Looking hard at executive pay: the SEC's proposed disclosure rules on executive compensation will force public companies to look intently at revising their proxy statements. Beyond that, there's a gathering governance storm over executive pay and executive severance.

Periodically, some prominent corporate outsider--former Securities and Exchange Commission Chairman Arthur Levitt, Vanguard Funds founder John Bogle or another recognizable name--issues a jeremiad against excessive executive pay. Recently, business legend Warren Buffett added his voice to the chorus. The issue is white-hot, and it has clearly become a governance issue, not just a compensation one.

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"The compensation world is under a real spotlight these days," says Derrick Neuhauser, senior manager and regional leader of the Compensation & Benefits Practice at BDO Seidman LLC. "Inside the Beltway, particularly, it's become something of a pinata to kick." And agitation certainly doesn't stop at the Beltway. "There's a lot of momentum among shareholders for procedures to hold compensation committees accountable for their decisions," says Richard Ferlauto, an official at the American Federation of State, County and Municipal Employees.

Even directors themselves have started to sense that something is amiss. A recent survey by PricewaterhouseCoopers with Corporate Board Member magazine found that fully 70 percent of directors polled in the U.S. thought that compensation was too high at U.S. companies--though perhaps not necessarily at their own.

Of course, what's "excessive" to outsiders may seem appropriate to those inside. The issue is almost certain to become more of a political football in 2007, when the next proxy season starts. By that time, the Securities and Exchange Commission's (SEC) bold proposal for far greater disclosure about executive pay--unveiled in January--will presumably have kicked in. Companies then will be forced to divulge details about their executive compensation at an unprecedented level, and in a clearer format, though SEC Chairman Christopher Cox has consistently maintained that the rules are aimed only at disclosure, not at setting or limiting executive pay.

Indeed, the SEC's request for greater disclosure will almost certainly raise issues for others besides the CEO--even though median direct compensation for CFOs at the largest companies, based on recent data, is about a third of that for CEOs (compensation specialist Equilar Inc. reported the numbers for 2005 at $2.55 million versus $7.38 million, respectively).

The comment period on the SEC's disclosure proposals was scheduled to end April 10. While too lengthy to summarize here, the proposals would add a whole new dimension of disclosure, both about the company's five named executive officers (NEOs) and, potentially, a handful of others who may be paid even more.

One key provision of the rules is a "tally sheet" that would summarize compensation, both in the current year and going forward under a possible change of control or retirement for key executives. While that used to be presented as a formula, Neuhauser says, it will now need to be calculated in far more detail.

"On the amount of disclosure, I don't think anyone has comprehended the level they are asking for," Neuhauser says. He notes that he recently outlined the proposal to a compensation executive at a very large financial services firm, who responded with a shocked, "Are you kidding me?"

As currently written, the rules would place the "principal financial officer" just below the "principal executive officer" in the summary compensation tables, assuring a high level of attention for CFO pay. And there could well be something to look at. According to a review of 100 proxies this year for S & P 1500 companies, done by Steven Hall & Partners, a New York compensation consultant, CFO compensation across the board was up an average of 13 percent, "reflecting stronger demand for talent in the post-Sarbanes-Oxley era," the firm said. At those same organizations, total CEO pay dipped 2 percent.

Executives contemplating this new order aren't necessarily gnashing their teeth, however. The latest quarterly survey of CFO members at Financial Executives International, done in conjunction with Baruch College, actually found strong support for the general idea behind the SEC proposals: 71 percent approved, and nearly a third felt the rules would make companies more careful not to award excessive pay.

"In general, I think it's fine," says Frank Borelli, former CFO of Marsh & McClennan Cos. and a former FEI chairman, of the SEC effort. "The basic thrust is to have all that information in one place ... Before, you had these things listed elsewhere in the proxy. You couldn't really put all of it together, and sometimes all of the information wasn't available."

However, the agency will allow companies to withhold "confidential commercial or business information." That could include targets intended for performance-based bonuses, and even critics have acknowledged that true transparency could put a company at a competitive disadvantage.

In addition to requiring far more preparation work, the presentation of the numbers will require a lot more space--perhaps as much as three times as much as the existing tables, Neuhauser says. Myrna Hellerman, a senior vice president at The Segal Co., a compensation and benefits consultant, says she has heard that the new tables and the related explanations could add an additional 25 pages to a typical proxy.

