Boards exerting more control over CEOs.

Complaints still abound that corporate pay is excessive, but times have changed in at least some executive suites. Consider Avery Dennison Corp.

Several years ago the Pasadena office products and labeling firm was rewarding its executives with straight stock options. Now, the company has turned to performance-based restricted stock grants--with the major measuring stick being the company's relative annual return on total capital.

Top-level executives only receive the vested grants when Avery Dennison's capital return exceeds the 67th percentile of a "market basket" of 50 public companies.

"We're seeing much stronger use of requiring executives to achieve performance goals before receiving awards," said Ron Battano, co-practice leader of the executive compensation advisory unit for Korn/Ferry International, the Century City-based executive recruiting firm.

After years of outlandishly high payouts to their chief executives--and looking the other way when those executives don't meet basic performance standards--local boards of directors are exerting more control over their chief executives.

Companies like Avery Dennison and East West Bancorp are increasingly tying executive bonuses and stock grants to meeting preset, long-term targets. What's more, boards are starting to show more willingness to force chief executives to step aside when they don't meet goals. Performance issues were likely part of the reason longtime Computer Sciences Corp. Chief Executive Van Honeycutt stepped down on short notice late last month, though the company strenuously denies it.

Much of the driving force behind these changes stems from the crackdown on corporate excesses of the 1990s. The resulting public company disclosure rules under the 2002 Sarbanes-Oxley Act drew even more attention to executive compensation, while the requirement beginning in 2006 to expense stock options also played a role.

Meanwhile, boards have faced increased pressure from shareholders, especially major pension funds and other institutional investors, who are questioning the exorbitant compensation packages given to top executives even when a company is not performing well.

So far, most of the changes have come on the compensation side, where board committees have been restructuring the bonuses and stock grants their top executives receive.

In the case of Avery Dennison, the restrictions on the stock grants not only applies to Chief Executive Dean Scarborough, but also to other top officers, including the chief financial officer and the chief operating officer, according to a proxy statement filed this past March.

Moreover, the peer group of 50 companies is wide-ranging, including Air Products & Chemicals Inc., Black & Decker Corp., Cummins Inc., B.F. Goodrich Co. and Parker Hannifin Corp.

Paul Hodgson, senior research associate with the Portland, Me.-based Corporate Library, a public company watchdog organization, said using a peer group as a measuring stick is generally regarded as more of a performance-based incentive than internal targets because it's less open to manipulation.

"You can set an internal target and meet that but still be underperforming the rest of your industry," Hodgson said.

An Avery Dennison spokesman was unable to find someone within the company to comment on its policy.

Expense effect

At Pasadena-based East West Bancorp, both internal and external targets are used as performance benchmarks for the granting of restricted options. The internal targets primarily include earnings per share growth, while East West also uses a peer group of major commercial banks as an external check. Goals are set for two-year periods, to ensure a longer-term focus.

Dominic Ng, the company's chairman and chief executive, said the bank holding company adopted these targets in advance of the Jan. 1, 2006 deadline for expensing stock options, the final cost of which can't be determined until an option is exercised.

"When stock options became an expense item, it became more difficult to justify giving stock options when we didn't know in advance how much the executives will get and how much they will make," Ng said.

Another key feature of the plan is that the board has discretion to award less in bonuses than allowed under pre-set formulas, but not more. According to East West's proxy statement, based on earnings per share growth and return on equity in 2006, Ng could have received 200 percent of his $750,000 base salary in bonuses; the board decided to instead award Ng 171 percent, or $1,280,000.

Ng said these performance targets have not played a major role in how he runs East West. "I'm glad that these performance targets are there; measuring CEO performance on a quantitative basis is essential. But I don't get bent out of shape by focusing too much on these targets. I don't want to be distracted from running the day-to-day business."

But while several local public company boards have instituted pay-for-performance policies, they've been less willing so far to give chief executives the boot for not meeting those goals, despite a rising tendency towards performance-related dismissals at public companies nationwide.

Back in 2005, nearly two thirds of companies that posted below average returns on their stock price had a chief executive with a tenure greater than seven years. By 2006, that number had dropped to 26 percent, according to a study released last month by the Booz Allen Hamilton consulting firm.

"Today, aided by sweeping changes in governance law and regulation, boards do a good job of replacing CEOs who deliver poor returns to investors," the study said.

A prime example of that was the decision last year by the board of Home Depot Inc. to dump Chief Executive Robert Nardelli for the Atlanta company's poor sales and stock performance. Locally, however, this trend has yet to emerge.

Unexpected departures

Most of the recent forced chief executive departures have been related to the stock options backdating scandal, with former KB Home chief executive Bruce Karatz being the most prominent example.

Karatz, who netted $156 million from exercising stock options in 2005, abruptly resigned last November after an internal company audit concluded he had personally chosen and back-dated the dates for his stock option grants. This past March, KB Home overhauled its stock option policy, including requiring all equity awards to be approved by both the board of directors and the compensation committee.

Computer Sciences chief executive Honeycutt's departure is so far the only recent example of a major local chief executive leaving amidst concerns about the company's overall performance. The company has underperformed the Standard & Poor's 500 index most of the time since Honeycutt assumed the helm in 1996 and its return on capital investments has been around 7.9 percent.

But even here, there were extenuating circumstances: Computer Sciences recently revealed in a Securities and Exchange Commission filing that it would restate earnings from 2000 through 2006 after finding "significant errors" in its tax liability accounting. Also, the company had earlier revealed that it found irregularities in the granting of stock options to Honeycutt.

Company spokesman Mike Dickerson disputed any notion that Honeycutt's departure was forced. "The decision was part of a planned transition," with chief operating officer Mike Laphen as the designated successor, he said.

However, in most planned chief executive transitions, the lead time between the announcement and the actual handover of leadership is measured in months, not days, as was the case with Computer Sciences.

BY HOWARD FINE 

Staff Reporter