Gravy Train


Utilities must trim the fat from excessive stock options, stock grants and executive pay.

Fortnightly Magazine - July 2006

This month’s cover story (“Baby Boom Blues” and “HR Roundtable: Bridging the Talent Gap”) focuses on how utilities intend to find the talent they’ll need over the next few years to replace all those retiring baby boomers. And part of that puzzle naturally involves executive pay: how to attract the best and brightest without going overboard on rewards for performance.

Yet beyond the impending workforce crisis, the task just now warrants an urgency all of its own. As many will already know who regularly read the Wall Street Journal and the Financial Times, recent weeks have seen scandals develop involving both the timing of stock options (, United Health) and shareholder criticism of excessive executive compensation (Home Depot, Exxon Mobil).

The way executives are being compensated today, some argue, often does not line up with company interests. In fact, the late 1990s Internet boom created perverse incentives that led to financial scandals such as Enron and WorldCom. Part of the reason corporations were so free with their stock-option awards was that options did not have to be expensed. Stock options granted to employees did not need to be charged as an expense on the income statement, although the cost was disclosed in the notes to the accounts. This strategy allowed businesses to exclude a potentially large chunk of executive pay from current year expenses, thus leading to overstated income.

Top execs at several large utilities recently have exercised options and grants, sometimes reaping huge financial windfalls that would qualify as exorbitant by any rational measure. Perhaps the recent decision of the Financial Accounting Standard Board (FASB) to require expensing of stock options as of June 15, 2005, will put a damper on such payouts. Yet many stock options come at year’s end, with expenses showing up only in first-quarter financials, so it may be too soon to gauge the full deterrent effect, if any, of FASB’s new rule.

EES North America

Before reviewing some of the largest stock sales, the best solution would be to follow the lead of Duke Energy CEO James E. Rogers. In 2002, as CEO of Cinergy, Rogers made it corporate policy to prohibit executive officers and directors from selling stock acquired by exercising options until 90 days after having left the boardroom or the company’s employ.

The industry should go further. It should also prohibit the exercise of stock grants until 90 days after executive officers and directors have left the company or board, except in special circumstances or on a clearly delineated timeline (such as after 10 years of service). And some old-time corporate chiefs are not so lenient. They insist that senior company executives should never sell stock unless they are out the door.

Egregious Pay: A Debate With a Banker

After my February editorial criticized the multi-billion merger of Constellation Energy and FPL, I was accosted by a Constellation investment banker, Daniel B. More, of Morgan Stanley, who broke into a meeting I was having with a colleague of his at the bank’s headquarters in Times Square. At first blush it seemed to me that many of More’s arguments in the merger’s defense were dubious, as the merging parties had retained him as an advisor on the deal on a contingent-fee basis. But on second thought, our discussion over what constitutes egregious pay should at least shed some light on the scope of the problem.

More disagreed with my criticism that Constellation Energy CEO Mayo Shattuck’s $61 million stock sale in late December 2005, was “egregious,” as was my comparison of that action to the selling of $70 million in stock by Enron’s Kenneth Lay. But when the board of directors of Enron found out about Lay’s $70 million sale they were outraged, and that was before any of the criminal activity came to light in 2001. Enron at its height boasted a market cap of between $50 billion to $60 billion. Constellation Energy, on the other hand, can claim a market cap of only $9 billion and change. So if the board of directors of a $60 billion firm could question a $70 million pay out, then $61 million should be enough to raise eyebrows at a much smaller firm.

Even Jeff Immelt of General Electric didn’t make as much money as Shattuck last year—and he’s the CEO of a $350-billion energy company.

Nevertheless, Dan More still defended Shattuck’s pay, explaining that Constellation was like an “investment bank”—a belief I hope does not prevail at the company.

Will Constellation spawn imitators among utilities or their holding companies? If you’re curious, then click on Yahoo!Finance, or the Web site at the Securities and Exchange Commission, and check out the reports of insider transactions for companies such as Exelon, Entergy, Sempra, AEP, Edison International, and many, many more. What will you find?

You’ll find CEOs and senior executives cashing in millions (in some cases) in stock. You’ll also find insider transactions listed for HR executives, CFOs, and CIOs earning millions, as well as government affairs representatives and legal representative who are pulling seven figures.

But the real question is, Did these executives earn their compensation? Pension funds like CalPERS complain that CEOs and top executives should not be compensated excessively just for being at the company during a run-up of the company’s stock price. CalPERS, in press statements, favors compensation incentives only as a reward for actual performance.

It may be that these excessive stock awards stem from record stock price gains in the utilities industry. But if that were true, they would not necessarily be awards for executive performance. That is why a frank discussion about overhead costs, or what management should cost ratepayers and shareholders, must take place in the industry. Some consumer advocates say that a return to basics and greater use of ratebase and traditional regulation indicates that utilities are taking fewer risks, and therefore, utility executives should earn less. I suspect we’ll soon find out whether the compensation committees at utility boards of directors agree. Some stock analysts predict that utility stock valuations will edge lower as interest rates rise, which will make lavish stock options and stock grants more difficult and put a white-hot spotlight on executive compensation and performance.

From the Oracle of Omaha

Famed investor Warren Buffett believes that stock options do not align the interests of recipients with those of stockholders, as executives don’t experience the same pain that stockholders do if the share price drops. Furthermore, he has said in public that options are given away too freely without sufficient regard to the dilution suffered by stockholders. Not to mention, he is concerned that companies sometimes unwisely spend money on a stock repurchase to reverse the dilution caused by the exercise of options. Clearly, another method is needed to provide the right incentives to lure bright executives to the utilities industry without creating perverse results.

Fellow billionaire Bill Gates, CEO of Microsoft, agrees. In 2003, the company announced that all Microsoft employees would be granted stock awards instead of stock options. The Microsoft stock award program offers employees the opportunity to earn actual shares of Microsoft stock over time, rather than options that give employees the right to purchase stock at a set price.

The utilities industry is long overdue to change how it rewards top executives. Let’s hope that the rewards will always outweigh the pay.