What's more, the SEC is stressing simplicity and clarity, with the use of bullet points, short sentences and examples--not footnotes. Borelli, who serves on the compensation committee of Genworth Financial, does see room for improvement. "A lot of companies put in too much information, and it fogs the windshield," he says.

Still, "the first reaction [to the new tables] is going to be, 'These are big numbers,'" says Hellerman. The totals for long-time executives, especially CEOs, will look especially large, given their long-term accumulation and the value of pension accruals, she says. Indeed, those would look much heftier--and perceptually, disproportionate--compared to a CEO who had been hired only recently.

Some experts see a huge role for finance in the preparation for the new display.

Management of stock option programs is often held there, or overseen jointly with human resources or the legal department, Hellerman says. But collecting and collating the data and interpreting it will require strong consolidation. Some experts warn that if companies aren't careful, some pay could be counted multiple times.

"There is a very dominant role for finance in overseeing that data, in stewardship; it's really something of an extension of the auditing function," Hellerman says. Yet, "in many organizations, this process can be very sloppy."

While a clear majority in the FEI survey--64 percent--oppose a House of Representatives bill (H.R. 4291) that would require shareholder approval of executive pay packages, a surprising one-third said they approved of the bill outright or under certain circumstances. Approval for this proposal was higher among private companies than public companies.

Colleen Cunningham, President and CEO of FEI, noted that the questions on executive pay drew some of the strongest comments in recent survey history. "In general, respondents acknowledged the problem of excessive compensation but felt responsibility for its control lay with the board and its compensation committee rather than via additional regulation," she said.

Compensation experts fear that people who don't understand what the new display represents will blow the numbers out of proportion. "If people just look just at the charts, there will be headlines all over the place," says Segal's Hellerman. "There will be apples and oranges and grapes comparisons."

"Right now, there's a lot of comp that just slides under the radar screen," says James Clary, CEO of benefits expert MullinTBG. Once the new tables are published, "There will be a whole new round of scrutiny in terms of what's fair, and the appropriate levels of compensation."

"I don't think disclosure is bad," he adds. "In some cases, companies may be putting things in contracts without really adding up what they've signed up for." Says Neuhauser: "Is clarity going to create better pay for performance? I don't know the answer."

"I think it will it put pressure on those companies that aren't doing well," says Borelli. "If you have a bonus plan, you usually set a target at the beginning of the year. If you don't hit that target, how much should you reduce that bonus? Some companies have been too generous there."

What companies will wind up doing is unclear. Seven out of 10 companies polled recently by Watson Wyatt said they don't plan to change their compensation programs in response to the SEC proposal. Only 9 percent planned to make changes, while the remaining 21 percent weren't sure. Additionally, almost half (48 percent) of the 112 large public companies surveyed don't intend to change their proxy disclosures this year, while nearly 23 percent said they will. The remaining 29 percent didn't know.

"We believe many companies are taking a wait-and-see approach to the proposed rules," says Ira Kay, global director of compensation consulting at Watson Wyatt. "While some companies recognize their disclosures are inadequate, most want to see what the final rules entail and how other companies respond."

These days, there is a new, related bogeyman to go after: excessive severance pay. It isn't hard to find examples in the news, and virtually all of them involve chief executives. In March, for instance, it was announced that John Kanas, the CEO of Long Island-based North Fork Bancorp., would walk away with $185 million in payments after selling the highly regarded regional bank to Capitol One Corp. The year before, James Kilts had secured a similar payday after Gillette Corp., where he had been CEO, was sold to Procter & Gamble Co.

Kanas pointed out that he wasn't a short-timer who dressed up the bank for sale; he had been there 35 years and was the architect of its growth from a sleepy community bank to a hard-charging regional player that mushroomed through acquisition while continuing to reward shareholders richly. Kilts, on the other hand, had been with Gillette for only four years.

Then there's Philip Purcell, the former CEO at Morgan Stanley who was pushed out after a long and ugly battle last year. His severance package, while far smaller, has been put at $44 million, plus a $250,000 yearly annuity--and his departure was hardly the result of a merger.

"Investors and the general public getting tired of reading about executive paydays [like those]," says Clary at MullinTBG. "In some cases, they may be hard to justify; in others, you just don't know what went into the numbers."

