Who’s making the dough in Virginia?
New SEC rules require greater disclosure, but there’s still room for confusion

by Garry Kranz
for Virginia Business
October 2007

Despite growing shareholder angst over executive pay, it’s still sweet to occupy the corporate suite of one of Virginia’s largest public companies. Chief executives received an average of about $7 million last year in total compensation, according to a study commissioned by Virginia Business. It focused on CEOs at companies with at least $1 billion in annual revenue.

How that figure compares with previous years is hard to tell since 2006 marked the first year companies had to comply with new federal rules aimed at improving the transparency of executive pay.

This spring’s crop of proxies contained greater detail on previously obscure issues. There’s more information on severance pay, perks, parachutes, even how boards determine compensation strategies.

Ironically, the new regulations approved by the Securities and Exchange Commission caused more confusion in one area: the reporting of stock-related awards. That’s because companies now are required to disclose the valuation of stock options and awards that have vested from previous years, as opposed to only the awards granted during the latest fiscal year.

Consequently, this new accounting rule can inflate the total value of a CEO’s pay package.

For example, Capital One Financial Corp. in McLean reported pay for CEO Richard Fairbank at $37.4 million in 2006, making him Virginia’s highest paid executive. Most of that amount, however, came from grants made in 2003, 2004 and 2005. What he really received in 2006 were stock option awards valued at $18 million. To address this discrepancy, the attached chart lists a column under “latest proxy reported total” and “total estimated compensation” with the latter being our consultant’s best guess on what an executive actually made in 2006.

The shakeout over the revamping appears far from over.

The SEC has already sent letters to 300 companies across the country, asking questions about some of this year’s disclosures and seeking more information. Clarity is still a ways off, agrees Henry L. Federal, a principal at Findley Davies Inc., the Charlotte-based human resources consultant that compiled the data for Virginia Business.

“Organizations were using many different practices to value executive compensation,” he says. “It will take several years to determine if shareholders and investors are getting a more accurate picture of executive compensation.”

Still, shareholders itching for a so-called “say on pay” welcome the more stringent reporting. These resolutions, floated by investors at more than 60 companies across the country, would give shareholders the right to cast nonbinding advisory votes on executive compensation. Although recent initiatives in Virginia at Sprint Nextel Corp. and Capital One Financial Corp. failed, they signal a growing momentum to give investors some leverage.

In the meantime, the hue and cry has yet to exert tremendous influence on pay packages for decision makers here. Federal says Virginia companies are following national trends by tying executive pay to performance benchmarks. In most cases, changes in a CEO’s compensation could be directly linked to changes in shareholder returns for the year. “We know that stock prices change for many reasons, but I think it is significant that for 75 percent of the CEOs, their compensation went down if the stock went down and it went up if the stock went up,” says Federal.

As for the remaining 25 percent? Well, let’s just say there were some notable departures. With a compensation package valued at more than $21 million in 2006, Gary Forsee ranks as Virginia’s second-highest-paid CEO. Forsee, 56, earned a salary of $1.4 million last year to run Reston-based Sprint Nextel Corp., the country’s third-largest wireless carrier and one of Virgina’s largest publics. Though hardly an outlandish sum, Forsee’s salary reflects a one-year increase of nearly 15 percent at a time when Sprint Nextel was losing customers and profits following its 2005 merger with Nextel. However, Forsee didn’t receive a bonus in 2006, and he opted to forego a short-term incentive award of $414,000.

And while the company was required to report $10 million in stock awards and $8.3 million in option awards under the new rules, Sprint spokesman Jim Fisher says Forsee actually got $962,000 in restricted stock units and $4.8 million in stock options in 2006. As for total pay, Fisher says a more realistic figure would be $8.6 million. “That’s what he got for his performance in 2006. … How that is showing up, according to the rules is a different matter, because it’s spread over several years.”

No matter how you count it, it was a bumpy ride last year for the company’s shareholders. Sprint Nextel’s total return to shareholders in 2006 was negative 18.7 percent, and its performance compared with the S&P 500 over the same period of time was also flat.

At the company’s annual meeting in May, activist investors lobbied to give shareholders a vote on executive pay. Although largely symbolic, a nonbinding advisory vote would “allow shareholders to express their opinion” about whether pay levels for senior executives were appropriate, according to SEIU Master Trust, a Washington organization that owns about 56,000 shares of common stock.

