If 2002 was a year that brought chief executive officer pay to the forefront, 2003 is a year that shows that CEOs know how to adapt.
As healthcare CEO pay illustrated in 2002, executives cashing in on thousands of dollars in stock options for a gigantic windfall just weeks or months before a sharp drop in the company's stock price will spark a firestorm of protest from investors, unions and corporate governance advocates.
One answer to that problem was a shift from stock options to restricted stock grants, in which executives receive actual shares of stock. The value of option grants fell last year, while the number of restricted stock awards to executives increased by more than 20%, according to a study of CEO compensation by the Corporate Library, an independent investment research firm providing corporate governance data and analysis.
The structure of stock-based pay changed a little from 2002 to 2003 among 31 healthcare companies in three sectors-acute-care hospitals, specialty healthcare providers and health insurers, according to Modern Healthcare's second annual report on healthcare CEO pay at for-profit companies. Eleven of the surveyed companies provided CEOs with both stock options and restricted stock grants in 2003, up from just six in the previous year. Fewer provided stock options without restricted stock grants-13 in 2003 vs. 17 in 2002. In both years, seven companies gave their executives no stock-based compensation. At one company in 2002, Universal Health Services, stock-based compensation was restricted stock only.
Still very lucrative
Despite all the attention, CEO pay increased strongly in 2003. Comparing the results of this year's survey with the 2002 survey (Aug. 4, 2003, p. 6), health insurers nearly doubled their median total compensation to $14.2 million. Median total compensation for acute-care hospital CEOs was up 12.5%, to nearly $2 million, and for specialty providers, the median total compensation rose 18.2%, to $1.7 million. (For more information on hospital industry executive pay, see Modern Healthcare's 24th annual Executive Compensation Survey.)
"Pay continues to escalate and in many cases to obscenely high levels," said Ann Yerger, deputy director of the Council of Institutional Investors, which represents pension funds. "This continues to be the No. 1 issue for our members." Yerger said more vocal opposition to corporate pay packages could help change the tide.
Some of the differences between the healthcare sectors can be traced to stock performance for fiscal 2003. All 11 of the health insurers included in the survey saw double-digit increases in their stock price, ranging from 19.2% to 140.6%. All but one of the specialty providers saw a double-digit increase in stock price in 2003, with a high of 65.1%. Among the seven publicly traded hospital companies included in the survey, two had small declines in their stock price and the largest gain was 22.5%.
The median total compensation for CEOs of companies listed on the Standard & Poor's 500 was up more than 22% in 2003, to $4.4 million dollars, said Paul Hodgson, the author of the Corporate Library's report. This increase was more than double the 9.5% increase in the median in 2002, Hodgson said. Except for the value of stock-option grants, every form of CEO pay increased for the S&P 500 CEOs, he said, including base salary, annual bonuses, restricted stock grants, long-term incentive payments, the value realized from exercising stock options and total compensation.
Hodgson expects regulators to eventually require all companies to list options as expenses on their balance sheets. That way, they would be less likely to regard issuing options as "free money," he said, that doesn't affect the earnings the company reports. Hodgson argues that stock price appreciation is not a sufficient measure for granting options because, over time, about half of the gain in any individual stock is tied to the overall increase in the equities market.
Change comes slowly
Corporate boards did not change the structure of executive pay in 2003 as much as Clark Consulting had expected, said David Bjork, managing director of the firm's healthcare group. "We have seen a modest shift toward using restricted stock instead of options, but we have not seen as big a change as we expected to see," he said.
Stock-option grants are being structured differently, Bjork said. Some options require the company to meet certain performance goals before the options vest to the CEO, he said. Other boards are setting the exercise price for the options at 10% to 15% above the current stock price to avoid rewarding CEOs for a general upswing in the stock market, he said.
The thinking behind restricted stock grants is they provide an executive with a downside risk: The value of the grant drops if the company's stock price drops. Since the grants are made at the current price of the stock, the executive can't sell them immediately after receiving them to turn a quick profit.
With options, the same line of thinking goes, the executive has great incentive to run the stock price up in the short to medium term to get a big spread between the stock price and the options exercise price. Then the executive can exercise the options and immediately sell the stock on the open market for a big gain that is safe and secure in his or her pocket no matter what happens to the stock price after the sale.
Bjork said the total compensation figures are bound to remain high for several years because of stock options granted nearly a decade ago. Even if a company hasn't granted its CEO any stock options in the past year or two, longer-serving CEOs usually have hundreds of thousands of older stock options that are vested and ready to be exercised and sold at prices much lower than the option grant price, which is the price the executive pays. A better measurement of current compensation is to study the value of the options granted, he said, although that requires an estimation of their future value.
On the basis of salary and bonus alone, hospital and specialty healthcare CEOs both saw their median salary and bonus rise from 2002. For the hospital executives, the median was up 45%, to nearly $2 million. For specialty-care CEOs, the median was up nearly 43%, to $1.4 million. The insurance CEOs had the same median salary and bonus of $3 million in both years.
