an earnings decline of 5.5 percent.
And yet, according to the committee of
Verizon's board that determines his compensation, Mr. Seidenberg
earned his pay last year as the company exceeded ''challenging''
performance benchmarks. Mr. Seidenberg's package was competitive
with that of other companies in Verizon's industry, shareholders
were told, and was devised with the help of an ''outside
consultant'' who reports to the committee.
The independence of this ''outside
consultant'' is open to question. Although neither Verizon
officials nor its directors identify its compensation
consultant, people briefed on the relationship say it is Hewitt
Associates of Lincolnshire, Ill., a provider of employee
benefits management and consulting services with $2.8 billion in
revenue last year.
Hewitt does much more for Verizon than
advise it on compensation matters. Verizon is one of Hewitt's
biggest customers in the far more profitable businesses of
running the company's employee benefit plans, providing
actuarial services to its pension plans and advising it on human
resources management. According to a former executive of the
firm who declined to be identified out of concern about
affecting his business, Hewitt has received more than half a
billion dollars in revenue from Verizon and its predecessor
companies since 1997.
In other words, the very firm that helps
Verizon's directors decide what to pay its executives has a long
and lucrative relationship with the company, maintained at the
behest of the executives whose pay it recommends.
This is the secretive, prosperous and
often conflicted world of compensation consultants, who are
charged with helping corporate boards determine executive pay
that is appropriate and fair, and who are often cited as the
unbiased advisers whenever shareholders criticize a company's
pay as excessive.
It is a world where consulting fees can
reach $950 an hour, rivaling those of the nation's top lawyers.
And it has grown into a substantial industry where there is
little disclosure about how executive pay is determined.
Marc C. Reed, executive vice president for
human resources at Verizon, declined to identify the company's
compensation consultant, noting that the Securities and Exchange
Commission did not require it. ''We understand the potential
perception issue,'' he said in an e-mail message, ''but we think
it's important to honor the confidentiality of our advisers, and
we have always ensured there have been no conflicts of
interest.''
Suzanne Zagata-Meraz, a spokeswoman for
Hewitt, said in a statement: ''Hewitt Associates has strict
policies in place to ensure the independence and objectivity of
all our consultants, including executive compensation
consultants. In addition, Hewitt adheres to strict
confidentiality requirements and a strong Hewitt code of
conduct.''
Because much of what goes on in
compensation consulting stays in the hushed confines of
corporate boardrooms, the roles of these advisers in determining
executive pay have been hidden from investors' view.
Nevertheless, corporate governance experts say, the conflicts
bedeviling some of the large consulting firms help explain why
in good times or bad, executive pay in America reaches dizzying
heights each year.
Warren E. Buffett, the chief executive of
Berkshire Hathaway and an accomplished investor, has noted the
troubling contributions that compensation consultants have made
to executive pay in recent years.
''Too often, executive compensation in the
U.S. is ridiculously out of line with performance,'' he wrote in
his most recent annual report. ''The upshot is that a
mediocre-or-worse C.E.O. -- aided by his handpicked V.P. of
human relations and a consultant from the ever-accommodating
firm of Ratchet, Ratchet & Bingo -- all too often receives
gobs of money from an ill-designed compensation arrangement.''
How Much Is Too Much?
Executive pay has been a subject of criticism for
decades. Even though last year's pay figures showed slower
growth than in previous years, the fact that executive
compensation often has little relationship to the performance of
the company has contributed to a growing sense among investors
that pay is diminishing shareholder returns. ''Everybody should
have an interest in controlling this explosion in executive
pay,'' said Frederick E. Rowe Jr., chairman of the Texas Pension
Review Board who is also chairman of Greenbrier Partners, a
money management firm in Dallas. ''The wealth of America has
been built through the returns of our public corporations, and
if those returns are being redirected to company managements,
then the people who get the short end of the stick are the
people who hope to retire someday.''
The median compensation for chief
executives at roughly 200 large companies rose modestly to $8.4
million last year, from $8.2 million in 2004, according to
Equilar Inc., a compensation analysis firm in San Mateo, Calif.
The median was $7.2 million in 2003.