The publicity that has erupted over these payouts is certain to trigger some re-examination of change-of-control, "golden parachutes" and other compensation policies drafted to help retain key executives. The policies have been around for many years but have become more complex and sophisticated, especially related to issues around tax-related "gross-ups" intended to ensure that executives aren't hurt at tax time by any onetime windfalls.

As Neuhauser explains, many golden parachutes for departing executives are subject to a 20 percent excise tax. It's common, he says, for companies to gross up the executive's pay to include payment for that tax.

Gross-ups, however, have long been a bulls-eye for compensation critics. "Grossing-up an executive's pay to cover the income taxes on his or her executive perks is inconsistent with good corporate governance," says Bruce Ellig, author of The Complete Guide to Executive Compensation.

"If companies are going to gross-up pay-for-failure or severance, should they not gross-up pay-for-performance, namely, annual and long-term incentives?" Ellig argues. "Where does it stop? It's hard to find anyone who would say that executives aren't paid enough to pay their own income tax."

These payments aren't the result of formulaic HR policies; they represent programs carefully crafted by compensation consultants and approved by boards. As such, they call attention to the board's compensation committee and its independence from management--increasingly, a critical governance notion.

Some golden parachutes have resulted in legal actions, and more suits are likely. Last year, a group of Walt Disney Co. shareholders lost a key court case challenging the board's approval of a huge severance package for former president Michael Ovitz back in the 1990s. Ovitz held the job for only 14 months but walked away with $130 million.

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The long-running tangle between New York Attorney General Eliot Spitzer and Dick Grasso, the former chairman of the New York Stock Exchange, continues to play out as the two sides continue their legal jockeying. Spitzer has accused the head of the NYSE's compensation committee, Kenneth Langone, of misleading the board about Grasso's pay; Spitzer has deemed that pay (variously calculated at up to $188 million) wildly excessive and is seeking to get much of it returned. A trial isn't expected to begin until the fall.

Meanwhile, in San Francisco, a suit was brought in federal court in March by the Indiana Electrical Workers Pension Trust Fund and pension funds administered by the Service Employees International Union (SEIU) over the severance package given to former Hewlett-Packard Co. CEO Carly Fiorina. Fiorina, who stepped down early in 2005 in a tiff with the company's directors, is expected to get a combined $42 million in severance and other payments.

The funds brought the action against HP's board of directors, charging that they breached corporate policy in granting the payments. The suit was structured as both a derivative and class action on behalf of the company and other HP investors. The company has said it believes the suit has no merit.

Specifically, the Indiana pension fund and SEIU accuse Hewlett-Packard of violating a company policy not to approve severance packages exceeding 2.99 times the sum of an executive's annual base salary (plus target bonus) without first seeking shareholder approval. HP, which initially fought the idea, later published the new policy in both its 2004 and 2005 proxies.

Fiorina, who joined HP in 2002 and directed its merger with Compaq Computer Corp., received severance of $21.4 million, plus stock options and other benefits that raised her total exit compensation to roughly $42 million. Although the package exceeded the 2.99 formula, no vote was sought authorizing the payout, the suit alleges.

Change is not always readily discernible on governance issues, which usually morph through evolution, not revolution. Yet, change in this area is coming; the SEC's proposed rules would compel that. Compensation authority Ellig expects that the attention the SEC will bring to airing executive perks will cause many of them to disappear, to be replaced by increases in salary.

Virtually every day in recent months, there have been headlines or columns about excessive executive pay, even before the proxy season was in full swing. Just the perception of companies reacting may be important. "Change may not be happening fast enough to stop the gathering opposition," wrote Wall Street Journal columnist Alan Murray in a March column about perceptions of excessive pay. "If the pace doesn't quicken, companies may find it forced down their throats."

RELATED ARTICLE: takeaways

* A flurry of headlines in recent months about huge pay packages and criticism by prominent commentators have made executive compensation a hot governance issue.

* The SEC's proposals for much fuller disclosure will require a huge effort by companies to tie numbers together and present the data in fuller detail.

* An FEI survey found that 71 percent of responding CFOs support the general thrust of the SEC rules, and a third believe the rules might help curb excessive pay.

* Huge severance packages have ignited criticism and a number of lawsuits aimed at the company boards that approved the payments.