Less of a target this year
The two lightning rods of healthcare CEO pay in 2002-Richard Scrushy of HealthSouth Corp. and Jeffrey Barbakow of Tenet Healthcare Corp.-are out of the picture now.
In Scrushy's case, his huge stock-based compensation paved the way for his ouster from the company. It was Scrushy's stock sales and the repaying of a $25 million loan from the company with HealthSouth shares that lost nearly all of their value because of an earnings warning that prompted the Securities and Exchange Commission investigation that uncovered the company's massive accounting fraud (March 24, 2003, p. 4).
HealthSouth replaced its founder with former HCA executive Jay Grinney in May. Grinney's pay package for 2004 won't be revealed until HealthSouth begins financial reporting again either late this year or in 2005, company spokesman Andy Brimmer said. Interim CEO Bob May was paid $40,000 per month in 2003 and joined the company around April 1, for a total of $360,000, Brimmer said.
At Tenet, Barbakow's sale of stock valued at more than $110 million in January 2002 was viewed much more suspiciously when the company's high-flying earnings unraveled just 10 months later amid questions about Tenet's Medicare outlier billings (Nov. 7, 2002, p. 6). Barbakow resigned in May 2003 and was replaced by Trevor Fetter in September 2003.
Not-for-profit hospital and health system CEOs are also facing more scrutiny, and from an even tougher taskmaster than investors-the Internal Revenue Service. The IRS is auditing the pay and perks of not-for-profit executives who earn $1 million or more annually (May 31, p. 6), and that should include upward of 50 hospital or health system CEOs, Bjork said. Pay at the highest levels of not-for-profit care is growing much more rapidly than in the middle ranks, where increases are in the 4% to 5% range, he said.
Modern Healthcare's report ranks the top 10 companies in each of the three sectors by net revenue. An 11th company was included in the health insurance sector because of the similarity in revenue in 2003 of three smallest insurers-WellChoice, Coventry Health Care and Oxford Health Plans.
The top pay among hospital CEOs in this year's report went to Alan Miller, chairman, president and CEO of Universal Health Services. Miller received a salary and bonus totaling $1.8 million, exercised stock options that netted him $6.9 million and received forgiveness on a company loan valued at $7.4 million, according to Universal's proxy statement. Universal posted the second-largest gain on its stock in fiscal 2003 among the hospital companies, with a 16.2% rise. Universal's stock has faltered in 2004, dropping nearly 15% this year.
Miller is also the founder of Universal, which celebrated its 25th anniversary earlier this year, and he and his family retain control of the company by holding stock with greater weight in shareholder votes than the class of stock sold to the public.
Through a spokesman, Miller declined to comment.
The specialty provider with the top pay is also a family affair, Select Medical Corp. Robert Ortenzio, president and CEO of the long-term acute-care hospital provider, topped the specialty provider chart with a total compensation of $15.9 million. His pay package included $2.5 million in salary, bonus and benefits and $13.4 million in stock options. Moreover, Robert's father, Rocco Ortenzio, who is Select's executive chairman and co-founder with Robert, hauled in $31.5 million, including $29.1 million gained on stock-option exercises.
Both Robert and Rocco Ortenzio declined to comment. Select spokesman Joel Veit noted that the bulk of pay for both men came in the form of stock-option exercises, and that they held those options for many years as they built up the company. Select turned in the second-highest increase in stock price in 2003 among the specialty providers, at 58.7%. The company's shares have lost nearly a quarter of their value in 2004, however.
Heavy scrutiny continues, however, for health insurance CEOs. Hefty revenue and profit increases last year led to bigger salaries and bonuses for the top brass of the nation's 11 largest publicly traded health insurers, while the stock market recovery prompted more of them to cash in their options, boosting total compensation to record levels, analysts said.
UnitedHealth Group Chairman and CEO William McGuire exercised $84.2 million in options last year, bringing his total annual payout to $94.2 million, by far the highest of all the executives. At year-end, he held $721 million in exercisable and unexercisable options, $32.8 million of which were granted in 2003.
UnitedHealth spokesman John Penshorn called McGuire's compensation "appropriate" for the top executive of a leading Fortune 500 company with 18.3 million members, $28.8 billion in annual revenue and operations in 40 countries. The insurer's 2003 earnings grew 35% to $1.83 billion and its stock price rose 39% to $58.15 on Dec. 31.
"Ours is an extremely complex business," Penshorn said, adding that UnitedHealth is not directly comparable to the other publicly traded health insurers, which are significantly smaller and far less diversified.
Penshorn said UnitedHealth has traditionally paid its executives less in cash and more in options than companies of comparable size. While that combination "has proven to be an effective tool for recruiting top executives from outside the industry," he said, it does not unduly affect shareholders.