Only 37 percent gave the idea a thumbs-up, thereby sparing Sprint Nextel the distinction of becoming the first Virginia company to adopt a “say on pay” proposal. Still, the number of “aye” votes indicates a trend, say experts. One third of the 60 proposed initiatives nationwide have been backed by 40 percent or more of shareholders — not enough to carry the day, but enough to cause boards to take notice, says Ron Bottano, an executive compensation consultant with Los-Angeles-based Korn/Ferry International.

Public outcry over executive extravagance has boiled over in recent years in response to high-profile corporate scandals and super-size parachutes for departing CEOs. When Robert L. Nardelli resigned suddenly from Atlanta-based Home Depot in January, he left under a separation agreement that netted him about $210 million, including a $20 million severance payment and retirement benefits of more than $30 million.

“Under the new disclosure rules, a lot of elements of pay that were under the radar are now in full prominence,” says Jeffrey Bacher, a senior vice president in Philadelphia with Radford Surveys and Consulting, an executive-compensation advisory firm that is a division of insurance broker Aon Corp.

For example, should Sprint’s board of directors decide to replace him without cause, Forsee stands to collect about $50 million in salary and incentives, according to the company’s proxy. The figure swells to $66 million if he were to be ousted due to a change in control coming from a merger or acquisition. Then Sprint Nextel would be obligated to pay for other niceties, including outplacement services and a reimbursement of $16.1 million in taxes. Such itemized information was not readily available to shareholders before this year.

Shareholders probably won’t begrudge the $14.5 million awarded to Nicholas D. Chabraja in 2006, Virginia’s sixth-highest paid CEO. The 64-year-old head of General Dynamics Corp. in Falls Church received a $3.2 million bonus in 2006 on top of his annual salary of $1.3 million. Nearly half his compensation came in the form of performance-based stock options, as the aerospace and defense contracting giant continued to feed a voracious appetite for its tanks, submarines and weaponry.

Sales of its combat systems in the U. S. and Europe rose 22 percent from a year ago. Investors are reaping the rewards of the company’s robust performance. Total returns to shareholders last year were up by 32 percent, and General Dynamics beat the S&P 500 by more than 18 percentage points.

Other CEOs saw their compensation drop precipitously. After collecting $12.4 million in salary and bonus in 2005, Massey Energy Co. chieftain Donald L. Blankenship saw his cash pay slide by 85 percent to $1.8 million. Although his base salary of $1 million stayed the same, Blankenship’s bonus this year was $814,054, compared with $11.4 million in 2005 (with $10 million of it a deferred incentive bonus that vested in 2005).

Massey operates 33 underground coal mines and 11 surface mines in Virginia, West Virginia and Kentucky. The company increased coal production last year to 1.9 billion tons, generating revenue of $2.2 billion. Although energy stocks in general suffered, Massey’s one-year shareholder return was negative 38.2 percent, battered in part by bad news.

The U.S. Mine Safety and Health Administration hit Massey with a $1.5 million fine in March. The penalty — the largest ever imposed by the federal mining agency — punished Massey for safety violations that contributed to the death of two miners in West Virginia last year.

Shares tumbled again in July after an adverse court ruling. A West Virginia jury ruled that Massey would have to pay nearly $220 million to settle a contract dispute with Wheeling-Pittsburgh Steel Corp. for failing to honor its coal-supply contract — a verdict Massey plans to appeal.

In some cases, CEOs at the bottom of Virginia’s pay ladder turned in the best performances. Under the guidance of Thomas E. Gottwald, shareholders in Richmond-based NewMarket Corp. enjoyed one-year returns approaching 144 percent, and it beat the S&P 500 by more than 100 percentage points.

NewMarket is the parent corporation of Virginia chemical manufacturers Afton Chemical Corp. and Ethyl Corp. Based on that performance, Gottwald’s $942,000 pay package — which includes a $510,000 base salary and a $350,000 bonus — seems like a relative bargain.

Median CEO compensation rose 9.3 percent in 2006, according to a study by The Corporate Library in Portland, Maine, down from a median increase of nearly 16 percent a year earlier.

While huge pay increases seem to be slowing, that probably won’t squelch the momentum building to give shareholders an advisory role on compensation. This spring Columbus, Ga.-based insurer Aflac Inc. became the first U.S. company to voluntarily give shareholders a nonbinding vote on pay decisions. “The public’s perspective [remains] that pay is out of control, and this is a way for shareholders to get that message across,” says Bottano.

Findley Davies’ Federal offers a more subdued view. “Any executive compensation abuse is in a small portion of companies … By far, executive compensation is performance-based. … If you look at individuals in hedge fund management, or even the sports and entertainment industry, their compensation, on average, is greater and has grown at a faster pace than CEOs.”