Taking a Tougher Stand on CEOs With Bad Returns

Should top executives make a lot of money when their investors lose out? Absolutely not, more corporate boards have decided.

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Fifteen big and midsize businesses, including AT&T, have capped incentive-plan payments for this reason since 2006.

Keen to avoid investor outcry over executive pay, a growing number of U.S. companies are limiting the upside for top leaders in down years for stock prices by restricting certain compensation when total shareholder return is negative. (Total shareholder return equals share-price changes plus reinvested dividends.)

The little-noticed move is unusual because the impetus comes from board members themselves, and not activists.

"It's distasteful to pay out very high reward levels when your shareholders are losing money," explains Laurie Siegel, who spearheaded such limits as head of the board compensation committee at CenturyLink Inc., a telecom company based in Monroe, La.

Fifteen big and midsize businesses, including Pfizer Inc. and AT&T Inc., have capped incentive-plan payments for this reason since 2006, with seven doing so since 2011, a Hay Group analysis for The Wall Street Journal found.

Pinched Pay

Some firms limit rewards for top bosses when investors lose money over three years

• Diebold: Top officers don't get additional shares tied to performance, adopted in 2012
• Dell: Top officers don't get extra restricted-stock units tied to performance, adopted in 2012
• CenturyLink: Senior executives don't get added restricted shares tied to performance, adopted in 2011
• AT&T: Top officers keep no more than 90% of shares tied to performance, adopted in 2008

The most common tactic is lowering payouts of "performance shares" during down periods�even if a company outperforms rivals. Performance shares involve grants of company stock tied to various measures; if goals are met, the executive can keep those shares. Directors often impose a 100% cap, giving executives a chance to keep their full grant. Without a ceiling, pay plans typically allow senior officers to receive up to twice as many shares, even when there is a negative shareholder return.

Northrop Grumman Corp. and Diebold Inc. were among companies adopting curbs last year. Rewards for a stock-price decline "should be balanced against the potential misalignment with shareholder value," Diebold said in its latest proxy statement.

The board action reflects a shift in best practices, a spokesman says. Thomas W. Swidarski, CEO of the struggling maker of automatic teller machines, stepped down Jan. 24.

About 10% of all public U.S. companies pinch executive pay due to a negative return, twice the proportion that did so in 2008, estimates Irving S. Becker, head of Hay's U.S. executive compensation practice.

He predicts nearly 40% may do so by 2015.

"It's bad optics to pay out at the maximum level when total shareholder return is negative," Mr. Becker says. He believes board members who aren't seen as punishing top bosses for poor results may spur shareholders to vote down executive-pay plans. Under the Dodd-Frank financial-overhaul law, investors began casting nonbinding votes on executive pay in 2011.

Though the votes can't nix top officers' packages, boards are loath to ignore investor wishes.

Institutional Shareholder Services, which advises large investors how to vote in corporate elections, recommends a "no" vote for an average of 13% of say-on-pay votes a year. Yet last year, the proxy-advisory firm recommended a "yes" vote at 20 companies with payout curbs for negative returns, says Carol Bowie, head of U.S. research for the proxy-advisory firm. That indicates a considerably higher endorsement rate than ISS usually gives to say-on-pay votes, according to Ms. Bowie.

"Boards deserve some credit for capping payouts without being prodded by investors," suggests Aeisha Mastagni, an investment officer for California State Teachers' Retirement System. The big public-pension fund frequently targets underperforming companies with overly generous management rewards.

CenturyLink, for example, embraced a cap in 2011 largely because Ms. Siegel liked the idea. Senior executives of the telecom concern won't receive additional restricted shares tied to its relative stock performance if shareholder return is negative over a three-year period. The first such period ends in May 2014.

Ms. Siegel says she recommended the restriction because similar steps by conglomerate Tyco International Ltd. in 2007 had pleased investors there. (She was Tyco's senior vice president of human resources until she retired last fall.)

Stacey Goff, general counsel for CenturyLink, recalls that he and affected fellow executives decided a pay circuit breaker "seemed logical and fair." He adds, "it really wasn't a big issue for us." (To be sure, few executives would risk publicly agitating for more money in the event their investors suffer.)

Mr. Goff collected a 2011 pay package worth about $1.9 million, including performance-based restricted stock, CenturyLink says.

Hypothetically speaking, Mr. Goff figures if the cap had been in place for 2011 and there had been three years of negative shareholder returns�which there weren't�he would have been able to keep performance-based restricted shares valued at a maximum of $590,000. Without a cap, the value of the maximum would be double that.

Pfizer hoped to hew more closely to shareholder interests when it introduced performance shares with payout curbs in 2007, a spokeswoman for the drug maker says. Senior leaders lost all or most of their initial grants in 2009 and 2010, partly due to a negative return during the prior three years. She declined to comment on those leaders' reaction.

Drug-industry rival Eli Lilly & Co. takes an even tougher stance. Under a performance-share plan launched in 2007, executive officers get no shares if Lilly investors see zero or negative returns over a three-year period. That has already happened twice.

Developing a new medicine frequently takes at least a decade, so Lilly executives "recognize the need for their equity compensation to reflect this long-term view," according to a Lilly spokesman.

"Few businesses have imitated Lilly's approach because it's so radical," observes David Schmidt, a senior consultant for James F. Reda Associates, a unit of Gallagher Benefit Services Inc.

Some corporate boards considering such actions fear upsetting executives. Directors at two big industrial concerns recently debated a proposed restriction, says Ira Kay, a managing partner at Pay Governance LLC who advised them. They dropped the idea after concluding "it would not be fair to the executives."

Write to Joann S. Lublin at joann.lublin@wsj.com