|LRO - SUPPORTED PROXY PROPOSALS FOR LUCENT'S 2006 ANNUAL MEETING|
AWARD PERFORMANCE-BASED EQUITY COMPENSATION
Resolved, that the shareholders of Lucent Technologies request that our Board of Directors adopt a policy whereby at least 75% of future equity compensation (viz., stock options and restricted stock) awarded to senior executives shall be performance-based, and the performance metrics adopted by the Board disclosed to shareholders.
“Performance-based” equity compensation is defined here as:
(a) Indexed stock options, the exercise price of which is linked to an industry index;
(b) Premium-priced stock options, the exercise price of which is substantially above the market price on the grant date; or
(c) Performance-vesting options or restricted stock, which vest only when the market price of the stock exceeds a specific target for a substantial period (e.g., 180 days).
As long-term shareholders, we support compensation policies for senior executives that provide challenging performance objectives that motivate executives to achieve long-term shareholder value. We believe that a greater reliance on performance-based equity grants is particularly warranted at Lucent.
The compensation of Lucent’s senior executives appear to be completely disconnected from returns to shareholders. During her first three years as CEO, Patricia Russo received equity compensation valued at over $33 million – including nearly 15.4 million standard options – yet Lucent’s share price remains 55% lower than the day she became CEO in 2002.
For fiscal 2003, Lucent reported a net loss of $1.2 billion. The Board’s response? It awarded the top five senior executives 9.3 million standard stock options in 2003 – at an exercise price equal to the market price.
For fiscal 2004, Lucent reported net income (before income taxes) of $1.14 billion, its first profit in four years. But, as Wall Street analysts observed, nearly all of this “profit” resulted from $1.11 billion in non-cash accounting credits attributable to projected returns on Lucent’s pension assets. The Board’s response: it awarded 5.6 million more options to the five top officers.
We believe that Lucent is the classic case of a company that awards an unnecessarily large quantity of standard stock options that can yield windfalls for executives who are merely lucky enough to hold them during a rising market. Moreover, because Lucent’s Board does not seek shareholder approval for its stock-based incentive plans, the Company loses the tax deductibility of executive compensation exceeding $1 million.
Many leading investors criticize standard options as inappropriately rewarding mediocre performance. Warren Buffett has characterized standard stock options as “really a royalty on the passage of time” and has spoken in favor of indexed options.
In contrast, peer-indexed options reward executives for outperforming their direct competitors and discourage re-pricing. Premium-priced options reward executives who enhance overall shareholder value. Performance-vesting equity grants tie compensation more closely to key measures of shareholder value, such as share appreciation and net operating income, thereby encouraging executives to set and meet performance targets.
This proposal received support from a majority (50.2%) of shares voted last year, yet we see no evidence that Lucent’s Board has moved to benchmark equity compensation to the relative performance of management against the market.
Please VOTE FOR this proposal.
Exclude Pension Credits from Calculations of Executive Compensation
Resolved: The shareholders of Lucent Technologies urge the Board to determine future awards of performance-based compensation for executive officers using a measure of earnings that excludes non-cash “pension credits” that result from projected returns on employee pension fund assets, and to report annually to shareholders on the specific financial performance measure used to award performance pay.
A very large share of the Company’s reported earnings is not cash flow from ordinary operations, but rather accounting rule income from “pension credits.” Because pension credits reflect neither operating performance nor even actual returns on pension assets, we believe these credits should not factor into performance-based compensation.
For example, for fiscal 2004 Lucent reported $1.14 billion in pretax net income – it’s first profitable year since 2000. But as Wall Street analysts quickly observed, non-cash pension credits accounted for $1.11 billion (or 98%) of this reported gain.
Merrill Lynch’s analyst wrote last May: “Pension credits continue to mask weak underlying profitability. Excluding these credits, Lucent’s operating income was only 1.3%, among the lowest in telecom equipment.”
This accounting alchemy has continued year after year, pumping up executive pay, but not shareholder value. Lucent used pension credits to boost its reported net operating income by $971 million in 2000, $1.03 billion in 2001, $1.22 billion in 2002, and $1.02 billion in 2003.
Pension income is simply not a relevant measure of management’s operating performance.
Moreover, because accounting credits are based on assumptions set by management, the projected gains may not even exist. For example, while management assumed a $6.8 billion return on pension assets for 2001 and 2002, the pension trust actually lost $9.3 billion. The funded status of the trusts plunged from a $19 billion surplus to a $1.7 billion deficit.
In the 2004 proxy statement, Lucent stated that it would “effectively exclude pension credits from consideration when calculating executive compensation.” But subsequent performance awards suggest the Board has either changed the policy, or is interpreting “effectively exclude” quite liberally.
As noted, Lucent’s celebrated return to profitability in 2004 was almost entirely attributable to pension accounting credits. In the 2005 proxy statement, the Board Compensation Committee did not discuss the reality of a trivial $30 million pretax gain (after subtracting pension credits). Instead, it gushed that “Lucent’s 2004 results were at the high end of the operating income performance range established at the beginning of the year.” In recognition of this “profitability” (98% of it attributable to pension credits), the Board awarded CEO Russo a $2.95 million bonus, far exceeding her $1.8 million target bonus.
Boosting performance pay with pension income also creates incentives contrary to shareholder interests, in our opinion. If incentive pay formulas encourage management to skip cost-of-living adjustments expected by retirees, or to reduce retirement benefits expected by employees, we believe the ability to recruit and retain highly-skilled employees is undermined.
We believe that excluding pension credits from performance compensation metrics would help to assure shareholders that this discretion will not lead to conflicts of interest.
Please VOTE FOR this resolution.