Stocks may fall, but pay doesn't

Warren Buffett says it's only when the tide goes out that you learn who's been swimming naked.

If that's the case, investors should keep their children away from the beach this proxy season, because the tide went way, way out for Corporate America in 2007, exposing all sorts of embarrassing details about business strategies and CEO compensation.

How embarrassing?

KB Home kbh had an abysmal year, losing $929 million on revenue of $6.4 billion. Shareholders also suffered from the home builder's anemic performance, as the company's share price dropped from $53 last February to the high teens by November.

But CEO Jeffrey Mezger weathered the storm. In addition to his $1 million base salary, he was awarded a $6 million cash bonus for 2007. In explaining the bonus, the board of KB Home said Mezger exceeded the objectives set for him, which included strengthening the company's balance sheet and rebuilding the senior management team.

So it goes in the topsy-turvy world of executive compensation, a land like Garrison Keillor's Lake Wobegon, where each CEO is above average.

"This shouldn't be like the fourth-grade soccer team, where everybody gets a trophy," says Nell Minow, editor at The Corporate Library, a governance research firm. "This is the big time. This is why they pay these guys the big bucks."

Do they ever. A USA TODAY review of CEO pay for 50 of the largest companies in the Standard & Poor's 500 showed the median compensation last year was $15.7 million. The analysis includes data for companies that filed their proxies by the end of March. And as KB Home illustrates, smaller companies also compensate their CEOs very well.

Under reporting rules adopted by the Securities and Exchange Commission, public companies have to disclose the compensation paid to the top five named officers each year. Data for USA TODAY's CEO compensation survey were compiled from these SEC filings by CEO compensation consists of base salary, cash bonus and incentive awards, grants of stock and stock options, as well as perquisites. In its calculations, USA TODAY does not include stock and options awards made in prior years but accounted for in 2007 proxy statements.

Despite the economic downturn in 2007, it's easy to see that CEOs as a whole fared better than investors.

"There are a few laws of pay-physics," says Bill Coleman, chief compensation officer of "The first is that it rarely goes down."

That's certainly true in the case of Kenneth Chenault, CEO of American Express axp, whose compensation more than doubled, from $22.4 million in 2006 to $50.1 million last year — though some compensation experts applaud Chenault's package for its long-term focus. Alcoa aa CEO Alain Belda also saw a big jump. He received $10 million in 2006, but two and a half times that last year, or $25.6 million.

When times are good, as they were for financial firms, mortgage lenders and home builders through 2006, CEOs and shareholders alike made lots of money, and few complained.

But the bursting of the real estate bubble last summer caused credit markets to seize up and destroyed hundreds of billions of dollars of shareholder value. The fallout from the credit crunch sowed panic in the markets, spurring the Federal Reserve to lower interest rates. The lower rates contributed to higher oil prices, which, in turn, slowed the economy, depressing home prices even further.

At a time when average Americans feel poorer because their homes are worth less and the economy's teetering on the brink of a recession, the public is focusing on CEO compensation as never before.

Don't think boards of directors aren't paying attention.

"This is a jump-ball year," says Jeff Cunningham, chairman and CEO of Directorship magazine. "We get the message. Directors are at the negotiating table with their CEOs, looking for very rational pay schemes; no funny business, no games — just pure performance-driven pay planning."

This new attitude is already showing up in some areas, says Ira Kay of Watson Wyatt, a compensation consulting firm. "Bonuses are definitely following profits, especially in the retail and financial sectors," says Kay.

The fact that the economy began slowing in 2007 — and that the stock market has been on the skids for six months — is likely to play a bigger role in 2008 compensation. "CEO pay follows what happens in the market; it doesn't lead it," says Coleman.

The fallout from the turbulence in the financial markets affected the earnings of bank CEOs.

Bank of America bac chief Kenneth Lewis saw his compensation drop from $22.7 million in 2006 to $20.4 million in 2007. At Wachovia wb, CEO G. Kennedy Thompson's pay slipped from $18.3 million to $15.7 million.

Heads I win, tails you lose

Two years ago, the pay packages that stirred the loudest outrage were the ones granted to Bob Nardelli, former CEO of Home Depot hd, and Hank McKinnell, former CEO of Pfizer pfe.

Both men were ousted from their jobs in 2006 following mediocre performances, but both walked off into the sunset with nearly $200 million in severance packages.

Last year, the biggest CEO blowouts took place on Wall Street. The subprime mortgage crisis, which led to home foreclosures across the country, had been fueled by easy access to mortgages, even for people who were unlikely to make their monthly payments.

The easy access to money, meanwhile, was fueled by Wall Street banks that saw minimal risk in securities backed by these subprime mortgages. These banks, led by Citigroup, Merrill Lynch, UBS and Bear Stearns, plunged headlong into the business of packaging and selling mortgage-backed securities, and stashed billions of dollars worth of the stuff onto their own balance sheets, as well.

When the market imploded last summer, those financial products did, too, forcing the firms that owned them to take billions of dollars in write-downs.

Shareholders paid dearly for the bad decisions and inadequate risk-management practices on Wall Street as bank stocks plummeted. How did the executives responsible for this mess fare?

