The biggest annual loss in Alpha Natural Resources’ (ANR) history should have been bad news for Chief Executive Officer Kevin Crutchfield. Under the compensation formula set by the coal miner’s board, Crutchfield wasn’t entitled to a cash bonus in 2011. Yet directors at the Bristol (Va.)-based company paid him a $528,000 bonus anyway, for total pay of $6.7 million, citing his “tremendous efforts” toward improving worker safety.
It was a similar story at generic drugmaker Mylan (MYL), where the board decided that CEO Robert Coury deserved an extra $900,000 because it wasn’t his fault that the European sovereign-debt crisis and natural disasters in Japan hampered results. And Nationwide Mutual Insurance more than doubled its CEO’s bonus by declaring that claims from U.S. tornadoes shouldn’t count against his performance metrics.
Most companies in the Standard & Poor’s 500-stock index pay their CEOs annual bonuses that are conditional on meeting specific goals. Yet companies often find ways to lower or reset the performance benchmarks to ensure that their CEOs get at least a portion of their bonus. The practice, which has become more frequent since the 2007 economic downturn, risks turning bonus plans into a “meaningless exercise,” says Carol Bowie, head of Americas research at ISS Governance, the largest adviser to institutional shareholders on proxy votes. Bonus plans are “not simply a mechanism to deliver pay,” she says, “but they should be designed to focus executives on the kinds of operational metrics that are going to deliver value.”
Performance bonuses are typically targeted to equal or exceed the executive’s base salary, and most pay out under a formula tied to a specified goal, such as earnings or sales. (Executives also usually receive stock and options as the third—and typically the largest—element of their pay package.) Companies often justify moving the goal posts as a way to protect executives from events out of their control—bad luck, such as a hurricane or rising fuel costs. Yet CEOs also benefit financially when good luck strikes. Departing from a bonus plan “only works if a board is willing to use it on the upside and the downside,” says Blair Jones of Semler Brossy Consulting Group, who advises corporate directors on executive compensation. “If it’s only used for the downside, it calls into question the process.”
Several studies of U.S. CEO pay have confirmed the lopsided practice. One study, from researchers at Claremont Graduate University and Washington University in St. Louis, found that executives lost far less pay for bad luck than they gained for good luck. Todd Milbourn, one of the study’s authors, says the results don’t, in most cases, suggest pushover boards. Instead, it may be good corporate policy to encourage CEOs to seek out good luck—say, by betting on a new line of business that’s primed for growth. If they were penalized equally for bad luck, Milbourn says, CEOs might never place such bets. “My gut feeling is that good corporate governance actually predominates,” he says.
Precise numbers don’t exist on how many companies depart from their bonus plans each year, says Paul Hodgson, chief research analyst at GMI Ratings, a corporate governance consultant. “There have been recent years where this kind of thing hasn’t gone on at all,” he says. “As soon as the economic crisis hit, bang, we started to see discretionary bonuses.”
Making exceptions to pay bonuses can cost shareholders. Under a 1993 law, only the first $1 million of an executive’s pay can be deducted from a company’s federal income taxes as a business expense, unless the pay is “performance-based.” Changing the plan sometimes runs afoul of that rule. That may be the case at Alpha, the country’s second-largest coal producer. Crutchfield boosted his bet on coal last year with the $7.1 billion acquisition of Massey Energy just as competition from natural gas was reducing demand. The shares lost 66 percent of their value in 2011. The company said in February it would shut six mines and reduce production at several others, affecting 320 jobs, and announced another 1,200 job cuts last month. Alpha’s shares had the second-worst performance in the S&P 500 last year.
The annual net loss, driven by a goodwill writedown associated with the Massey deal, voided any bonus under the rules of Crutchfield’s pay plan. But in February, Alpha’s compensation committee decided “to reward Alpha’s employees for their tremendous efforts and success” on safety. For Crutchfield, the $528,000 bonus was about 40 percent of his original target award. Since the company went public in 2005, it had never handed out a special bonus to senior executives just for safety.
The safety bonuses weren’t related to any specific goals, Alpha said in a statement to Bloomberg News. The company says management had helped lower accident rates at former Massey mines 17 percent after their acqusition. Alpha in its statement says the safety awards “may not be” tax deductible under Internal Revenue Service rules.
Some companies boost bonuses by adjusting their financial results to ignore certain costs that shareholders can’t. SunTrust Banks (STI), for example, set aside $120 million last year to fund a settlement with regulators over improper foreclosure practices, then ignored the expense when calculating CEO William Rogers Jr.’s bonus. The move boosted the executive’s award by $140,000, to $982,000.
In a regulatory filing in March, Atlanta-based SunTrust said the bonus was warranted because the anticipated settlement stems from criticism of industrywide mortgage-servicing standards, not “individual behavior.” Rogers had been the bank’s president since 2008, and his tenure included the period when regulators say most of the alleged foreclosure misdeeds occurred. He became CEO in 2011, when his total pay was $9.3 million.
Drugmaker Mylan said the factors outside of its CEO’s control that justified the increased bonus included “intense price competition” as well as Europe’s debt crisis and natural disasters. The company’s shares gained 1.6 percent in the year, while Coury collected a total bonus of $4.5 million as part of his overall pay of $21.3 million. Nina Devlin, a company spokeswoman, declined to comment.
At Nationwide Mutual Insurance, which is owned by its policyholders, a spate of tornadoes led to “unprecedented claims” and a $582 million annual loss that helped wipe out most of CEO Stephen Rasmussen’s bonus under the insurer’s plan. The board later shifted the formula, more than doubling the award he would have gotten under the original formula, the company said in a regulatory filing for one of its subsidiaries, without disclosing the amount. Rasmussen collected about $5.3 million in total pay, according to the Insurance Forum, an industry newsletter. Nationwide said in a statement that the pay revision applied to employees “across the organization” and not just to senior executives.
The bottom line: Since the economic crisis, pay experts say more boards are paying CEO bonuses regardless of benchmarks.
