It's open season on corporate compensation and the critics haven't spared healthcare executives.
The pay police have been focusing much of their healthcare scrutiny on HealthSouth Corp. and Tenet Healthcare Corp. In each case, the troubled company's former chairman and chief executive officer sold millions in compensation-related stock in the months, or even weeks, before bad news pummeled their company's investors. In both cases, each was the top-paid executive in his field.
For HealthSouth, the nine-figure paycheck that founder Richard Scrushy took home last year also played a role in triggering the investigation into the alleged massive accounting fraud at the Birmingham, Ala.-based rehabilitation company. The Securities and Exchange Commission was probing stock sales made in 2002 by Scrushy when it learned of the allegations that led to its civil suit against HealthSouth and Scrushy in March.
At Tenet, the $111 million stock sale that former Chairman and CEO Jeffrey Barbakow made in January 2002 has been characterized by the company's critics as the perfect symbol of the greed that led Tenet into trouble. Tenet has disclosed an SEC investigation of some sales of Tenet stock, but the Santa Barbara, Calif.-based company has not said whether they included Barbakow's transaction.
Modern Healthcare's first-ever comprehensive report on CEO pay in for-profit healthcare services and insurers picks up on many of the themes that are part of the debate over how much CEOs should be paid and how that pay should be structured. The magazine reviewed securities filings-proxy statements or annual 10-K reports-for 30 companies, 10 each in acute-care hospitals, specialty-care providers and health insurers. The acute-care hospital companies are the 10 largest by revenue that publicly report results. The specialty-care providers are the 10 largest by revenue, excluding companies whose businesses are primarily skilled nursing or assisted living. The health insurers are the 10 largest by revenue (See chart.)
The pay landscape
Historically, healthcare services and insurance CEOs have not been highly paid relative to chiefs in other industries, said Jose Pagoaga, an Atlanta-based principal with Mercer Human Resource Consulting. In 2002 the median salary-and-bonus total was $1.1 million for acute-care hospital companies and $1 million for the specialty-care providers, compared with the $1.8 million median for the nation's 350 largest public companies, according to Mercer. The top 10 insurers, however, fared better last year: They had a median salary-and-bonus total of $3 million.
While the number of options granted is important, a soaring stock price can play an even greater role in boosting pay, Pagoaga said. "You could take two companies with identical compensation packages, but one ends up worth a lot more because of the performance of the stock," he said. As for CEOs taking home tens of millions of dollars by exercising stock options, Pagoaga said, these huge payouts only come if the stock has increased in value.
Company directors are watching executive compensation much more closely than they used to, said David Bjork, a healthcare compensation consultant for Clark Consulting in Minneapolis. Partially, that's a reaction to the perception that boards have failed to properly oversee management in some of the scandals that have rocked the business world, he said.
In addition to the Enron Corp., Global Crossing and WorldCom corporate scandals, the not-for-profit hospital industry has had to weather the Allegheny Health, Education and Research Foundation scandal, in which the board practiced little oversight of management, Bjork said. Pressure from government regulators and media coverage also has increased the scrutiny, he said.
Healthcare directors, Bjork said, face a powerful pressure that is unique to their industry-the nationwide concern over rapidly increasing healthcare spending. Handsome compensation agreements are harder to defend in light of that concern, especially when directors are facing rising costs to insure their own employees, he said.
Critics of some insurance executives, for instance, say their pay packages are too lavish at a time when Congress is considering legislation to restructure Medicare by moving more beneficiaries into private managed-care plans. The 10 largest publicly traded insurers, each of which covered more than 50,000 Medicare enrollees in 2002, stand to benefit the most, said Ron Pollack, executive director of Families USA, Washington.
"These plans claim they are more cost-effective than traditional Medicare. But they are really far more expensive because their spending on administration, marketing, agent commissions, profits and, of course, executive compensation, is so much higher," Pollack said. He noted that HHS Secretary Tommy Thompson and CMS Administrator Tom Scully were paid just $166,700 and $130,000, respectively, in 2002.
Despite these pressures, CEO pay continues to rise because of competition for executives, Bjork said. On the corporate side, Bjork said, CEO pay skyrocketed in the late 1980s when companies began to offer executives much larger stock option grants. The thinking was that a company's CEO would hold the same goal as shareholders-a rising stock price-the more the CEO stood to benefit from such an increase. But there turned out to be a downside to this thinking. Looking back on the bursting of the stock market bubble, Bjork said, huge stock option grants seem to have encouraged aggressive accounting, misstatements of results and possibly even fraud.
To be fair, he added, option grants also seem to have encouraged prudent risk-taking that brought strong returns for shareholders and other stakeholders. Bjork cited UnitedHealth Group, Minnetonka, Minn., as an example, saying the company has grown into the largest health insurer with good returns to shareholders while avoiding scandal. "Some of the for-profit hospital companies have saved any number of hospitals in small communities from going bankrupt," he added.
