Echoing John F. Kennedy’s famous admonition, “Ask not what your country can do for you,” Computer Associates International Inc.’s CEO, Charles B. Wang, is giving compensation to his company, to the tune of $144 million. That may sound like a noble case of executive sacrifice, but don’t look for other CEOs to ask how they, too, can give something back to their companies. Not unless they are forced to at the point of a court order. If anyone is likely to be inspired by the Computer Associates pay fiasco, it will be shareholders rather than executives. Investors should take away at least two lessons from this episode: Do some math before signing off on an executive compensation scheme, and don’t set a performance target that ignores what happens in the broader stock market. Let’s recap what happened. Wang and two other top executives of the Islandia, N.Y.-based software maker agreed last month to hand over more than $263 million in stock granted under a 1995 compensation plan to settle shareholder lawsuits over the awards. The story began in May 1995, when CA’s board compensation committee among whose three members is Richard Grasso, the head of the New York Stock Exchange approved an unusual compensation plan that called for Wang and his two top lieutenants, Chief Operating Officer Sanjay Kumar and Executive Vice President Russell Artzt, to get 6 million shares of stock utterly free if the stock hit certain targets during, essentially, the following five years. In presenting the plan to shareholders, CA’s board never mentioned how much those shares would be worth if the targets were reached. Even in 1995, 6 million shares spread among three executives surely didn’t seem very high, and CA’s shareholders dutifully approved the plan. The fine print Had the shareholders done the math, they would have learned that Wang and his two associates stood to get free shares worth as much as $1.1 billion if the stock reached the target. And that, folks, was on top of already-lavish pay arrangements, including hefty cash bonuses, lots of other free shares and lovely stock option grants. One of the many targets in the plan provided that if CA’s closing price exceeded $180 a share during any 60 trading days within any 12-month period, all of the shares would be earned, regardless of whether this event occurred before the end of the nominal five-year performance period. May 21, 1998, proved to be that 60th day, and Wang took final receipt of what had, through three different stock splits, become 12.15 million shares worth $670 million. His two associates received between them shares worth $447 million. Free shares of stock, in contrast to stock option shares, require a company to charge its earnings. But when the shares became fully vested, Computer Associates had charged virtually nothing, so on July 22, 1998, it stunned the world by announcing it was taking a $675 million after-tax charge for the cost of the plan, thereby wiping out 43 percent of its pre-plan earnings for the preceding three years. When investors heard the news, they promptly sent the stock diving 31 percent on that single day. The disclosure generated a host of lawsuits. Most such suits are aimed at convincing a court that the board of directors negligently wasted the shareholders’ assets. And almost all such suits end up going nowhere, because the board clothes itself in the “business judgment” rule, which gives it immense latitude in exercising its business judgment. Overlooked detail However, one lawsuit directed at CA took a different tack. Pay plans involving company stock routinely contain so-called anti-dilution language, meaning that if a stock split occurs after the approval of the plan, then the number of shares provided under the plan are duly adjusted. But some lawyer forgot to include the anti-dilution language in this particular plan. I figure that lawyer has for some time been living in an emerging nation under a forged identity. Accordingly, this particular lawsuit demanded that Wang and his associates return 9.5 million shares, which, the plaintiff argued, did not qualify for split adjustment. The court agreed on this narrow ground, and after negotiations, Wang and company agreed to return 4.5 million shares. Wang’s piece of the giveback came to $144 million, dropping his pay for the fiscal year ended March 31, 1999, to $511.4 million and making him, not 8,500 percent overpaid by my calculations, but just 6,611 percent overpaid. The saga serves up two cautionary notes. First, shareholders need to improve their reading and analytical skills before approving a compensation plan. Ironically, a leading shareholder advisory service, Institutional Shareholder Services, recommended rejecting the plan in 1995 and its advice for which its clients paid good money was largely ignored. Second, if ever there was a case for indexing stock-based rewards to the overall market or an industry subset, this was it. While 20 percent annual price growth was not common when the board approved the plan in May 1995, the S & P; 500 Index rose at the rate of 24 percent a year between May 17, 1995, and April 3, 2000. And the S & P; Computer Software Index rose at the rate of 43.2 percent a year during the same period. If CA had tied its compensation plan to an index, it certainly would have produced smaller payouts, if any, than those that were awarded. Graef Crystal is a columnist with Bloomberg News.
