Executive Pay Cuts

Executive Pay Cuts

July 27, 2009

Ken Silverstein
EnergyBiz Insider
Editor-in-Chief

Times are tough inside utility boardrooms. A biting recession and volatile energy prices are creating a backlash among the various constituencies, forcing those members to generally stifle pay raises and especially those for top managers.

Executives must be concerned about the messages that their compensation deals are sending to employees and shareholders. It's particularly true in a difficult economy when companies are cutting expenses and reducing staff. Workers don't mind seeing their chief executives get rewarded for good work. But they, too, want to be compensated if they deliver results. Now, though, it is time to hunker down so as to emerge lean and mean when the coast is clear.

According to the worldwide consulting firm Mercer, a quarter of all companies are freezing salaries in 2009. The biggest budget decrease is at the executive level where 77 percent of respondents plan to reduce their salary budgets from their 2008 projections.

"Given lackluster corporate performance and recent pressure from regulators, shareholders and the (U.S.) President, it's not surprising to see that over the past few months, more than one-third of participants who reported executive salary data went from a 2009 planned base salary increase for their executives to a freeze," says Steve Gross, global leader of Mercer's broad-based performance and rewards consulting business. "In 2009, executives are less likely to get a salary increase than rank and file workers."

Compensation is made up of salary, cash bonuses and long-term incentives, traditionally stock options that give executives the right -- but not the obligation -- to buy stock at a fixed price at some point in the future. Cash bonuses are calculated using such benchmarks as revenue increases, return on assets or return on equity. Stock price is also a popular measurement, although it is typically used to gauge longer-term results.

According to the Hay Group, corporate boards must assure that pay standards are transparent and the process to assign compensation is fair and does not conflict with employee benefit policies that apply to everyone else. Shareholders, in fact, display antipathy for CEOs who get richly rewarded for mediocre performance. In 2008, Hay reports that median oil and gas execs were paid nearly $10 million while typical energy and utility chiefs were compensated about $7 million and $5.8 million, respectfully.

Until last fall, "boards were dealing with how to retain top management and executive unrest," says Bob Dill, an executive compensation director for the Hay Group. "But now those boards have got to be conscientious. Executives, too, know they have a position and a charge. They are going to just put their heads down and make it happen. In the heyday, the top executives could go anywhere. But they can't do that now."

Strategic Objectives

Utilities have different strategic objectives and the criteria used to assess performance will therefore vary. Executives running regulated enterprises will be evaluated differently from those overseeing unregulated ones. In each case, the idea is to meet certain goals, such as achieving revenue targets, maintaining market share or increasing shareholder value. And bonuses may be tied to long-term performance. So, if utilities showed good results in two of the last three years, then those top managers may have met their aims and would be compensated for it.

According to financial publisher SNL, a handful of utilities paid their leading executives more than $10 million in 2008. They include Dominion Resources ($14.3 million); PG&E ($13.3 million); Entergy ($13.6 million); FirstEnergy Corp. ($13.5 million); Sempra ($12 million) FPL Group ($11.5 million) and Allegheny ($10.2 million). In the case of the top brass at Entergy, FirstEnergy and Sempra, they took pay cuts from the year before. PG&E's and Allegheny's chief execs, though, got lucrative pay hikes.

Hay Group's Dill says that the tendency is toward paying for long-term performance. In the old days, he says that companies would reward execs with stock options at fair market values. But, for the second year in a row, long-range indicators that consider the total value a worker brings took the lead, which was unimaginable five years ago when stock options ruled. Additionally, he notes, companies are using "time-vested restricted stock."

Utilities are clearly aware of their public images and how their CEO compensation packages might be construed against a backdrop of recessionary times and rising utility rates. They simply don't want the scrutiny from regulators or any adverse media attention. Along those lines, the executives that far exceed industry pay standards really do need to make justification, or else shareholders will question their true worth.

"When you are using an organ of the state such as a public utility commission to enforce your prices, you have to be mindful of that and take good care of those dollars," says Byron Harris, consumer advocate leader for the state of West Virginia. "In a perfect world, I understand that executive pay goes along with the performance of a company. But I am cynical on that front. There have been so many shenanigans."

Utilities, of course, are attuned to their local communities and the financial pressures that their stakeholders now face. Keeping salaries in line and avoiding unwanted attention is therefore paramount. As the economic engines gear up, the eventual rewards should be distributed fairly throughout the value chain.