Pushing for redesign
Brandon Rees takes a decidedly dimmer view of stock options and executive pay generally. Rees is a research analyst in the AFL-CIO's office of investment. The umbrella union organization considers stock options "inappropriate compensation" because CEOs get the benefits of rising stock prices, but don't feel the pain when the stock prices plummet. The union prefers restricted stock grants that executives receive only if the company reaches certain goals going forward, called performance-vested grants, Rees said. Grants that vest over time simply reward longevity for its own sake, Rees said.
Alan Miller of Universal Health Services, King of Prussia, Pa., received $16 million in performance-vested restricted stock grants in 2002, or about 80% of his direct compensation. Miller, who declined to be interviewed for this story, will receive the stock grants only if Universal hits profitability targets in 2003 and 2004.
Restricted stock grants have become more prevalent in the past two years, but they aren't common enough to be called a trend, Mercer's Pagoaga said.
Stock options overtook restricted stock grants as a favored form of compensation in the 1980s because stock options don't count as an expense on the income statement. Paul Hodgson, a corporate governance researcher, expects regulators eventually to require all companies to count the value of stock options as an expense. With that change, company directors would be less likely to issue options as "free money," said Hodgson, a senior research associate at the Corporate Library, a governance research group based in Portland, Maine.
Tenet changed its policy earlier this year to expense options on its income statements, becoming the first hospital operator to do so (March 24, p. 6). PacifiCare Health Systems, Cypress, Calif., also said earlier this year that it would begin expensing options next year. HCA considered the same move last year, but decided against it because it questioned the accounting methods used to estimate the cost of options.
HealthSouth, Tenet, Oxford
Scrushy not only was paid a $10 million bonus in 2002-a year in which the company's stock price plummeted nearly 72% even before the fraud allegations became public-but he also has "a founder's retirement benefit" that he is entitled to even if he is fired for cause, Rees said. HealthSouth did just that in March, after the SEC suit was filed.
"Scrushy really symbolizes some of the worst excesses of the 1990s CEO pay," Rees said.
Not so, according to Scrushy's attorney. HealthSouth's founder earned every cent building a start-up company into the country's largest rehabilitation provider over two decades, said Donald Watkins, a Birmingham, Ala., lawyer who heads Scrushy's legal team. "This is not a company where some guy took a company five years ago that was already in flight and took it up another 5,000 feet," Watkins said. "He built the plane and made it take off."
As for the fraud allegations that have engulfed the company, Watkins contends Scrushy is just as much of a victim as the company's shareholders, and that the 14 executives who have agreed to plead guilty to fraud charges "knew how to operate underneath the radar screen." Scrushy denies that he had any knowledge of the alleged inflation of profits. HealthSouth has not reported any results for fiscal 2002.
Tenet's Barbakow had a different reaction when his company's shares plunged last year. He agreed to restructure his compensation so that he received no bonus and no stock options for the last seven months of 2002. Eventually, he agreed to step down as chairman and CEO.
Barbakow's case highlights another point Bjork makes: Decisions that affect executive pay are made two years or more before they show up as compensation to the CEO. In the fiscal year ended May 31, 2002, Tenet stock soared 64%, and the company earned profits of $785 million on $13.9 billion in revenue. It wasn't until late October that the stock plunged, after details came to light regarding Tenet's high Medicare outlier payments and an investigation of two physicians at its 188-bed Redding (Calif.) Medical Center.
Tenet spokesman Harry Anderson said the January 2002 stock sale that accounts for most of Barbakow's direct compensation in fiscal 2002 was the first time the former chairman and CEO had exercised options since he joined Tenet's predecessor, National Medical Enterprises, in June 1993. When those options were granted, NME stock traded for $6, but by the time Barbakow exercised the options, Tenet shares were worth more than $40, Anderson said. "That's certainly pay for performance," Anderson said.
The highest-paid insurance executive last year was Norman Payson, who retired as chairman and CEO of Oxford Health Plans, Trumbull, Conn., in November 2002. Payson walked away with $76 million in total direct compensation, including $73 million in exercised stock options.
Gary Frazier, Oxford's senior vice president of investor relations, said Payson's compensation was based on an analysis of Oxford's growth and an extensive review of compensation at other insurers. "Our company went through a pretty dramatic and successful financial turnaround under Payson, and so (his pay) was adjusted to get more in line with the compensation of comparable CEOs, as well as to reflect our significantly improved financial position," Frazier said.
Indeed, Payson, who was brought on board in May 1998 when Oxford was teetering on the brink of bankruptcy, is widely credited with transforming the ailing insurer into one of the most profitable in the industry. Oxford earned $222 million last year, up from a loss of $624 million in 1998. The 1.5 million-member insurer's medical-loss ratio, a percentage of premiums spent to cover medical costs, dropped to 79.3% from 94.4% during the same period. Its stock now trades around $43, up from a low of $6 in August 1998.
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