Overpaid Underachievers.

SHAREHOLDERS GETTING FED UP WITH BOARDS THAT GRANT EXORBITANT SALARIES

CIRCUS was one word used to describe Mattel Inc.'s shareholder meeting in Manhattan Beach this month. And a circus it was. Shareholders shouted from their seats, and lined up at the microphone to spew their outrage at the $40 million-plus severance package given to former CEO Jill Barad, who is widely blamed for the company's huge losses and sagging stock price.

If current trends continue, expect more "circuses" coming to town soon.

"Shareholder rights group have become more prevalent, as well as more intelligent, because there is more information out there about what executives are getting paid," said Josh Luire, chief executive of Joint Information Inc., a New York-based compensation research firm. "As we see an increasing number of these outrageous pay packages, people are starting to wonder who approves these kinds of deals."

Company directors, especially those serving on boards' compensation committees, are the ones who approve the mega-pay deals. And an increasing number of shareholders are expressing displeasure, even outrage, at what they consider overly chummy relations between board members and company executives.

Among the most influential shareholders showing impatience with directors who sign off on huge pay deals for under-performing execs are the public pension funds, such as the California Public Employees Retirement System. With billions of dollars invested for the long haul, pension funds are getting more involved than ever in corporate governance.

At Mattel's shareholder meeting, CalPERS withheld its vote for the directors on the compensation committee who were responsible for Barad's severance package. (When board members come up for re-election, shareholders have three choices: they can vote yes, no, or withhold their vote. The latter choice is seen as a less-negative way for shareholders to show their lack of support for a director.)

Likewise, CalPERS withheld its vote for board members on the compensation committee of Occidental Petroleum Corp. In a release, CalPERS stated that the directors in question, including local billionaire Ronald Burkle, had awarded excessively generous compensation to executives of under-performing Oxy.

Indeed, Occidental's top executives, led by Chairman and CEO Ray Irani, are very well represented among the highest-paid public company executives in L.A. Irani made $14.1 million last year, including $11.3 million in stock options. Meanwhile, Oxy's share price, at a little over $22 as of late last week, is hovering at about the same place it was a year ago, despite a dramatic run-up in crude oil prices.

More shareholder initiatives

Although these actions by CalPERS and other pension funds are to a large degree symbolic because they represent only a small portion of the total voting shares, they are indicative of a more assertive attitude among shareholders.

"Where there is strong evidence that a company's corporate governance is detrimental to shareholders' interest we've seen growing support for shareholder initiatives," said Peg O'Hara, managing director with the Council for Institutional Investors in Washington, D.C. "For example, efforts to get independent directors on the compensation committee will get high votes."

However, because it is hard to show to what extent huge executive pay packages are detrimental to shareholder interests, shareholder proposals to outright restrict executive compensation tend to get little support, she added.

"In most cases, it's hard to prove that (exorbitant pay) is a bad thing," O'Hara said. "That makes it hard to craft a shareholders' proposal that is going to be successful."

Instead of putting restrictions on compensation, shareholders have been actively pushing other initiatives to make directors more accountable to shareholders and less beholden to management.

One of the most pressing concerns for shareholders has been to ensure that compensation committees, the group that puts together executive pay packages, are truly independent from management.

"We've noted conflict of interest on the compensation committees of 100 S&P 500 companies," said Brandon Rees, a researcher with the corporate affairs department of the AFL-CIO. "These include such things as interlocking boards, where executives from different companies sit on one another's compensation committees. But they don't include undisclosed conflicts of interest. For example, directors might share a vacation property with executives at a company."

Fed up with poison pills

Aside from pushing for only independent directors to serve on compensation committees, shareholders have also succeeded in passing motions to ensure that a majority of the board is composed of independent directors, and to overturn so-called "poison pill" provisions that give the board the power to block takeover bids without putting the matter to shareholders.

Thus, at Mattel's shareholders' meeting this month, 65 percent of the shareholders voted to overturn the company's poison pill defense.

"It's essentially a vote of no confidence in the board of directors," said John Chevedden, an independent shareholder activist. "It sends a message that the shareholders don't trust the same directors who were responsible for (Barad's) pay package to act in their best interest when it comes to a potential takeover bid."

Mattel spokeswoman Lisa Marie Bongiovanni took issue with that interpretation of the poison-pill vote.

"It's hard to say what shareholders think based on one proposal, which was a non-binding recommendation," she said. "Particularly since they voted with the board on other proposals."

Behind all the sturm and drang is the fact that corporate executives today are being enriched to a degree hardly seen since the Rail Baron years. Yet for all their wallet-busting pay, a lot of these executives have been only fair to middling leaders -- or worse.

Many experts point to a single factor driving the run-up in executive pay: the intense competition between Old Economy and New Economy companies (especially dot-coms). The former have seen many of their most talented and experienced executives jump ship for the thrills and megabucks that come with working for an Internet startup.

Because the startups have successfully recruited executives away from old-line corporations by offering equity in the form of stock options, those Old Economy businesses have had no choke but to follow suit. As a result, the stock-options portion of executive pay packages has grown much faster than base salaries and bonuses.

"If a guy at a Fortune 25 company sees another guy at a tiny startup or a spinoff making more than he is, he's going to say, 'Wait a minute, why can't I make that kind of money?" said David Chase, a principal with consulting firm William M. Mercer Inc. "So, we're seeing a model, equity instead of cash, which used to be a function of the startup market, being applied to other companies as well."

According to a Mercer study, stock options now account for two-thirds of the median executive pay package at public companies, compared to half five years ago. Meanwhile, the value of the median stock option grant has grown by 200 percent over the last five years, whereas cash compensation has grown by only about 45 percent over that period.

Long-term trouble

There is a concern among some shareholders that these lucrative packages will end up costing investors in the long run.

"Companies are using stock options as credit cards by deferring costs to the future," said the AFL-CIO's Rees. "Stock options are not reported as a loss on the company's income statement the way cash payments are. But when an executive cashes in on their options, the company can do two things. It can issue new shams and dilute the ownership stakes of existing shareholders, or it can buy back shares on the market, which means it has to use its earnings. As a result, these options have the potential to consume a company's future earnings growth. In either case, it is bad news for pension funds, who are long-term investors."

In addition, there is a worry among shareholders that option packages may incline executives to boost share values by using earnings to buy up shares, rather than invest in the future growth of the company.

Still, most shareholders are content to put up with these pitfalls as long as they come out ahead at the end of the day.

"What most investors are concerned about is that (executive) pay reflects performance," said William Mercer's Chase. "They're looking for better results and returns relative to the major indices, and they are less concerned about the size of stock-option packages."