'Comping' the CEO.

• Position: Letter from the Chairman - Executive compensation

FOR TWO DECADES many chief executives have gotten a free ride. When the stock market was high, they received compensation in the stratosphere. When the market returned to earth, their pay remained aloft, thanks to compensation committees unwilling to recognize the laws of gravity. In recent years, comp committees, often taking their cues from top management and their designated consultants, have found ways to prop up CEO pay by loading them up with new, lower-priced stock options and by raising cash-based remuneration. As a result, despite poor performance, CEOs generally have not suffered very much.

In response to perceived excesses, the 2003 proxy season has targeted executive compensation. Whereas last year less than 20% of shareholder proposals were aimed at executive comp, this year that number has doubled. Shareholder activists are attempting to rein in top management pay. Their proposals not only target the overall amount of pay, but also its composition, in particular stock option packages. Many investors blame compensation programs weighted excessively with stock options for the rash of corporate scandals. They believe that dangling dazzling sums of stock-based compensation encouraged CEOs to try to pump up stock prices, which often led to catastrophe.

Over the past few years, 60% of CEO total compensation has derived from stock options. For the largest companies, stock-based pay packages have constituted up to 80% of total comp. In many cases these plans have resulted in gargantuan paydays. However, the value that many of these superpaid CEOs supposedly created has evaporated, leaving shareholders holding the bag. In...