Cover Story: Written by Vince Galloro
and Laura B. Benko
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.
