Corporate Directors Give Executive Pay Model Mixed Reviews

Directors, Investors Agree Model Hurts Corporationsí Image, Disagree on Link to Performance

Most corporate directors and institutional investors agree that the U.S. executive pay model has tarnished corporate Americaís image. However, they disagree over whether it has resulted in improved corporate performance or has led to excessive pay levels, according to a new report by Watson Wyatt Worldwide, a global human capital consulting firm.

ìDespite major reforms, executive pay and corporate governance continue to be a source of controversy,î said Ira Kay, global director of compensation consulting at Watson Wyatt and one of the nationís leading authorities on executive pay. ìWhile the views of directors and institutional investors on executive pay issues are closely aligned in many areas, we found several differences between the groups, demonstrating that more work is needed on a few key issues.î

In a survey of 50 directors who serve on corporate boards, Watson Wyatt found that 79 percent believe that the executive pay model has hurt corporate Americaís image. A separate Watson Wyatt survey of institutional investors released earlier this year found that 85 percent think the pay system has damaged corporate Americaís image. Both groups also support pay that is closely linked to performance and greater disclosure in proxies.

However, some important differences have emerged between the two groups. Two-thirds (65 percent) of directors believe the model has contributed to superior corporate performance, compared with just 22 percent of institutional investors. Most institutional investors (90 percent) think that executives at most companies are overpaid, and 87 percent believe executives have too much influence in how their pay is determined. Directors take a more neutral view. Sixty-one percent say most executives are overpaid, while 48 percent think executive pay is too heavily influenced by executives.

Directors, Institutional Investors See Problems With U.S. Executive Pay System

Overall, the U.S. executive pay
model at most companies

Has hurt corporate Americaís image
Corporate Directors 79%
Institutional Investors 85%

Has improved corporate performance
Corporate Directors 65%
Institutional Investors 22%

Has dramatically overpaid executives
Corporate Directors 61%
Institutional Investors 90%

Is too heavily influenced by management
Corporate Directors 48%
Institutional Investors 87%

Is an example of poor U.S. corporate governance
Corporate Directors 41%
Institutional Investors 63%

The report also noted that more than three out of four directors and institutional investors favor enhanced disclosure of executive pay information in proxies.

ìGiven the continued controversy over executive pay, itís not surprising that most directors and institutional shareholders agree that greater pay disclosure would be shareholder-friendly,î Kay said. ìHowever, while shareholders may view enhanced disclosure as a way to curb an out-of-control pay system, directors may regard it as a way to demonstrate that the system generally works and to expose potential abuses. The SEC-proposed disclosure rules will likely provide both groups with what they are seeking.î

Directors and institutional investors both strongly favor pay for performance but disagree over how specific pay elements should be positioned relative to the market. The vast majority of directors believe that base salary, severance or change-in-control agreements and SERPs should be targeted at the market median. However, six out of 10 directors favor targeting long-term incentives above the market. Most institutional investors (61 percent) also favor targeting long-term incentives above the market median but say that severance or change-in-control agreements should be positioned below the market median.

ìWhile most directors believe the executive pay system needs further reform, they are unlikely to make dramatic changes to their programs. Given their greater responsibilities in dealing with management regularly and increasing pressure from shareholders and the media, we expect some reform will happen as directors try to find the right balance,î said Kay.

Other key findings from the report include:

ï Two-thirds of directors agree that the executive pay model has yielded high levels of executive stock ownership at most companies. About three out of four directors believe that the stock ownership guidelines for executives and directors are shareholder-friendly.

ï Like institutional investors, directors overwhelmingly agree (86 percent) that stock incentives are shareholder-friendly when they have performance-contingent vesting. However, they disagree substantially on the appropriate performance metrics to use.

ï Compared with institutional investors, directors are more neutral toward severance plans, especially at a change in control ó in part because they perceive a tighter market for executives.

Copies of the Watson Wyatt Board of Directors Survey Report are available at www.watsonwyatt.com.