•At Citigroup c, CEO Charles Prince was forced out in November, but on his way out the door, the board gave him a bonus of $10 million. He was also allowed to keep $28 million worth of unvested restricted stock and options, and was granted $1.5 million in annual perks.

•At Merrill Lynch mer, CEO E. Stanley O'Neal resigned in October. Although he didn't receive any special bonus or severance, he walked away with a $161 million package, consisting mostly of stock and options that he had earned through the course of his career at Merrill.

"It's outrageous for CEOs to take risks that hurt shareholders and walk away with enough to never have to work again," says Robert Mittelstaedt, dean of the W.P. Carey School of Business at Arizona State University.

"It's only in the wacky world of CEOs where you get severance for failing," adds Minow.

There's another way to treat CEOs who lead their companies into a sea of red ink.

At Washington Mutual wm, a leading mortgage provider that went from a $3.6 billion profit two years ago to a $67 million loss last year, CEO Kerry Killinger took a 21% pay cut. He was paid $18.1 million in 2006, $14.4 million in 2007.

It was worse for investors, who saw WaMu's stock drop from $46 in early January to below $14 at the end of the year.

In February, Washington Mutual's board changed the design of the company's bonus plan by de-emphasizing the importance of foreclosure-related write-downs. The company's top executives still have to meet specific performance criteria to qualify for bonuses, but the new plan allows the board to pay bonuses even when non-performing mortgages overwhelm the bank's other businesses.

"Our board felt this was an appropriate way to determine bonuses," says spokeswoman Olivia Riley.

This week, the company announced it had been forced to seek a $7 billion cash infusion from outside investors, predicted a $1.1 billion quarterly loss and said it would have to eliminate 3,000 jobs.

Down with the ship

The majority of CEO pay plans are built around the 12-month model: If the chief executive meets certain goals in the course of a year, he or she is rewarded accordingly. Most companies also have some form of long-term incentive plan, designed to reward chief executives who succeed over a three-year period.

The problem with these plans, says Harvard Business School professor Jay Lorsch, is that many businesses, such as pharmaceutical companies, depend on products that take years to develop.

"Every company in America thinks that the 'long term' is three years," says Lorsch. "That's nonsense."

On Wall Street, banks pay bonuses in part with restricted stock that can't be sold for several years, but the bonuses themselves are calculated on the basis of what happened during the previous 12 months.

Thus, the CEOs of Wall Street banks that plunged into the subprime mortgage pool were richly rewarded in 2005 and 2006, when profits from these risky securities juiced earnings. But when the subprime market tanked last year, blowing holes in the balance sheets of these banks, Morgan Stanley ms CEO John Mack and Bear Stearns' bsc then-CEO James Cayne announced they wouldn't take any bonuses for 2007.

But they kept their bonuses from the previous years, leading some critics to call for "clawbacks" of the CEOs' prior years' earnings.

"They're right about the clawbacks," says Alan Johnson of Johnson Associates, a compensation consulting firm. "There should be a longer timeline for such financial rewards. If you make it in the first three years but lose most of it in the fourth, you should have to give most of it back."

In the case of Bear Stearns, the CEO gave almost everything back. The investment bank's stock price had topped $170 early in 2007, making Cayne, who owned more than 5% of the stock, worth more than $1 billion.

But after the subprime meltdown, Bear's stock began a long slide, and early this year, rumors circulated on Wall Street that the firm didn't have enough ready cash on hand. Last month, Bear's trading partners and clients began demanding their money, putting the firm at risk. In mid-March, to avoid bankruptcy, Bear Stearns reached an agreement to sell to JPMorgan Chase jpm for $2 per share (later raised to $10). After the deal, Cayne sold his stock for $61 million, enough to retire on but a fraction of what it had been worth a year earlier.

Building long-term value

According to Mark Van Clieaf, who runs compensation consultancy MVC Associates, the 12-month pay period makes no sense. "In a one-year period, anyone can make the numbers look good," he says. "If you aren't looking at measuring a business over a four-to-six-year performance period, you're going to mismeasure a business, because it takes that long for new investments to work their way through the profit-and-loss statements."

In recent years, boards of directors at companies such as General Electric, DuPont and AmEx have begun looking at long-term goals when structuring CEO compensation packages.

In the case of AmEx, the compensation of CEO Chenault is measured over a six-year performance cycle. Van Clieaf says AmEx's peers might have benefited from a similar pay plan.

"If that had been in place for most of the Wall Street CEOs, would they have made the risk and product decisions they did, knowing they would have to live with them? I'm not sure they would have," he says.

Good work?

Jeffrey Mezger


Salary:$1 million

Bonus:$6 million

Incentive compensation:$97,500

Restricted stock awards:$2 million


KB Home stock price:?59.6%

1 — Fiscal year ended Nov. 30, 2007


Charles Prince

Former Citigroup CEO

Bonus:$10 million

Unvested restricted stock

and options:$28 million

Annual perks:$1.5 million

Citigroup stock price:?46.8%

2 — Fiscal year ended Dec. 31, 2007

Nov. 30, 2006


Nov. 30


Jan. 3


Nov. 4


Prince is

forced out

Daily stock closes for KB Home

Dec. 31


Daily stock closes for Citigroup