CEO's Rewards Will Rise With American's Performance

Aug. 3, 2005
Gerard Arpey of American Airlines has a chance to make some real money, some CEO millions. And almost nobody's complaining.

Finally, Gerard Arpey of American Airlines has a chance to make some real money, some CEO millions. And almost nobody's complaining.

This is no small achievement, considering that executive pay is one of the most contentious issues at American. Just two years ago, the subject almost derailed the company's restructuring and led to the chairman's resignation.

Yet American can't freeze executive pay forever. Several senior managers have moved to companies in other industries, and they got a lot more money.

So American's board has to walk a fine line: How does it dangle enough incentives to hold on to talented managers without enraging employees and losing their trust?

In a quarterly filing last week, American provided a look at its new blueprint. Arpey received a variety of stock awards, including a new class of shares that vest in a decade.

It's a complex approach to compensation that's heavily tied to corporate performance. The potential value is difficult to estimate, but it could be lucrative.

The leaders of American's unions were briefed about the pay package, and they haven't criticized it publicly. They appear to accept the argument that management stability is worth paying for, at least when the payment isn't cash.

Arpey, who's chairman, president and CEO of the world's biggest airline, may still be the most underpaid executive in America, considering the magnitude of American's turnaround.

His salary and (zero) bonus last year totaled $518,837, about one-fifth the median salary and bonus for a large-company CEO. But at least now, the 47-year-old Arpey has a piece of the upside if American continues to improve.

Since 2003, Arpey has twice turned down pay increases and once declined an offer for stock options, because employees were making so many sacrifices.

"It just didn't feel right," he said last year.

Well, he's loosening up. Or maybe the board has simply crafted a program that he's more comfortable with.

In July, Arpey received 58,000 shares of stock that have 11 performance thresholds -- and a 10-year vesting period. The company said he would get at least that many shares annually for the next four years, and it hinted at more to come.

American's 10-Q filing said the grants are "the first steps to induce Arpey to remain as the CEO and to motivate him during his tenure."

He also got 140,000 performance units, which pay out in three years but have a slew of hurdles.

He got 95,000 stock options, whose value hinges entirely on the stock price, and 24,000 deferred shares that are based on tenure alone. The deferred shares vest in three years.

Add this to what he received in 2004: 135,000 performance units and 172,000 stock options at $8.88 a share, and it's possible that Arpey's current package could top the $10 million mark.

That may be a lot of money to you and me. But in the world of corporate CEOs, it's below the median annual take for salary, bonus, stock options, stock grants and perks.

And Arpey's windfall is hardly a given. If American struggles and remains mired in red ink, he might net $1 million from it all -- years from now.

But if American ranks No. 1 among its peers, hits its financial goals, maintains good relations with its unions and essentially knocks the cover off the ball, his pay elements would be worth $14 million at American's current stock price.

There are a lot of ifs in that equation, from besting JetBlue and Southwest in the stock market to scoring high on employee satisfaction and labor relations.

If all this happens, it's worth noting that American employees would be along for the financial ride. When they agreed to make deep cuts in pay and benefits in 2003, they got a piece of the upside, too.

If American's pre-tax profit margins hit 5 percent, employees could get 10 percent of their pay as a bonus. If margins are 2.5 percent, bonuses would be 5 percent.

It has been so long since American demonstrated sustained profitability that the awards may seem like a pipe dream. But the company has made great strides in cutting costs and focusing on services that customers are willing to pay for.

If not for $60 oil, the financial picture would be a lot brighter. That would make it easier to boost pay for managers and hold on to them. American says its turnover for senior managers is about 4.5 percent.

In some pockets of the company, however, the rate is 13 percent to 29 percent. Some of the departures are the result of working in a struggling industry. American also has a history of being a starting point for up-and-comers.

But the board's compensation committee acknowledged the money issue in the latest proxy. It noted that no bonuses have been paid since 2000, most stock options granted earlier are underwater and performance shares that have been awarded were far below what was expected because of the company's weak performance.

That's probably fitting. If American can't make money, it shouldn't be paying a lot to its leaders.

But American competes against the world for executive talent. Maybe it can count on the loyalty of Arpey, but two chief financial officers and the top human resources executive bolted in the past two years, along with others below them.

Will the new pay packages be enough to stem the tide? Only if they pay off.

That's the one way to make everybody happy.