Board faces increased pressure to adjust compensation plans. (Inside The Books--Banking & Finance Report).

WHEN it comes to matters of corporate governance, Jakks Pacific Inc. could well be a poster child for reform.

Half the board is not made up of independent directors. The two founding executives each received $1.5 million loans in 2000. And bonuses are based on more accommodating pretax income rather than earnings per share.

They're the sorts of arrangements that, while not illegal, have raised the hackles of investors and corporate governance experts on the look-out for examples of poor board oversight.

Jakks is making several adjustments to the way it handles corporate governance, including hiring an executive compensation consulting firm. "We just need to double cross our Ts and double dot our Is," said Stephen Berman, president and chief operating officer.

Still, at a time when so much attention is focused on how public companies conduct business, such matters as loans to executives or re-pricing of stock options -- standard practices only a year or two ago -- suddenly stand out.

"It sends the message that management is running the company for themselves," said Robert DeLean, a frustrated equity analyst with Morgan Keegan & Co. "In the past, management has run this company like a private company."

Here is a review of several Jakks policies:

* Board Structure: Jakks remains among only a handful of comparable companies where the board remains closely aligned with management.

Data compiled by the Corporate Library, a financial watchdog organization based in Portland, Maine, found that among 519 companies in the Standard & Poor's Small Cap Index, only 4 percent of the boards were considered to have an inside majority. Inside majorities are defined as those on which half or more of the members were aligned with management. Jakks, a member of the S&P Small Cap Index, is among that 4 percent.

Under the recently passed Sarbanes-Oxley Act, it is likely that affiliated board members, such as an investment banker handling a company's underwriting, would not be considered independent. This is a more stringent gauge than the one used by the Corporate Library and one that would only make two of Jakks' six board members truly independent.

The company says it plans to realign how its board, now split between outside and related directors, oversees the business. Joel Bennett, the company's chief financial officer, said recent moves were "just a realignment of the committees," but added that, "If anything, we would probably add more independents."

The board consists of Berman, Chairman and Chief Executive Jack Friedman and General Counsel Murray L. Skala. Skala had also served on the board of THQ, a company founded by Friedman in 1991.

The three "non-employee directors" are Michael G. Miller, an advertising executive, Robert E. Glick, an investor in women's apparel manufacturing, and David C. Blatte. Blatte, a former senior vice president at Donaldson, Lufkin and Jenrette Securities Corp., which underwrote Jakks' 1999 secondary public offering, is considered an "outside but related" director.

"Miller and Glick were added because we needed two independent board members to be listed on the Nasdaq," said Bennett. 'We added Blatte to satisfy new ('01) board requirements. One had to be financially savvy," Bennett said.

Bennett noted that Blatte has satisfied Nasdaq's requirements for independence.

* Executive Compensation: Friedman received a salary of $821,000 in 2001, while Berman received $796,000. Both are entitled to an annual bonus equal to 4 percent of pre-tax income, up to $2 million each. Basing bonuses on pretax income typically provides a better deal for executives because it doesn't factor shareholder dilution by issuing more stock.

In total, Friedman and Berman each took home more than $2.5 million each in salary and bonus last year, when the company posted net income of $28.2 million.

The bonuses "started out of their employment agreements before the company went public and was a carryover from that," explained Bennett. "As a private company it was fine. But now that Jakks is a higher visibility company...it has become an obvious area to look at."

The company has retained the consulting firm Pearl Myer Associates to advise it on possible changes in compensation practices.

Jakks executives refused to provide specifics, saying only that they would strive to better align executive pay with shareholder interests. But Bennett said that the bonus program, initiated upon the company's founding in 1995, likely would be discontinued.

"More than likely (the new bonuses) will be based on earnings per share instead of pre-tax income," Bennett said.

* Options: Friedman, Berman and Bennett benefited by the re-pricing of options in 2000 when Jakks' share price fell below the strike price after it failed to meet earnings projections. This came because of a falloff in sales of its World Wrestling Federation toy line.

Bennett said the re-pricing was executed because the stock had been lagging despite quarter-on-quarter top and bottom line growth. He argued that options had to be worth something to employees "in order for a plan to be effective."

But investors, most of whom applaud Jakks' business prospects, were nonetheless incensed.

"The price comes down because you miss numbers and you re-price options just because you have the authority?" said DeLean. "That sends a negative message to the market."

The message was not helped by news that net income for the third quarter of 2000 would be up between 21 and 34 percent.

* Executive Loans: Another shareholder concern is that the company has given, and in one case forgiven, favorable loans to its top three executives. In filings with the Securities and Exchange Commission, Jakks said all three loans were made to assist "certain personal financial obligations."

Friedman and Berman have paid off about $500,000 each, and Bennett's $250,000 loan, extended in April 2000, was forgiven.

Bennett's loan was called a retention bonus in his May 2000 employment contract. It was to be paid back only if he left the company within two years. "If you look at the executive officers as a group, I bring the average way down," he said. "So I guess people are happy."

Bennett said he didn't think the loans outstanding were cause for concern, given the compensation packages at other companies. "On a relative basis, they're not very big," he said.

Still, company officials have been on the phone assuring investors that the balance remaining on their loans will be paid in full when they come due next April.

Bennett conceded that board changes and consultants will be little help if Jakks is unable to adjust its compensation policies. "There is an effort to change the perception," he said.

But perceptions may be hard to change.

"They're doing what a lot of companies are doing," said Charles Elson, director of the center for corporate governance at the University of Delaware. "The new rules are requiring a fundamental rethinking... investors require it as well."