There are those who defend the current
levels of executive pay, saying that the packages are set by the
market and reflect the rising value of executives in an
increasingly complex and competitive arena.
In an interview with The Wall Street
Journal on March 20, John W. Snow, secretary of the Treasury,
characterized executive pay this way: ''In an aggregate sense,
it reflects the marginal productivity of C.E.O.'s.'' Mr. Snow
added that he trusted the marketplace to reward executives. Mr.
Snow was a member of the Verizon board from 2000 to 2002 and on
its compensation committee in 2001.
But defenders of executive pay are
increasingly being drowned out by investors and workers who see
some packages not only as an unjustified cost but also as a
potentially divisive social issue.
Any discussion of executive pay quickly
leads to compensation consultants, because they are the experts
relied upon by company directors trying to balance their
fiduciary duties to shareholders and their desire to keep
management happy. Directors look to consultants for their
knowledge about prevailing pay practices as well as the tax and
legal implications of different types of compensation. Yet the
consultants' practices have received little scrutiny.
Consultants help select the companies to
be used in peer groups for comparison purposes in judging an
executive's performance. Picking a group of companies that will
be easy to outperform is one way to ensure that executives can
clear performance hurdles. Another is to structure an
executive's pay so that it is always at or near the top of those
in his industry regardless of his company's performance. This
pushes up pay simply when others in the industry do well.
Consultant creativity is behind some of
the pay practices that have generated huge windfalls for
executives in recent years. Some of the most costly practices
involving stock options, like mega-grants and automatic reloads
of options when others are cashed in, have vanished under
pressure as accounting rules have changed. But innovative
practices continue to crop up and spread quickly because
comparisons with what other executives receive is a central
factor driving executive pay.
An increasingly common practice of
consultants is to use the same performance benchmark to generate
both short-term and long-term pay. This arrangement rewards
executives twice for a single achievement, noted Paul Hodgson,
senior research associate at the Corporate Library, a corporate
governance research firm in Portland, Me.
A recent study by the Corporate Library,
''Pay for Failure: The Compensation Committees Responsible,''
identified 11 major companies whose shareholder returns had been
negative for five years, but whose chief executives' pay had
exceeded $15 million during the last two years combined. ''The
disconnect between pay and performance is particularly stark''
at these companies, the study noted. They include AT&T,
BellSouth, Hewlett-Packard, Home Depot, Lucent Technologies,
Merck, Pfizer, Safeway, Time Warner and Wal-Mart.
Directors Help Each Other
Verizon is the other
company on the list. Mr. Seidenberg's $75 million total pay for
five years looked especially high against a total shareholder
loss of more than 26 percent in the period, the study said.
Verizon's board received a grade of D in effectiveness from the
Corporate Library.
Robert A. Varettoni, a Verizon spokesman,
pointed out that Mr. Seidenberg had received the first increase
in base salary last year since the company was formed in 2000.
''During this particularly tumultuous time in the telecom
industry,'' Mr. Varettoni said in an e-mail message, ''Verizon
has maintained its financial health and infrastructure
investments, increased its dividends, lowered its debt,
transformed its revenue growth profile, and provided customers
with a steady stream of product innovations, such as wireless
broadband services and fiber-optic-based TV services.''
Doreen A. Toben, chief financial officer
of Verizon, sits on the board of The New York Times Company and
on its audit committee. Hewitt Associates is the compensation
consultant for The New York Times, said Catherine Mathis, a
spokeswoman for the Times, but does not handle other business
for the company.
Consultants are not alone in driving
executive pay. Corporate boards are often composed of other
chief executives with an interest in keeping executive pay high.
Even though stock exchange regulations require compensation
committee members to be independent of the executives whose
remuneration they oversee, their connections with those people
can run deep.
Verizon's compensation committee, for
example, consists entirely of chief executives or former chief
executives. Three of the four members sit on other boards with
Mr. Seidenberg. When he was on Wyeth's board, Mr. Seidenberg
helped set the pay of one member of Verizon's compensation
committee, John L. Stafford, previously the chairman and chief
executive of Wyeth.
