Washington (July 9, 2004) -- With executive compensation emerging as a top corporate governance issue in the 2004 proxy season, former Securities and Exchange Commission chair Harvey L. Pitt recommended that companies put a "substantial" portion of a chief executive’s pay in an interest-bearing escrow account, compensate senior executives with restricted stock, and limit the use of stock options to new or junior employees.


In his latest column for Compliance Week, Pitt, founder of Kalorama Partners, offered tips for assuring that company executives are "worth their salt."


He recommends that "a substantial portion of a CEO’s compensation be placed in an interest-bearing escrow account, to be paid upon the successful completion of the CEO’s tour of duty."


"Companies may increasingly be under pressure to recoup severance payments, salary, bonuses, option profits and other payments to executives who bear responsibility for a company’s sub-par performance or malfeasance," Pitt wrote. "The use of an escrow account can facilitate this process." Discretionary compensation should also be included. If the company restates its earnings materially or is accused of fraudulent or other illegal conduct, the escrowed earnings would be withheld and remain available to fund any fines assessed by the SEC, or could be returned to the company for the benefit of shareholders.


He also recommended that companies compensate senior executives with restricted stock. "If senior executives own a significant amount of stock and are required to hold it through their tenure and beyond, they are less tempted to stretch for short-term results," Pitt wrote, adding that using restricted stock "sends a clear message to shareholders that management is not out to make a quick buck."


Pitt noted that limiting stock options to new or junior employees helps eliminate some of the risk of using options, since junior employees have less ability to affect overall company results. He added that directors and officers should acquaint themselves with the various performance-based option plans that may become prevalent if proposed rules on expensing stock options take effect.


Among Pitt's other suggestions:

  • Compensation committees should be small (three to five members). Members should be completely independent of management and should be selected by the independent members of the board of directors, not the CEO.
  • Compensation should be linked to legitimate corporate goals. Three questions must be addressed: For what are the senior officers to be compensated? How much should they receive? And what form should the compensation take? Compensation should align management’s interests with shareholders'. Thus, Pitt says, CEOs should be rewarded for producing growth in fundamental company values, such as market share, not for achieving some measure of earnings per share.
  • The committee should follow and document meticulous procedures in determining CEO compensation. Members of the committee should select, hire and have access to experts to help determine compensation. But Pitt warned that it’s inappropriate for committee members to "rely blindly" on the advice of compensation consultants.
  • The independent board members collectively should make all ultimate compensation determinations. Every independent board member should understand and approve the compensation paid to the five most senior officers. If the full board varies the recommendation of the compensation committee, the reasons for that variance must be articulated and disclosed.
  • Compensation policies must be flexible enough to handle exceptions -- but exceptions must be documented in a manner that will stand up to outside scrutiny.
  • A complete description of compensation decisions and all relevant details should be included in company filings. Compensation committees should be specific in their disclosures, explaining the strategic rationales that underlie their decisions, the data they examined and the methodology used to arrive at their conclusions.

Executive compensation will remain a spotlight issue for the foreseeable future. According to Pitt, "Forewarned is forearmed, and perceptions matter. Those who tend to the details now, will reap the rewards later."-- WebCPA staff

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