Scandal fallout: tougher evaluation of CEO pay

CEO pay was the single most frequent target of shareholder resolutions in 2003 and 2004, and the 2005 proxy-voting season is shaping up to follow suit.

But in the move to broaden and customize incentives, some see a promising future.

For instance: Calvert, the nation's largest family of socially responsible mutual funds, is trying a new proxy tactic. It has filed resolutions pressing four companies to begin rewarding executives according to how well they meet the firm's own social goals, as well as financial ones. This could mean pay hikes for executives who oversee a surge in employee satisfaction or a drop in toxic emissions, to name a couple of possibilities. Response has been encouraging, the mutual-fund company says. Dollar General and Xerox have agreed to link incentives to their firms' social goals, moves that led Calvert to withdraw its resolutions.

Companies concerned with ethics are getting creative to see how much they can require in exchange for top dollar. The system has limits, Ms. Meyer says, since federal regulations require that bonuses be linked to quantitative measurements. But she's seeing companies set goals for organizational culture nonetheless. In those cases, a CEO's pay doesn't rise quite as much if the firm falls short of its cultural goals.

The trend in performance pay has its critics. Elaborate formulas with specific requirements have some chief executives "worried about being micromanaged by a board," Mr. Wilson says.

Others grumble that in the push to use performance as a carrot, one issue has all but disappeared: the ethics of paying leaders exponentially more than rank-and-file employees.

"It detracts from the dignity of the people doing the work of the organization" to pay a CEO at a rate several hundred times higher than an average employee, says Diane Swanson, a professor of business ethics at Kansas State University. "It causes alienation.... An alienated worker can passively sabotage the organization's goal."

In a 2000 study of 200 Australian executives, professor Swanson found a striking correlation. Those who expressed a preference for being paid far beyond what other employees earn were also the ones least concerned with matters of corporate ethics. Based on this, she recommends that companies screen out executive applicants on the basis of their pay preference in order to get leadership with scruples. Then, packages that encourage good behavior at the top will be most effective, and workers won't operate in a cloud of resentment, she says. "I would argue that executives earn their pay when they are attentive to these and other ethical issues."

But the purposeful practices of Vermont ice-cream maker Ben & Jerry's, where the average senior manager earns less than five times as much as the average manufacturing worker, have become something of a quaint anomaly in business. The reason, according to investors and consultants, is that artificial pay caps are unrealistic.

"We found the ratio to be rather arbitrary," says Nilloufer Daruwala, senior social research analyst at Calvert. "It just didn't get to the kind of results that we were trying to accomplish."

What's more, those seeking top talent won't get it if they constrain earning power to make a point, according to Meyer, the executive consultant.

"You're dealing with a market, and you have to pay market value," she says. "When you bring someone in and say, 'Save me,' you have to pay them.... While [pay levels] seem unethical or inappropriate, you have to get down to the reality of the situation."

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