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Coke Directors Agree to Give Up Pay If Company Misses Earnings Goals
posted by admin on 26/06/06

Experts argue directors may focus too much on short-term gains and stock performance that may lead to corporate scandals such as in the cases of Enron Corp and WorldCom Inc 

Coca-Cola Co. unveiled a radical new plan for compensating directors: eliminating their pay altogether unless the company hits financial targets. 

The plan appears to be unlike any other at a major company, and comes at a time when rising pay for executives and directors has drawn fire from critics. But it was greeted with skepticism by some compensation experts who said prior efforts to tie pay to performance have given executives an incentive to focus too much on short-term gains.
Coke said it aimed to give directors the same incentives as shareholders and executives. Standard corporate practice is to award board members a mix of cash and stock regardless of how the company performs. 

"This aligns the interests of shareholders and directors on both the upside and the downside," said billionaire investor -- and longtime Coke director -- Warren Buffett. "I've never seen a system as good as Coke has now." 

Under its new plan, the Atlanta beverage giant will annually allocate "equity-share units," initially valued at $175,000, to each director. The units granted in 2006 can't be cashed until three years have passed -- and only if Coke posts compounded annual growth of 8% in operating earnings per share in 2006, 2007 and 2008. The value of the units can rise or fall depending on Coke's stock price. 

Coke calculates that for directors to get paid, earnings per share will need to rise to at least $2.73 in 2008 from $2.17 in 2005. From 2003 through 2005, Coke's operating earnings -- the measure being used -- grew by 9.3% on a compounded annual rate.
The program, which takes effect immediately, replaces a more standard plan, under which directors got $50,000 in cash and $75,000 in share units each year -- plus other fees -- regardless of Coke's performance. 

Greg Taxin, chief executive of Glass, Lewis & Co., a San Francisco investment research and proxy-advisory firm, said Coke's plan "sets up the wrong incentives" for directors by tying their pay completely to company performance. "I think it's a scary thing to have an audit committee have those incentives," Mr. Taxin said. 

Corporate critics have said the lure of huge financial incentives tied to generous stock-based awards played a role in the wave of corporate scandals exposed earlier this decade, at companies such as Enron Corp. and WorldCom Inc., because executives and board members benefited personally from rising stock prices and weren't diligent about fraud. Indeed, partly in reaction to the scandals, big companies have been moving away from tying director compensation to corporate performance because of concerns it compromises independence. 

Some experts said it could be harder for Coke to attract future directors, especially among academics, nonprofit group leaders and former government officials with limited incomes. "There are going to be people who take a hard line," said Charles H. King, head of the global board practice for recruiters Korn/Ferry International in New York. "They will say, 'My time is worth something. I'm not going to put my time at risk.'" 

Moreover, tying pay to performance could create "economic disincentives to leave the board if you have a disagreement," said James Kim, a principal at pay consultants Frederic W. Cook & Co. 

But Coke directors said they had considered such questions too, and concluded there was little risk. Directors began debating the approach late last year, said James D. Robinson III, the former head of American Express Co. who has been a Coke director since 1975 and heads the board's corporate-governance committee. They discussed whether earnings-per-share was too narrow a measure, but concluded it wasn't, he said.
Asked whether directors might be tempted to prop up short-term earnings growth, Mr. Robinson said: "The likelihood of that happening to meet a payout is very remote" because "you have a very responsible set of directors." 

As for new directors, they will get a one-time cash payment of $175,000 as a sort-of signing bonus, Mr. Robinson said. If recruiting becomes a problem, he said, "we will deal with it.'' 

Mr. Buffett, who is leaving the Coke board this month, said he "would feel better about owning the stock of a company that had this kind of plan. It would not be the sole factor. But I like the idea of directors thinking with the same kind of calculus I would be using." He added that a strict pay-for-performance compensation plan might not be appropriate for directors of some companies that are struggling. 

To be sure, most directors on Coke's star-studded and very stable board will barely feel the loss of their guaranteed pay. In addition to Messrs. Buffett and Robinson, Coke's board includes investment banker Herbert Allen, Internet mogul Barry Diller and James B. Williams, the retired chairman and CEO of SunTrust Banks Inc., which is a major Coke shareholder and keeps Coca-Cola's secret formula in a bank vault. 

Given that, it's far from clear whether Coke's plan will catch on elsewhere or be seen as a one-shot. "I don't foresee this being widely adopted," said Mr. King of Korn/Ferry. 

"A lot of companies would have difficulty selling this kind of plan," to prospective directors, said Mr. Kim. But he added that Coke may be an exception because it can attract directors with prestige as much as with money. 

Still, Mr. Kim said, he knows of no other company that ties all of a director's compensation to performance. "It's not even a topic," in discussing director compensation, he said. A recent survey by the Corporate Library, an independent corporate-governance research organization in Portland, Maine., found just 2% of companies had a plan directly tying any director pay to company performance. 

Under the plan, Coke's board can reset the three-year financial target each year or keep it the same. Coke spokesman Ben Deutsch said the earnings-per-share goal is likely to remain in place, but there is flexibility to use other measures in future years. 

But Mr. Buffett said the board took the added step of making the performance target for the director's pay easily identifiable, in this case Coke's 2005 earnings per share of $2.17. "Corporations are famous for moving the target," he said. "This won't get gamed."
All additional cash that had been paid to Coke directors for attending meetings and heading board committees has been eliminated. For example, director Peter Ueberroth was paid $25,000 last year for heading the Coke audit committee. 

The plan is the latest step taken by Coke to shake up its governance practices. In recent years, its board has been ahead of many others in expensing stock options and ending the practice of issuing quarterly earnings guidance. 

At the same time, Coke directors have been criticized for granting lucrative payouts to departing executives at a time when company performance was lackluster. Last year, in response to pressure from investor groups, the Coke board said it would seek shareholder approval for severance agreements if the payout exceeds 2.99 times the sum of the executive's annual base salary and bonus. 

Coke's senior executives currently receive a mix of salary, bonus, stock options and performance-based stock awards contingent on earnings goals over a three-year period, much like the directors' pay plan. Last year, Chairman and Chief Executive Neville Isdell received $6 million in salary and bonus. In February, Coke's board granted him 900,000 stock options and the ability to earn another 160,000 shares if Coke hits certain profit goals. 

Coke shares were down 13 cents at $41.95 in 4 p.m. New York Stock Exchange composite trading. 

Write to Chad Terhune at chad.terhune@wsj.com and Joann S. Lublin at joann.lublin@wsj.com


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