The big pay (scale) back

Perhaps the day has come that critics of executive compensation have been waiting for.

For the first time in its seven years, Modern Healthcare's annual survey of corporate CEO pay has failed to turn up a healthcare CEO who raked in more than $15 million in compensation last year. The performance of the stock market in 2008 was a big reason that the compensation of the 30 CEOs covered by the survey was relatively low. Not a single CEO cashed in stock options worth more than $10 million in 2008, also a first for the survey.

The relative down year for healthcare CEO compensation probably won't generate much empathy for the CEOs. The median compensation for the 30 CEOs in the survey was still a bit more than $4 million. Moreover, as the detailed disclosures on executive pay required by the U.S. Securities and Exchange Commission show, every CEO has stock options that could be worth millions as the equity markets recover.

The magazine's annual survey reports compensation for the CEOs of the 10 largest companies, by revenue, in three sectors: acute-care hospitals, health insurers and specialty-care providers. Wayne Smith, chairman, president and CEO of Community Health Systems, tops the overall list and that for acute-care hospitals with a haul valued at $13.9 million. Last year's chart topper, Aetna CEO Ronald Williams, led the health insurers with compensation of $10.8 million. John Byrnes, CEO of home-health provider Lincare Holdings, moved up to the top spot among specialty-care providers thanks to the largest gain from exercising stock options of any CEO on the list. His total compensation was $11.7 million, including nearly $8.5 million from option exercises.

To be eligible, companies must file periodic reports, which include both their financial results and their executive pay, with the SEC. In the acute-care sector, to give just one example, Ardent Health Services, Nashville, would be eligible based on its 2008 revenue of just over $1 billion, as the company reported in Modern Healthcare's 33rd annual systems survey (June 8, p. 26), but the company does not file periodic reports with the SEC, and its executive compensation is not published.

The survey uses figures from the summary compensation table required by the SEC, with the exception of the table's estimate of the value of stock options granted to the executive. Stock options are not counted till they are exercised, and the net proceeds are then added to the CEO's salary, bonus, restricted stock grants, nonequity incentive payments and other compensation that includes use of leased or corporate-owned jets, car allowances, club memberships and health benefits.

The compensation of Community's Smith included restricted stock valued at $8 million, and a $216,000 bonus that the board granted to Smith (with smaller bonuses going to other executives) in light of the company's performance in the face of a deep recession, according to the company's proxy statement. The restricted stock valuation is what the Franklin, Tenn.-based company must recognize to comply with accounting rules, and it includes amounts granted in years prior to 2008, according to the proxy.

Smith declined to be interviewed for this story. In a written response, spokeswoman Tomi Galin said that Community boosted some financial incentives in order to maintain its management team after the acquisition of Triad Hospitals, which was completed July 25, 2007, and doubled the size of the company. Those incentives showed up in Smith's 2008 compensation, Galin wrote. In February, Community's board of directors approved a so-called clawback policy that could allow the company to recoup some executive compensation if the board determines that executive fraud forced the company to restate its financial results in part or in whole, according to the proxy. Smith suggested this policy change, Galin wrote.

Two new hospital executives joined the list, although the same 10 acute-care hospital companies are represented as in 2007. Gary Newsome replaced Burke Whitman as president and CEO of Health Management Associates in September 2008, and Kenneth Westbrook took over the top slot at Integrated Healthcare Holdings on Dec. 1, 2008.

For the second year in a row, Aetna's Williams was the top earner among insurance executives, but his total compensation was far short of what he earned in 2007, when he cashed in options worth $32.8 million and earned just shy of $43 million. Aetna declined to comment for this story. H. Edward Hanway, CEO of Cigna Corp., grabbed the second spot again. But like Williams, Hanway earned far less than in 2007. He took home a total of $10.2 million in 2008, down from nearly $31 million the year prior.

One new name among the insurers was Heath Schiesser, who replaced Todd Farha as CEO of WellCare Health Plans. For less than a full month at the helm in 2008, Farha took home $3.5 million, largely by cashing out stock options before he left the company. Farha received no severance or golden parachute when he left WellCare, according to company filings, and got just $17,223 at his time of exit, in unused vacation pay. He still managed to spend $16,000 in housing and car expenses in New York in January before his resignation, according to company financial statements. (See story below on the declining use of perks among not-for-profit hospital executives.)

Farha still could receive up to 130,000 unvested company shares under a 2005 agreement, provided he meets certain criteria, which likely will be determined by the outcome of pending state and federal investigations.

Clearwater, Fla.-based Lincare Holdings' CEO Byrnes earned the top spot in the specialty providers list this year. Byrnes had the highest proceeds this year from exercising stock options, at nearly $8.5 million. Byrnes can thank his long tenure at Lincare, having become its CEO in January 1997 and joining the board of directors in May of that year. Lincare provides respiratory care, infusion therapy and medical equipment to patients at home. Byrnes declined to comment for this story.

The only new name on the specialty-care list this year is O. Edwin French, president and CEO of heart-hospital operator MedCath Corp. French replaces Lawrence Higby, CEO of home-health provider Apria, which dropped off after Apria became a privately held company last fall and stopped filing reports with the SEC. After nearly 11 years with the company, Higby relinquished his CEO duties, but stayed on as vice chairman.

While public anger over executive compensation has reached new heights in this recession, academics who study the issue continue to echo Winston Churchill's opinion of democracy: Having corporate boards negotiate pay is the worst system they know, except for all the others.

New research from Carnegie Mellon University's Tepper School of Business, Pittsburgh, studied the effects of incentive-based executive pay on the aerospace, chemicals and electronics industry from 1944 to 1978 and then from 1993 to 2003. The study will be published in a future issue of the American Economic Review. It found that returns to aerospace companies, for instance, would have been 9% lower annually without incentive-based pay. Lower returns make for lower tax revenue, both from corporate taxes and taxes on dividends and capital gains, said Robert Miller, one of the study's co-authors and a professor of economics and strategy at the Tepper School.

The study also found that compensation was more closely correlated with the long-term value of companies—defined as the dividends they produce for shareholders—than with stock market performance, Miller said. “Shareholders and company boards make mistakes about how they should compensate their CEOs, but they are still in a much better position to gauge how their managers should be behaving relative to the rest of us, and they also have their own money at stake,” Miller said.

The Carnegie Mellon researchers are still studying a wider range of industries, including healthcare services, for the 1993 to 2003 period, for which the data cover all industries, Miller said. The initial results on healthcare services executives were not in line with expectations, but figuring out why will require more study, Miller said.

Alex Edmans, assistant finance professor at the Wharton School of the University of Pennsylvania, Philadelphia, contends that too much attention is paid to the handful of CEOs who are paid off to walk away from the mess that they created, rather than to the successful CEOs who made a big difference to the value of their companies. For example, the founders of Google have become extraordinarily wealthy, but they also created tremendous value for shareholders and online products used by millions of people, he said. If a CEO can produce a 1% improvement for a $10 billion company, that's worth $100 million, he added.

Ed Lawler, a professor of business at the Marshall School of Business at the University of Southern California and director of the Center for Effective Organizations, said that executive pay for 2009 will be a key test of the idea that a variable pay system means that it can go down, too.

“The results from 2008 show a slight decline in exec comp from 2007, but they don't show a sharp downturn, given the drop in company earnings and stock market performance,” Lawler said. “That's the thing that I'm looking for next.”

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