Human resources officials often work
closely with the compensation consultants and report directly to
the chief executives. Then there are the executives themselves,
who have been known to make quiet suggestions to their directors
about their pay, according to board members and compensation
experts who spoke about their experiences but said they feared
retribution if they were identified.
Mutual fund and pension fund managers,
too, regularly vote their shares in favor of large grants of
stock options or restricted stock.
The potential for conflicts in consulting
arrangements can be difficult for outsiders to spot. Even if the
consultant is identified, the other work that a consultant's
company performs for the compensation client is hard to plumb.
''I wish we could figure out how to flesh
out the conflicts that pay consultants have in the same way we
were successful in fleshing out the conflicts in Wall Street
research,'' said Richard H. Moore, who as treasurer of North
Carolina oversees $70 billion. ''This is one of the last pieces
that are pure unadulterated conflicts that neither the board nor
the shareholder is well served by.''
Room for
Potential Conflicts
The
only reference to Hewitt Associates in any Verizon filing, for
instance, is a letter sent by the company to institutional
shareholders and attached to a 2004 proxy filing. The letter,
written by a Hewitt official, details the supplemental executive
retirement plan in response to a shareholder proposal that would
have required stockholder approval of any ''extraordinary
benefits for senior executives'' at Verizon.
Last year, Verizon's directors described
the compensation adviser as an ''independent, outside
consultant.'' In this year's proxy, the word ''independent'' is
missing.
The Securities and Exchange Commission has
proposed rules on compensation disclosure that would require
compensation consultants to be identified. But the rules would
not force companies to disclose details of other services
provided by the consulting firm or its affiliates.
The potential for conflict is reminiscent
of that among auditing firms that were performing lucrative
consulting services related to information technology and tax
issues for the same companies whose financial results they were
certifying. When the S.E.C. required companies to disclose how
much they were paying in consulting as well as audit fees, the
industry was compelled to separate these businesses.
''Auditors' giving companies tax advice
while acting as their independent auditors was clearly crossing
the line into bad corporate governance in the cases of Enron and
Hollinger,'' said Mr. Hodgson of the Corporate Library.
Referring to pay consultants, he added: ''The perception has
been growing that it is better that there be a clear line of
distinction between the people the board hires and the people
hired by the corporation.''
The Conference Board, a nonprofit
organization that conducts research and conferences for business
leaders, issued a report in January suggesting, among other
practices, that boards hire their own compensation consultants,
who have not done work for the company or its current
management. The report quoted a former chief justice of
Delaware, E. Norman Veasey: ''Compensation committees should
have their own advisers and lawyers. Directors who are supposed
to be independent should have the guts to be a pain in the
neck.''
But according to consultants and
directors, compensation committees typically employ a consultant
who also works with a human resources executive, the company's
chief executive and the chief financial officer. In many cases,
a company's chief executive is present at meetings where the
compensation consultant and the human resources executive hash
out the terms of a package.
Some compensation committees have started
hiring their own pay consultants who do no other work for their
companies. James F. Reda & Associates, a small pay
consultant in New York, founded in 2004, works with some of the
nation's largest companies on executive compensation issues. But
such independence is uncommon.
In a comment letter to the S.E.C. on its
proposed disclosure rules, Mr. Reda noted that all but one of
the nation's large compensation consultants offered other
services. ''Most diversified H.R. consulting firms earn more on
selling other services than on performing compensation
consulting services,'' he wrote.
Hewitt; Watson Wyatt; Towers Perrin; Pearl
Meyer & Partners, a unit of Clark Consulting; and Mercer
Human Resources Consulting, a unit of Marsh & McLennan, all
provide a vast array of services to corporate clients.
Hewitt, for example, conducted mostly
actuarial work when it was founded in 1940. Now, it is much more
diversified, operating in 31 countries and providing things like
investment services. Of the $2.8 billion in revenues at Hewitt
in 2005, 71 percent came from its outsourcing business; 29
percent came from its human resources consulting unit.
Typically, only a fraction of a firm's
sales come from compensation consulting. Mr. Reda estimates that
compensation consulting generates less than 2 percent of a
diversified firm's revenues.
Verizon is not the only Hewitt
compensation client that uses the firm for actuarial,
administrative, investment advice or other services. According
to filings with the Labor Department, Hewitt has worn two hats
in its work for Boeing, Maytag, Genuine Parts, Procter &
Gamble, Toro, Morgan Stanley and Nortel Networks.
Because few companies identify their
compensation consultant, this list is by no means comprehensive.
At Verizon, Hewitt is ubiquitous. The
company operates Verizon's employee benefits Web sites, where
its workers get information about their pay, health and
retirement benefits, college savings plans and the like. Labor
Department filings show that Hewitt is actuary for three of
Verizon's pension plans. Hewitt also performed extensive work
for the two companies -- Bell Atlantic and GTE -- that merged to
become Verizon in 2000. Immediately after the merger, Verizon
employed Hewitt to help it assess overall human resources costs.
Over the years, Hewitt's Web site has offered testimonials from
Verizon officials about its services.
These multiple relationships are no
accident. Hewitt calls its offerings ''total human resources
solutions'' that help clients manage the costs of their work
force efficiently.
Towers Perrin, Watson Wyatt and Mercer
Human Resources make the same pitch. They contend, as Wall
Street firms once did about stock analysts and investment
bankers, that potential conflicts can be managed properly. In a
working group report written by corporations and consultants
last year for the Conference Board, they argued that companies
and boards are best served by using a single compensation
consultant -- less adversarial and lower cost -- and that the
consultant should work closely with the company's management in
devising executive pay. This argument was rejected in the
Conference Board's subsequent report.
A 'One-Two
Punch'
Brian Foley, an
executive compensation expert who operates his own independent
consulting firm in White Plains and who does not work for
Verizon, analyzed Mr. Seidenberg's pay for this article. ''If
you were a shareholder looking at how Ivan did financially, in
terms of new stuff, if you didn't know the facts, you would have
sworn they had a really good year,'' Mr. Foley said. ''Bonus up
23 percent and a 40 percent salary increase -- that's a one-two
punch in a year when stockholders are down.''
| "The
Compensation Loop'' |
The chief executive's pay package at
Verizon is overseen by four men on the board's compensation
committee with the assistance of an unnamed outside consultant.
According to people briefed on the arrangement, that outside
consultant is Hewitt Associates. As such, Hewitt both recommends
Ivan Seidenberg's pay and reaps hundreds of millions of dollars
in other consulting work from his management team.
Ivan G. Seidenberg
VERIZON -- Chief
executive since 2000 Pay last year: $19.4 million
WYETH --
Current board member, and on compensation committee
HONEYWELL -- Current board member, and on compensation
committee |
Interlocking Board
Members
The men on the compensation committee that
is charged with determining fair pay for Verizon's chief
executive often encounter each other and Mr. Seidenberg at other
board meetings. In addition, all five men belong to an exclusive
group: they are current and former chief executives of major
companies.
Richard L. Carrión
VERIZON -- Director since '97, pay last year: $196,075*
BANCO POPULAR DE PUERTO RICO -- Current chief executive
WYETH -- Board member 2000-5, and on compensation
committee
Robert W. Lane
VERIZON --
Director since '04, pay last year: $200,884*
DEERE & CO.
-- Current chief executive
Walter V.
Shipley
VERIZON -- Director since '97, pay last
year: $206,254*
CHASE MANHATTAN -- Former chief executive
1994-'99
WYETH -- Current board member, and on compensation
committee
John R. Stafford
VERIZON
-- Director since '97, pay last year: $200,200*
WYETH --
Former chief executive 1986-2001
HONEYWELL -- Current board
member, and on compensation committee |
| * Includes cash, stock, travel
insurance premiums and telecommunications equipment.
|
According to Verizon's proxy, Mr.
Seidenberg received his raises last year in part because the
company expanded ''its customer base through innovative products
in wireless, broadband, data, video and long-distance
services,'' according to the company's proxy statement. In
addition, Verizon made significant investments in its network
and enlarged its market share. Verizon's annual consolidated
operating revenue increased 6 percent, driven by 16.8 percent
revenue growth at Verizon Wireless and 10.5 percent revenue
growth in wireline data revenues.
Mr. Reed noted that last year Verizon's
board canceled 209,660 restricted shares Mr. Seidenberg was to
receive. ''Ivan and the board have made a series of strategic
business choices that are designed to create sustainable
long-term shareholder value,'' he said in an e-mail message.
''In 2006, these plans have begun to take root, and our
shareholders have begun to benefit accordingly.''
But Mr. Foley pointed to several aspects
of Mr. Seidenberg's pay that seem out of sync. One is the low
level of performance -- beginning at the 21st percentile of
other companies -- that generates an incentive stock payout.
''If you have 100 companies in the sample, as long as you beat
20 of them you start making money,'' Mr. Foley said. ''That
hurdle is so low it's almost embedded in the ground.''
Another surprise, Mr. Foley said, was
Verizon's contributions to Mr. Seidenberg's retirement plan in
recent years. ''They've put in almost $6 million in four years
in new contributions -- that goes beyond holy cow,'' he said.
''I look at this in the context of all the retrenchment Verizon
has made in retiree benefits and medical for the rank-and-file
guys.'' Verizon has frozen future benefits to be paid under Mr.
Seidenberg's retirement plan, which had grown to $15.2 million
by the end of last year.
Each year that Mr. Seidenberg has been
Verizon's chief executive, a shareholder proposal has appeared
on the company's proxy that is critical of its executive pay. At
this year's meeting, scheduled for May 4, shareholders will vote
on a proposal that would require that at least three-quarters of
stock option and restricted share grants to executives be
''truly performance-based, with the performance criteria
disclosed to shareholders.''
The company's directors say its incentive
pay plans already ''provide aggressive and competitive
performance objectives that serve both to motivate and retain
executives and to align their interests with those of the
company's shareholders.''
But the Corporate Library study concurred
with Mr. Foley in questioning Verizon's practice of paying
bonuses even when the company's performance lags well behind
that of most companies in its comparison groups. ''This is not
even logical,'' the study asserted.
Mr. Reed of Verizon noted that the
consultant used by the compensation committee did not certify
board actions, ''but its perspective -- which board members may
or may not agree with -- is one of many inputs considered before
the board reaches its independent decision.''
On the matter of disclosing the
consultant's identity, ''We'll continue to look at this issue,''
he said, ''even if the S.E.C. does not adopt new guidelines.''
Gary Lutin, an investment banker at Lutin
& Company in New York and an adviser in corporate control
contests, said: ''Paying some friendly consultant $100 million
to help you justify the diversion of shareholder wealth to
managers is just adding another $100 million to the diversion.
If you're really trying to be a responsible director, you'd
never rely on an expert who can't be considered objective.''
Shareholders Speak Up
Verizon's compensation committee is led by Walter
V. Shipley, former chief executive of the Chase Manhattan
Corporation, and is made up of Richard L. Carrión, chief
executive of Banco Popular de Puerto Rico; Robert W. Lane, chief
executive of Deere & Company; and Mr. Stafford, formerly of
Wyeth.
None of Verizon's directors agreed to be
interviewed for this article.
Many of the Verizon directors who are on
its compensation committee have also met Mr. Seidenberg at board
meetings of other public companies. At Wyeth meetings, Mr.
Seidenberg encounters Mr. Shipley, who is the chairman of
Verizon's compensation committee and who is a member of Wyeth's
committee, sitting with Mr. Carrión, at least until 2006.
Mr. Seidenberg sees Mr. Stafford when the
board of Honeywell International meets. Mr. Stafford is chairman
of Honeywell's compensation committee, which includes Mr.
Seidenberg.
C. William Jones, the president and
executive director of BellTel Retirees, a group of 111,500
people, has had many meetings with Verizon executives to discuss
pay.
BellTel Retirees have placed four
shareholder proposals relating to executive compensation on
Verizon proxies in recent years; the organization has won
significant concessions from the company after the proposals
attracted shareholder support.
Mr. Jones said Verizon executives had
always treated him with respect. But the dialogue stops on the
subject of Verizon's consultant. ''I spoke to a senior vice
president of human resources and said, 'Who is it?' '' recalled
Mr. Jones, who retired in 1990 with 30 years' service. ''He
said, 'We have a policy that we do not disclose that
information.' I don't know what the secret is.''
| 
In a 
